Peg Stability Module

When market prices drift beyond the DMM's operating range, the Peg Stability Module activates as a second line of defense. The PSM holds reserves of both the index token and stablecoins, allowing it to trade against the market to apply corrective pressure. Unlike the DMM which provides passive liquidity, the PSM actively intervenes when deviation exceeds defined thresholds.

The PSM's activation threshold is typically set at the outer edge of the DMM's band. If the on-chain market price trades at a premium to the oracle reference price beyond this threshold, the PSM can sell index tokens from its reserves to push the price down. If the market trades at a discount, the PSM can buy tokens to push the price up. These interventions are rate-limited and subject to utilization caps to prevent reserve depletion during sustained one-directional pressure.

The PSM captures spread during these operations. When it intervenes, it trades at the oracle reference price plus or minus a small fee. This fee structure means the PSM tends to generate revenue during periods of elevated volatility, which helps maintain its reserve buffers over time. The captured spread does not go to any individual but rather accrues to the protocol's net asset value, benefiting all token holders proportionally.

The PSM operates with explicit constraints on how much capital it can deploy per transaction, per hour, and per day. These constraints prevent the PSM from exhausting its reserves during extreme scenarios and ensure that its interventions remain economically rational. If market pressure persists beyond what the PSM can handle within its constraints, the system escalates to the third layer of protection.