Proposal Summary
Set the target collateral ratio (CR) of the Frax protocol to 100%. The increase in the CR will be achieved over time through protocol growth and earnings. This proposal does not include minting any FXS to increase the CR.
Abstract
The time has come for Frax to gradually remove the algorithmic backing of the protocol. The Frax protocol has grown and evolved dramatically since the protocol launched in December 2020. The original protocol included a variable collateral ratio which adjusted based on the market demand of FRAX, effectively letting the market dictate how much collateral was necessary for each FRAX to equal $1.00. This was a highly innovative, elegant approach that Frax pioneered but has now outgrown. The costs of being slightly undercollateralized now far outweigh the benefits – especially because it can undermine the perceived safety of FRAX. Gradually shifting the protocol to 100% CR is the best path forward for the long-term health and growth of the protocol.
This is a significant change to the protocol that over time effectively retires the algorithmic backing of Frax. It has become clear to many active in the community that this is the best path forward. The intention of this proposal is to coordinate the community on increasing the CR to 100% permanently. It is more focused on the destination (100% CR) than how we get there - there is no imminent need to increase the CR and there are many ways of reaching the target CR. Ideally growth, asset appreciation and protocol earnings will increase the CR to 100% over time. To be clear, this proposal does not rely on minting any FXS to achieve the 100% CR.
Background and Motivation
Frax has always approached the algorithmic backing of FRAX conservatively. Even before launch, it was clear that relying on FXS to back the algorithmic portion of FRAX required locked liquidity to ensure smooth functioning of the protocol. Unfortunately, we have now seen many projects that didn’t understand this and failed. The downside of locked liquidity is that the protocol pays for it in the form of FXS rewards.
While this approach made sense to start, the circumstances around Frax have changed. Frax achieved 0 to 1 product market fit and now has a supply exceeding 1,000,000,000 FRAX. The next phase of growth requires increasing the “money” attributes of FRAX, specifically making FRAX an asset that users are comfortable holding, without any incentive, as a long-term store of value. The small algorithmic backing of FRAX creates the perception that FRAX is the less safe option for users to hold, especially after UST’s failure tainted the algorithmic stablecoin concept (whether fairly or unfairly). There is very little benefit in maintaining the current CR of 92%.
@dennett has made the point that FRAX can be fully collateralized by non-FXS assets and still be fractional reserve by deploying protocol owned liquidity via AMOs. Increasing protocol collateral also means that additional collateral can be deployed via AMOs to create liquidity and revenue for the protocol. Frax will continue to be the most capital efficient safe stablecoin while removing the need to constantly fund locked liquidity. At this point, all protocol expansions occur via AMO and effectively are at 100% CR. This means that protocol growth increases the CR.
The gentlest way to increase the CR is to retain protocol earnings as the protocol grows. As part of this proposal, FXS buybacks will be deferred until the CR reaches 100%. This is effectively an investment in the future of Frax that will increase protocol assets and remove the need for FXS emissions towards locked liquidity. There appears to be little impact from FXS buybacks lately and the impact is probably overestimated at this point. This proposal does not impact the current veFXS yield. From the perspective of FXS holders, this proposal should increase the soundness / perception of Frax and accelerate protocol growth.
Finally, this proposal would authorize protocol comptrollers to strategically exchange up to $3m of protocol assets for frxETH each month. frxETH is becoming an important decentralized asset on Frax’s balance sheet, both increasing the CR while also increasing the supply of frxETH and validators. frxETH also offers a strong return potential for the protocol. Up to $3m per month is a small amount given the size of Frax’s protocol assets – it also limits the protocol’s exposure to frxETH price volatility by keeping the value relatively small. The selling of protocol assets authorized by this proposal is not intended to decrease Frax’s holdings of CVX or CRV and will not include either asset.
Proposal
This proposal approves the following changes:
I. Increase the target collateral ratio to 100%. This is the long-term target of the protocol and will require time to reach. No FXS will be minted to achieve this target. As part of this change, the protocol is retiring the algorithmic backing of FRAX and the decollateralize function.
II. Retain protocol revenue to fund the increased CR, including pausing FXS buybacks. veFXS yield remains the same.
III. Authorize up to $3m per month in frxETH purchases to increase the CR.
For - Approve the changes described above, including setting the long term target CR of Frax to 100%
Against - Do nothing