The purpose of this article is to explain the function of the Pana protocol’s Loss Ratio Peg (LRP), how the protocol benefits from it, and what adjustments will be made with this in mind. We are also going to explain our modified proportional–integral–derivative controller (PID) and what functions it performs and when.
Refresher — What is a Loss Ratio?
In an early AMA we discussed what a loss ratio was. As a refresher the following are the key points of a loss ratio as it applies in the insurance industry:
- A loss ratio is the amount of money an insurer pays for claims as a percentage of premiums earned
- A high loss ratio often is an indication of financial distress
- If a loss ratio for a particular policy becomes excessive a provider may raise the premiums for coverage or not renew the policy
The loss ratio is an important metric in the Pana protocol because it represents the percentage of the Pana token that has been minted and is currently residing in the Pana/USDC and Karsha/USDC liquidity pools. This metric helps to determine how much liquidity users of the protocol are willing to shed.
What is Pana’s Loss Ratio Peg (LRP)?
Pana will use its treasury to manage the supply in the liquidity pool, keeping the pool in proportion to the supply growth. The initial target is 22.5%, which will allow participants to enter and exit the protocol with less slippage.
In our GitBook we reference the following example:
“When a parametric event occurs, it is possible that large amounts of Karsha may be sold. When that happens, the supply of Karsha in the Karsha/USDC liquidity pool increases. This can cause adverse price slippage for other participants depending on the timing of their transaction. (GitBook)”
As participants exit the protocol, the protocol-owned liquidity pools are maintained at 22.5% to lessen the impact on those exiting and new participants entering. All of the LP tokens used to maintain the LRP will come from the master treasury’s ownership of the liquidity pools. There are no new tokens minted to help maintain the LRPs.
Given that blockchain smart contracts are unable to act on their own accord, you may be asking yourself “How is the protocol going to maintain this LRP?”.
Enter our Modified Proportional-Integral-Derivative Controller (PID)
In technical terms; The basic concept of a PID controller is to continuously calculate a value as a difference between a setpoint and a measured process variable. Once this measurement is done a correction is applied based on proportional, integral, and derivative terms.
In terms of the Pana protocol; Our modified PID will monitor the LRP at the time of bonding to determine the loss ratio of the protocol. The loss ratio is the percentage of the protocol’s liquidity that is lost. If the loss ratio falls outside of the allowed percentage, set by DAO governance, the PID will work to bring that loss ratio back into an acceptable percentage.
All tokens that are moved into and out of the liquidity pools to maintain our LRP are maintained in the master treasury. For clarity, this is not a burn mechanism as there are no tokens burned during these operations. Tokens are simply moved into and out of the liquidity pools to smoothly move back to the target loss ratio, set by DAO governance.
Wont this cause huge fluctuations by the modified PID?
We set the Pana modified PID controller to smoothly move the loss ratio back within the set percentages as bonding continues to occur. This will smooth out the curve so that the LRP does not cause wild fluctuations in token liquidity that would overshoot the target percentage. If this process is not smooth, we would ultimately succumb to flapping between being high and low, and eventually drain the protocol with transaction fees.
We believe that this is an innovative use of a modified PID that will help keep the protocol viable for the long haul to being democratized insurance to the underserved.
A Humble Mission to Serve the Underserved. A Bold Goal to Provide Insurance to Everyone.