Answering Questions to “pSOL: yield-stripped SOL”

Recently an article by “solana-researcher” argues that it may be the wrong assumption for users to “expect pSOL/SOL to remain close to 1”. We’ll explain why the argument in the article is mistaken, and that the real reason that pSOL/SOL is under peg is because of leverage yielding through pSOL.

This temporary problem with the peg could be remedied by raising the interest rate of minting pSOL.

Why pSOL is not 0.81 SOL

The core argument of the article is that prtSOL accrues rewards and increases in value over time. Whereas pSOL has no yield, therefore is worth less than prtSOL.

The article author writes:

> In those 5 years, the person who put 1 prtSOL into the vault will have an equity position worth 1.25 SOL. Meanwhile, a person who bought 1 pSOL on the public market 5 years ago would still have something worth at most 1.01 SOL (and probably a lot less) for the same reason as before.

The author follows that with a mistaken conclusion:

> That seems to imply that pSOL is worth at most 0.81 SOL

This is not true, and it’s easy to see why not.

Imagine the same user traded prtSOL for SOL in the beginning (when prtSOL worth 1 SOL), then in 5 years prtSOL would be with 1.25 SOL. Does this imply that the price of SOL is worth at most 0.81 SOL?

Of course not, 1 SOL is 1 SOL. This is just pointing out the uninteresting fact that if you don’t stake your SOL, you lose the 7% per annum value accrual, so SOL (unstaked) is going to be worth less than staked SOL (i.e. prtSOL).

Over-time pSOL is going to be worth less than prtSOL, as designed.

pSOL is an over-collateralized synthetic, and its price is subject to various market factors, which could make it below or above peg.

There are deeper arguments whether an over-collateralized synthetic should be above or below peg. The natural tendency of over-collateralization is actually for the synthetic to be above peg. Because it takes more than $1 to generate $1 of synthetic. If the price is below peg, there is always a bonus to purchase the synthetic to repay the debt.

Leverage Causes pSOL:SOL To Go Off-Peg

Why is pSOL:SOL off-peg? The root cause (we argue) is not the over-collateralized model, but that pSOL’s borrow interest rate is very low (0.1%).

This creates a problem where the stableswap pool pSOL:SOL LPs essentially become a free source of leverage for yielding stake SOL rewards.

Here’s how a user can leverage up:

  • Start with 10 SOL
  • Mint 10 prtSOL
  • Mint 9 pSOL from prtSOL
  • Trade 9 pSOL for SOL (from stableswap)
  • Minting 9 more prtSOL

So by swapping pSOL for prtSOL, the user now has a leverage of almost 2x, having 19 prtSOL accruing block rewards. This user doesn’t pay for that leverage, then who’s paying? It’s because the stableswap is subsidizing the yield with rewards.

At the end of the day, pSOL leverage users will have to unwind their position by:

  • Burning pSOL to get back prtSOL
  • Unstake prtSOL to get SOL
  • Swap SOL back to pSOL to unwind leverage

Remedy

The parrot team is looking to raise the borrow interest rate on PAI and pSOL on a gradual basis to mitigate the “free leverage” problem. Suppose that the borrow rate for pSOL is 2%, then leveraging up 5x would cause ~10%.

This would encourage leverage users to unwind their pSOL positions, and repay the SOL debt that they have accumulated.

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