FIP - 68 - Move Collateral Ratio to 100%, institute Credit Ratio

Frax is one of the most forward-thinking stablecoins in the market, and in light of that I wanted to suggest a step-change improvement, largely based on suggestions Sam made on Telegram. This is intended to be a preliminary discussion to be refined and then proposed as a FIP.

First up is taking the CR to 100%, due to market conditions. This would ease concern over the risk of $FRAX to the market and would completely disincentivize anyone from attacking the protocol. CR is 87.25% at the time of writing; we could discuss the merits of a lower CR, as well as how quickly to achieve this. My suggestion would be to get there by raising CR 25-50bps per day until we reach 100% collateralization, which would be 22-44 days.

Second suggestion is that we move from CR (collateral ratio) to a CR (credit ratio). This would allow the protocol to issue short-duration loans in FRAX, which could be used to earn interest. For example, the Credit Ratio (CR) could be set at a static 10% to begin and we could propose some mechanism that allowed this amount to float, once established.

This moves us away from using equity (FXS) as a direct piece of the mint-redemption model, where it is no longer used as a liability against $FRAX.

FRAX would be minted using 100% $USDC. Upon minting new $FRAX, the protocol would create a short duration illiquid FRAX loan at the current Credit Ratio to be used to earn interest; simultaneously a representation of this loan would be created on-chain, with an additional module on the dashboard tracking each new loan origination and its duration. Perhaps loans would expire/renew on 3 day cycles at first, allowing a short enough duration to obviate the risk of an attack. The earned interest from loaned FRAX could be used to buyback $FXS via TWAMM and burn it or return it to veFXS stakers; I prefer the latter, but it’s worth discussing.

Upon redemption of FRAX, redeemers would receive 1:1 $FRAX:USDC. In the instance that there was not enough idle $USDC available, $FXS would be minted and sold into the most liquid pool for $USDC, paired with the collateral available, and returned to the redeemer at 1:1.

The above serves to distance FRAX from a similar stablecoin + governance token model as UST/LUNA, creates a fully collateralized stablecoin model that can still earn significant returns using its AMOs, a conservative amount of credit, and maintain stability in all markets.

Please feel free to discuss and I will track suggestions and incorporate changes accordingly. I won’t have all the answers, but wanted to get a discussion started around this topic as I think it’s a very positive step in what is likely to be an increasingly regulated environment.

**UPDATE 14/5/22: It appears that there is quite a bit of contention over this move and concern with the overall proposal, with particular regard to the focus on USDC. This was just a suggestion, but it is clear that something of this magnitude needs more discussion prior to going to vote. **

For that reason, I would suggest we not move this to vote after the typical 5 day discussion period and give time for the Frax team and community to provide an outline that seems more broadly accepted.

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Probably a good long term move for frax, FXS holders will eventually benefit over a much longer timeframe

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I support this proposal and if you need someone to post to snapshot let me know and I’ll be happy too once all the details are figured out.

Frankly the term “algorithmic stablecoin” has been tarnished by recent events with UST/LUNA. By moving towards a credit model and being 100% backed, it offers a new way to construct a narrative around Frax and is more conservative in implementation overall.

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then what is point of Frax? We just make wrapped USDC?

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Not really. The credit model would serve to allow Frax to manage additional FRAX in the market, generating additional profit for veFXS stakers, while remaining far less susceptible to real and imagined risks.

FRAX can ultimately introduce non-USDC backing, but we need to have a thoughtful dialog about this and how it would be implemented, guardrails, etc.

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Yes sir, that is the entire point. And it still maintains the ability for the protocol to earn additional yield to reward veFXS lockers.

Set 1:1 $FRAX:assets(like $USDC) permanently could stop $FRAX growth and turn $FRAX to be $FEI or $ LUSD, but it does make sense in current market condition.

Iam going to say $FRAX should have two parts V1 & V2
V1 is FRAX = stablecoin + $FXS but minting on L2 and CR decided by the market
V2 is AMO, CR = 100% permanently and it can be backed by many assets.

In this way $FRAX will be safe with growth. If there were any exploiting happens to Frax, $FRAX could be brought back from Frax V1 with extra $FXS generated and that can be burnt by veFXS voting.

Yeah again, AMOs should have CR =100%

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The collateralized portion of Frax is not all USDC. See https://app.frax.finance/amos.

Ultimately, every stablecoin offers something different, and in the long run it is likely that there will be dominant stabelcoins for each of the following usecases.

  • The stablecoin you want to HOLD: minimum depeg risk, aim is for 0% risk, currently USDC is the leader.
  • The decentralized stablecoin you want to HOLD: minimum depeg risk, aim is for 0% risk, currently DAI is the leader.
  • The stablecoin you want to BORROW: cheapest borrowing rate dominates, downside risk is actually preferable for borrowers as they can either repay 1:1 or if they sell the borrowed stable they can repay for less - that being said the depegging risk should be essentially 0. Fei and Frax currently lead in this space IMO.

Ultimately it seems for Frax the market in which it should excel is as the stablecoin you wish to borrow in. I cannot come up with an argument as to why you would wish to hold FRAX over something like DAI or maybe even LUSD - I would love to know the argument if there is one. But Frax does have the potential to be the cheapest asset to borrow. This is also what Fei is attempting to achieve with the integration of Rari and Fei Turbo.

There may be a 4th category of the ‘most liquid’ stablecoin but I’m not entirely sure that’s enough of a value proposition alone.

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I think when we say USDC means assets rather $FXS

It’s a very important distinction to make as FRAX is not wrapped USDC as some try to claim.

$FRAX is never a $USDC wrapper, ppl don’t want to spend time to understand this.

Market determined CR is in my view the strongest selling point of FRAX. Suggesting to kill it requires a million times more arguments for the alternative setup than this proposal. You are suggesting to change the very bedrock of FRAX.

Having said that, I can see the point in the current market to potentially make the protocol even more proned to move to a higher CR. This is can support.

An alternative model could be to update eg Curve AMO to v2, where it not only looks at its LP ownership portion as collateral, but also qualifies what is actually in the pool. This has already been talked about on TG around how to handle UST risks in the 4pool. But we could make this more general. Eg. If the 3pool is perfectly balanced, then the value of the LP is counted 100% towards the market set CR, if the pool gets out of balance, like we see at this moment around USDT, then the “quality of the pool” is lower and would therefore count with a smaller “Quality factor” towards the market set CR.

In combination, I believe these two updates will be a much smarter move as it keeps all on-chain, keeps the CR market set, and thereby ensures a perfect balance of collateral efficiency and market requirement for collateral.

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First I like to say that FRAX can not be attacked like UST was. We have two lines of defence that cover those attacks.

  • Protocol owned liquidity from AMO’s
  • Locked liquidity

But it is clear that an under collateralized stable is not as safe as an over collateralized one. For FRAX to be the dominant decentralized stable, we need to be more conservative as we grow.

Therefore I agree with the CR → 100% part of the proposal.

Not sure about the short term bonds part, maybe better to put that in a separate proposal.

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As a member of the Frax community since 2019, having lived through all major stablecoins rises and falls, I would vote against this proposal for 2 reasons:

  1. Efficiency: having a CR lower than 100% is what makes Frax more efficient than any other stablecoin, for every unit of collateral you have more units of frax which you can deploy in defi and earn more, that’s our advantage, losing that will make frax another wrapped usdc with the same inefficiencies that stablecoins have, FXS token will struggle just like MKR token is struggling.

  2. The peg is Safe: in the mists of what is happening now with UST, understand that UST had effectively 0% CR which has been proven it won’t work (ESD, Basis cash) and was reflexive which also has been proven not sustainable (Iron finance).

Reflexivity is a set of positive or negative feedback loops that ultimately killed many stablecoins:

  • on the upside: UST price above 1$ (anchor demand) - Arb burn Luna - Luna appreciate - Confidence in the system (more people use UST) - UST price above 1$
  • on the down: UST price below 1$ (people leaving) - Arb create Luna - Luna depreciate - loss of Confidence in the system (more people leave) - UST price below 1$ (people leaving)

How Frax defends its peg: Protocol Owned Liquidity
$FRAX owns 51% of total $FRAX supply. POL to $FRAX is what hashrate is to pow blockchains, pol protects from depeg attacks just like hashrate protects from 51% attacks. With CR at 87% 1$ of $FRAX is backed by 0.87c $USDC and 0.51c $FRAX.

if CR is at 80% (efficient) Frax needs to own 20% (plus a buffer) in pol, it is literally impossible for a depeg attack to succeed if frax owns enough liquidity.
to get this pol we need to ditch the burning mechanisms and pivot to printing frax during expantions, I’d even argue for going 100% yield in fip1559.

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If we divide the proposal into 2 parts, which is more important: CR=100% or the debt mechanism?
Imho seems that CR=100% somewhat contradicts the original idea. Also, I do not consider that 300+ million “algorithmic” dollars (at the peak of frax capitalization) insignificant. If you imagine a total capitalization of about 15 billion (UST-like), the algorithmic part will be comparable to the current total capitalization.
In addition, in my opinion, a 100%+ collateralized stable with USDC-collateral will definitely worse to a similar one with a fully decentralized collateral (DAI).
Summing up - if there is no threat of a depeg right now, it seems to me much more important to think over the debt mechanism than focus on CR=100%. If the debt mechanism really can be an alternative to CR, and it will be clear and easily explained, then the proposal will be ready to implement in a complex.

During times of rapid growth, credit ceiling could be expanded from 10% to 20%.

I really like the idea of starting to back Frax with other assets, but that needs to be another step forward. This proposal is really to button up Frax/FRAX/FXS from regulatory and market headwinds that will likely play out in the coming weeks, months, and years.

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Thank you for a most thoughtful response.

I agree that FRAX needs to differentiate itself from others and believe the team has done an excellent job so far; we should steer clear of deviating too far from the path forward, but if we can choose a better methodology of getting there while being slightly more conservative, I think it is warranted at this time.

Things I would not want to impede:

  • ability to integrate with new protocol partners. Frax team has done an incredible job of partnering with as many new protocols as possible that may prove to be very additive
  • peg stability - Frax has been perfect thus far, but we are also entering a new arena of scrutiny and (potentially) attacks.
  • ability for Frax to scale profitability on behalf of FXS holders
  • ability for Frax to be a lowest cost lender to other protocols, particularly if market rates continue to rise; this can be a big differentiator (combined with peg stability) as RWA come online and defi is adopted.

A 100% collateralized model allows Frax to continue scaling in a sideways or bear market through the use of credit, relieves scrutiny (warranted or unwarranted), and ultimately protects us from black swans (unless USDT goes down; then we dead! :slight_smile: )

I also believe that freeing $FXS of the burden of being seen as the punching bag (think LUNA) in downturns will greatly liberate it from being dumped without mercy in market volatility events.

Just thinking into the future, adopting this model DOES NOT prevent us from allowing for new forms of collateral to mint FRAX against, perhaps in their own risk pools, which is another way to scale.

Simply put, what I’ve proposed is a set of imperfect variables, but ones that seem better than what we have now, given the LUNA/UST debacle and the likelihood of knock-on effects.

Thanks for your input!

Why does it need to be market determined Collateral Ratio, instead of market determined Credit Ratio? The market could decide how much credit the protocol is allowed to issue itself against current asset base. This would allow for full collateralization alongside a widened ability for profit generation.

Are you saying you’d like to measure the health of the Curve pools in order to adjust CR?

Thanks for your feedback.

The short term bonds would go hand in hand with the change to fully collateralized, in order to allow Frax to generate additional yield on top of the existing collateral. They could be broken into two separate proposals, but 100% Collateralized without the short duration bonds would impair Frax’s ability to efficiently earn on behalf of FXS holders IMO.

The debt mechanism is really just a variation of CR, as I see it. We currently have capital efficiency through undercollateralization; by using full collateralization + Credit Ratio, you are still undercollateralized when factoring in the short duration bonds, right? But you also have the benefit of 100% backing, which is a big plus given the scrutiny that algo-stables are going to be facing across markets and in regulatory actions.

As a bonus, FXS is no longer seen as the reflexive punching bag of FRAX contraction, but will continue to accrue value from POA and the yield on the credit ratio’d FRAX.