FIP - 71 - 100% full collateralization though fraxlend + seniorage




Backing the protocol’s liabilities produced though the Seniorage process, in the form of FXS, with the over-supply of collateral generated by fraxlend’s lending activity though the use of FXS denominated Interes Rates and Dynamic Collateral Requirements for the creation of new CDPs.

(Grant a 20k FXS compensation for the development of the model and an advisory role to Liscivia to oversee its development and success.)

Background & Motivation:

The recent UST depeg event has lit a light on the importance of security and full collateralization of stablecoins.
In this context, algorithmically backed or undercollateralized stablecoins are quickily loosing ground in terms of popularity and community trust in favor of overcollateralized designs such as MakerDAO’s DAI.
This is understandable.

Overcollateralized designs, though, also suffer from specific issues such as:

Governance vs Users:

  • The Govenance (long peg) mostly profits when Interes Rates are high aka during the contraction phase/bear market.
    During these market conditions demand for leverage/risk is low and so is the rate of adoption, consequently the market capitalization is expected to shrink.

  • Users (short peg), on the other hand, tend to seek risk/open a CDP during the expansion phase/bull market when Interest Rates are low, therefore Governance isn’t profitable.

  • When the market is bull , there is not much demand for stability and moreover the earnings are low (low Interest Rates)

  • When the market is bear, even if the Interest rates are high, the m.cap is still shrinking because Users are de-risking

These problems can be identified as a scalability bottleneck for money markets in general.

Seniorage, on the other hand, allows for incentives to be aligned for inclusion, growth and equity decentralization but not for security.


Utilize Fraxlend’s oversupply of collateral to fully back Seniorage’s liabilities.

For this purpose I suggest the implementation of two new forms of collateral ratios:

  • Undercollateralized Ratio or UCR: Refers to that % part of FRAX’s emissions covered by FXS, the “unbacked” part.
  • Overcollateralized Ratio or OCR: Refers to the % of excess collateral supply present in Fraxlend and backing CDPs.

To obtain FRAX’s full collateralization OCR and UCR have to remain balanced in Dollar terms.
This allows emissions to remain unbalanced between the Seniorage process and Fraxlend.

Example 1 (Same volume of emissions):
-100$ total FRAX emitted from Seniorage.
80% CR, 20% UCR = 80$ of collateral and 20$ of FXS
-100$ of FRAX emitted from Fraxlend.
20% OCR = you need 120$ of collateral to open a CDP and borrow 100$ of FRAX
UCR 20$ = OCR 20$

Example 2 (Different emissions between Seniorage and Lending):
-200$ total FRAX emitted from Seniorage.
80% CR, 20% UCR = 160$ collateral and 40$ of FXS
-100$ of FRAX emitted from Fraxlend.
40% OCR = you need 140$ of collateral to open a CDP and borrow 100$ of FRAX
UCR 40$ = OCR 40$

These examples allow us to understand how the introduction of Dynamic Collateral Requirements (DCR) in needed to provide the protocol with the necessary flexibility to withstand demand fluctuations between the Seniorage and the Lending minting process.
(aka DCRs allow UCR/OCR’s $ value to remain balanced even if emissions vary between the two minting processes)

DCRs would resemble what regularly already happens within legacy lending.
When a new CDP is opened the User would need more or less collateral to obtain a bigger/smaller FRAX loan, according to OCR/UCR.

These terms remain fixed until CDP repayment.
Interest Rates float to incentivise repayment or the opening of new positions.

Moreover, to allow redemptions through Seniorage at 100% collateral value, regardless of the % of CR, Interest Rates have to be paid in FXS.

If Fraxlend emissions correspond to 100$ in FRAX and the collateral is worth 150$, Users will be ok paying up to 49$ in FXS as Interest Rates to redeem the collateral inside the debt positions.

This system would allow FXS to sustain a floor price which would be proportional, in $ value, to the oversupply of collateral present in Fraxlend, effectively allowing the algorithmic portion of FRAX to be backed by Fraxlend’s collateral oversupply, attaining capital eficiency and allowing redemptions to happen at full collateralized value even through Seniorage.

(In a real world scenario the makret should also price FXS’s P/E ratio on top of its floor value, provided by hard collateral. So, actually, FRAX would always be more collateralized than 100% as long as FRAX’s business is producing earnings)

Let’s analyse how this model would work during both market phases:

Contraction (bear market):

  • CR of the Seniorage :arrow_up:
  • UCR⬇️
  • Less collateral requirements in the MM to open a CDP⬇️OCR⬇️
  • IR hikes (paid in FXS):arrow_up:to force CDP repayments

During the Contraction phase the sell pressure on FXS, caused by its supply expansion through the Seniorage process, is counterbalanced by the buy pressure due to IR hikes from Fraxlend.
Demand for leverage decreases in a bear, so does the OCR, incentivising loans (Incentives align)

Expansion phase (bull market):

  • Seniorage’s CR :arrow_down:
  • UCR :arrow_up:
  • OCR⬆️( Demand for leverage increases in a bull, so does risk = less FRAX lent and more collateral gets required in CDPs)
  • IR :arrow_down: but since FXS’s value is increasing due to Seniorage, the business stays profitable

In particular:

In a bear phase “Demand for leverage decreases[…], so does the OCR, incentivising loans”
In a bull phase “IR :arrow_down: but since FXS’s value is increasing due to Seniorage, the business stays profitable”

These are exactly the problems that overcollateralized stables face in terms of profitability, adoption and therefore scale, which are resolved in this case by applying the undercollateralized incentives structure to the model.

On the other side of the equation, by adding the security of an overcollateralized stablecoin, we solve the scalability issue of the undercollateralized design.

As you can now understand, the complementary nature of undercollaterlized vs overcollateralized stablecoins match in this model, ultimately fixing each other issues, achieving scalability and sustainability.


Implementation of UCR for the Seniorage minting process and OCR + FXS denominated Interest Rates + Dynamic Collateral Requirements in the upcoming Fraxlend’s design.

(Grant a 20K FXS compensation for the development of the model and an advisory role to Liscivia, to oversee its development and success.)


Do nothing.


What do you expect would happen in a scenario like this past week, where collateral posted to Fraxlend may be down 20-30% in a day?

  • Collateral value drops in Fraxlend
  • OCR drops (excess collateral in Fraxlend)
  • Interest Rates (paid in FXS) grow to force repayments
  • UCR responds dropping as well
  • CR increases and recollateralization happens @ Seniorage lvl
  • FXS buypressure from IR hikes counter FXS sell pressure from Seniorage diluition

Basically, we keep 100% full backing, collateral just flows from the money market to Seniorage as CDPs are closed/liquidated and Seniorage recollateralizes while Users can redeem anytime @ full collateral value because of FXS’s floor provided by IR Hikes.

(Not even counting the fact that the excess of POL in AMOs could keep us well above 100% collateralization acting as an emergency reserve.)

The money market design and the strenghts of the overcollateralized model provide the security during the crash.
During such a scenario demand for leverage would suffer though.
We outplay the competition because recollateralization allows us to offer better Loan to Value conditions to open new CDPs (DCR go down).
Also, because of demand destruction for leverage, the other money markets aren’t very profitable in this bear scenario.
Then a recollateralized Seniorage can be very profitable through POL.
This advantage in earnings could allow us to subsidize Interest Rates for new CDPs, again, just enough to outcompe the other money markets.

Question @Liscivia_Honey_DAO, has there been any timing indication of when Fraxlend would hit mainnet/L2s?

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I like this in concept a lot, though I’m still trying to get my head around how this would work in various market scenarios. A concern I have is that it has a lot of moving parts that all have to be moving in tandem, and potentially more rapidly too by introducing volatile collateral like ETH. There’s definitely a good reason that other borrowing services are as overcollateralized as they are, since it gives the protocol some leeway with managing liquidation events. The Lend side would be perfectly capable of this but I worry the seniorage side as designed currently wouldn’t react fast enough to always balance out with the Lending side and you would get times when Frax was undercollateralized (or fully collateralized but including the FXS share as backing which we know now can cause problems). I may be wrong about this though… like I said still trying to get my head around it.

One thing I think you should change would be paying for interest in FXS on the user side, it would make more sense to pay the interest in whatever the supplied collateral is and have the protocol buy FXS on the open market with it. Requiring the user to hold a second volatile asset on their balance sheet in order to pay the interest seems like an undue burden that would make it more difficult for Frax to compete in an already crowded field.

Fraxlend is currently being audited and to use Sam’s own words “it’s just around the corner”

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Thank you for you words,
You raise a valid argument and the integration of the UCR/OCR Ratios would definitely require a rework of the current CR stability mechanism to allow it to achieve equilibrium as efficiently as possible while considering the new parameters.

As far as interest rates, I believe denomination in FXS allows us to understand well how the model builds up the floor value of FXS.

Ofc the protocol could accept any sort of payment and instantly swap it for FXS.
That would produce the same outcome.
Honestly that would be a nice utility! Ty

I thought that is key of your proposal, why you just fork Frax to another project and try whatever you want?
My locked LPs can only do things that was told when locking.

I see this proposal as well fitted and perfectly timed for what FRAX already has in place, in terms of tech, and currently is looking for, in terms of solutions to grant more security at scale.
From the words of @samkazemian himself:

Please understand the fact that:
1 - The idea of covering the protocol’s liabilities with lending was given out for free, I’ve been and I currently am, working on this model for free and open sourcing my work and though process both here, on Twitter and in the Official Telegram chat.

2 - Requesting an FXS denominated grant as a form of compensation for DAO collaboration isn’t an unusual practice as you can see for this other recent proposal:

The compensation would allow me to keep my interests aligned and my full focus oriented towards the continuous development of the proposed economic model.

I feel and I think, the most important thing is that the amount of value created for the community far outweights that of the compensation.
In this regard, to judge whether this is the case or not, is completely put back into the hands of the community itself.

It is unusual. Would suggest removing.

Also this should probably just be a discussion thread for now and be submitted as a FIP at a later time. (Maybe that was intent but point is shouldn’t move to a vote any time soon)


Right, so liquidations would just take place like they would on any other overcollat platform (i.e. MIM), with the unique mechanics that the team has already built into Fraxlend.

Well then. Accept the suggestions. I’ll edit.

On Interest Rates:
-The protocol remains highly profitable in a bull phase (FRAX’s supply expansion) because as minting through Seniorage increases FXS’s demand, FXS’s subsequent price increase counterbalances the lowering Interest Rates in the money market.
-If the over-supply of collateral in the money market (Fraxlend) remains balanced with Seniorage’s liabilities (UCR = OCR in $ value) the protocol is always 100% solvent, regardless of FXS’s price action.
This is because Interest Rates can be hiked as high as the total value of the collateral oversupply (OCR) -1$, at any time, to force repayments.
Also, If liquidations were to happen at the correct Loan to Value threshold, the protocol is still solvent.
The $ value of liabilities is covered regardless of IR denomination.
-Redemtions, happening during the contraction phase, can be fullfilled without having to diluite FXS if the protocol can always acquire enough excess supply (in FXS) through IR hikes at any time as long as OCR = UCR in $ value.

-FXS accumulated by the protocol from Interest Rates paid during the expansion phase could be sold to accumulate a Collateral Reserve and further POL, compounding profitability and security (SELL HIGH)
-This Collateral Reserve could subsidize a fast recollateralization process during contraction.
Because of this economic surplus (collateral Reserve) produced during expansion and if the protocol still holds a OCR = UCR $ value, Recollateralization could happen:
a) Faster
b) Without having to diluite FXS.
IF all the selling pressure, happening on FXS during the contraction phase, can be absorbed by FXS’s earnings that the protocol had in the past or can produce hiking IR to the OCR value in the present, we can now understand how a “sort of” floor is created.
Meaning that price action can really do what it wants to, but the protocol is always overly solvent, peg is safe, seniorge redemptions always happen at 100% collateral value and FXS’s selling pressure is effectively counteracted by the buy pressure to pay IR (not supply dilution).
Aka when selling pressure happens of FXS because of contraction, the protocol can utilize its past/present (IR Hikes) earnings IN FXS to counter that instead of the diluition of its supply.

If the protocol has successfully accumulated a Collateral Supply during the expansion phase by gradually selling FXS (TWAP in FRAXsawp?) that makes the protocol overly solvent during contraction, so the FXS payments, coming from Interest Rates hikes during this phase, could potentially produce an excess of FXS supply vs 100% solvency for the protocol.
It results as intuitive that because:
a) Interest Rates are High during this phase
b) FXS’s price is low
The protocol would be better off deploying the collateral from the, previously accumulated, Collateral Reserve for recollateralization and HODL the excess FXS. (BUY LOW)

Still solvency is met at anytime.

i dont mind the grant part and i like that its in FXS. But i think it should be performance based.

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I think you misunderstand how a CDP backs a stablecoin.

Collateral owned by the protocol does not work the same as externally owned collateral in a CDP. All collateral owned by the protocol can be used to buy back FRAX, but for a CDP that is not the case. The collateral is not owned by the protocol, so the protocol can not touch it to avoid unpegging.

Excess collateral in a CDP actually does not back the token borrowed, if the CDP contains enough collateral, then it is just a loan that is likely to be paid back.
To use an extreme example: A CDP that has 1 FRAX borrowed and has $1.20 of collateral is worth the same to the protocol as a CDP that has 1 FRAX borrowed and has $1B of collateral. To the protocol, they are both worth 1 FRAX, because they are both likely to be paid back.

The value of a healthy CDP is just worth the amount that it has borrowed, therefore it does not make sense to use your OCR in protocol decision making.


seems the UK is not happy about stables that are not 100% backed.


The CDPs could hold as much collateral as they’d want to over the min Loan to Value/liquidation threshold.

One way in which the protocol accrues that extra collateral is liquidation.

The other way is through Interest Rates that, if necessary, can be hiked to extract a $ value as high as the difference between emissions (FRAX) and the min Loan to Value (OCR)

If the protocol has loaned 100$ in FRAX and required 120$ as collateral (bcs has emitted, for example 200$ of FRAX through Seniorage and CR is 90%) the protocol is 100% solvent at 90% CR.

People could supply really what they want, multiples, over those min 120$, to avoid liquidation, you know that the protocol is solvent in any situation WITHOUT needing to touch a single $ inside the CDPs because in any situation you know that you can raise rates up to 19.99$ and people will pay to get back those 20$.

If they don’t pay they get liquidated so you end up getting those 20$ anyways, still being solvent.

This might be a good timing to work in the direction of full-backing then!
CR doesn’t require to be 100% to be fully backed though.

Ok, so you agree with me that defining the OCR as “excess collateral present” as you did in the original post does not make any sense. And now you redefined it as the “excess collateral required”, more like a LTV.

The protocol is still not solvent, because borrowers can repay their loan anytime and take back the excess $20. The only guarantee is that the protocol will get back the 100 FRAX that is borrowed.
If we increase interest rate, every borrower will just pays back their loan and then we are still insolvent due to the CR being below 100%.

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The excess collateral present in the money market IS the excess collateral required for the protocol to stay solvent.
Please understand that you don’t have to touch a single $ of the collateral inside the CDPs.
This doesn’t work by confiscation at all.
Interest Rates go up during the contraction phase and they can go up AS MUCH as there is collateral oversupply present in the Money Market and required to keep the CDPs open.
When demand for contraction on FRAX’s supply happens, you increase IR accordingly and they add up to the debt positions, they are absolutely not optional to be paid.
Please note that if borrowers close a CDP they do contract FRAX’s supply in existance.

Your case is valid only when there is 0 borrowing activity in Fraxlend.
If any borrowing activity happens, like I said, interest rates are not optional to be paid.
By the way, that’s not a real world scenario but we would still be solvent with excess POL just as we currently are in the present moment.
That would be the strating point anyways.

Building up Collateral Reserves, like I suggested to also do with the FXS demoninated IRs strategy, also serves in the case emission’s volumes become very unbalanced between Seniorage and Fraxlend to allow for a fast recollateralization of the Seniorage in any circumstance.

If we assume a non 0 activity of the MM, people need to respect the Loan to Value/Collateral Ratio if they don’t want to incur in liquidation.
The protocol IS solvent in the moment the CDPs are opened.