This article will explain the Savvy DeFi mechanism that maintains the price correlation between base token and svToken. If you are unfamiliar with Savvy, please see this primer.
As a reminder, when you borrow against a base token (for example, ETH), your loan is denominated in an svToken (svETH). Savvy treats svTokens interchangeably with the base token. You can always repay your loan with either svETH or ETH in order to withdraw your deposit.
It is important for Savvy to maintain a tight correlation between the base token and svToken, so users can swap these tokens when they like. Savvy accomplishes this correlation through three mechanisms: incentivized liquidity pools, Savvy Swap, and protocol owned liquidity.
Incentivized Liquidity Pools
Savvy will provide incentivized BaseToken/svToken pools hosted on third-party DEXs. Initially the liquidity pools will be on Trader Joe, but Savvy plans to deploy to other DEXs over time. Liquidity providers deposit Base Tokens and svTokens to liquidity pools to earn trading fees and SVY incentives. 37.5% of the total supply of SVY is reserved for liquidity incentives. The allocation of liquidity incentives is controlled by voting DAO members via veSVY.
If the svToken is trading at a discount to the Base Token, users with open lines of credit have the opportunity to purchase svToken to repay their loan at a discount. The demand for svToken from this opportunity would help to bring svToken price correlation back in line.
Savvy Swap
The Savvy Swap is a mechanism that uses yield generated by the Savvy Position Manager to guarantee noninstantaneous base token/svToken swaps. If the svToken is trading at a discount to the base token, users can purchase the svToken and bond it in the Savvy Swap contract. Over time, the bonded svToken is burned and an equal amount of base token is paid to the user. Alternatively, if there is a mismatch in price, anyone can purchase the cheaper token and arbitrage the price difference through Savvy Swap.
Protocol Owned Liquidity
Lastly, as previously mentioned in the Savvy Overview and Flow of Funds blog-post, 90% of the yield generated by user deposits become protocol owned liquidity (POL). The Savvy Sage contract, inspired by battle-tested Alchemix Elixir contract, acts as an Algorithmic Market Operation (AMO), utilizing the POL to deposit or withdraw liquidity from Base Token/svToken liquidity pools to keep the pools balanced. For example, if the svToken is trading at a discount to Base Token, the AMO would deposit Base Token from the POL to the liquidity pool in a single-sided manner to bring the pool back to balance, thus improving the price correlation.
The Savvy Sage also algorithmically determines how long it takes for svTokens that are bonded in the Savvy Swap contract to convert to Base Tokens. In addition, when Base Tokens aren’t needed to maintain price correlation with svTokens, the Savvy Sage deploys the Base Token to yield strategies to increase the POL over time.
Here is a visualization of how the price correlation mechanisms relate to the rest of the protocol:
We invite you to browse our whitepaper if you are interested in the finer details of how the protocol works.
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