So, SBD distracts traders from trading STEEM. By having that, SBD becomes an easier target for speculation and market manipulation because of its smaller market capital ($16.5 million), thereby breaking its peg.

If you are saying that people buying SBD takes away demand from people buying STEEM, I would say there is really no evidence to support that. In fact, during times when SBD was pumping, a lot of users were turning around and buying more STEEM with it.

However, SBD's price is higher than STEEM! Maybe because people are trading more STEEM since rewards aren't paying them SBD anymore?

Highly speculative. A lot more plausible theory is that SBD has a relatively safe floor around $1.

A lot of your theory seems to be based on the idea that traders are making an either-or choice between SBD and STEEM, and demand for one reduces demand for the other. I disagree with the premise, but it is not really something either one of us will be able to substantiate.

Until then, I'm not sure SBD will hold its PEG all the time, which defeats its purpose.

I would go so far as to say that without reverse conversions (or some other mechanism to support the peg in the other direction) that the peg will not hold. It is not implemented in a way that will provide a stable value token.

Despite not living up to it’s original purpose though, there are still other benefits to keeping it around (even as-is) such as the ones highlighted in the post (leverage and effectively HODLing).