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

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)

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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.

Also:
-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.

Moreover:
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.

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

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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.

Ok, I did not get this from you original post, people are required to keep their CDPs open, even if they do not want to? That is very risky for users, because the protocol can unilateral decide to increase the interest rate and they get REKT. I do not think we will attract a lot of borrower this way, even if we start at an interest rate of 0%.

When the CR is below 100%, it means we are NOT solvent, that is kind of how it is defined. POL is calculated as collateral in the CR calculation, so that can not make it more solvent. The way we currently prevent a bank run is by using locked liquidity, this locked liquidity can absorb sell pressure and can not be used during a bank run. We have enough locked liquidity now to avoid a run on the bank.

Locked liquidity is far more efficient in avoiding a bank run, because it effectively removes liquidity. The locked CDP’s you propose, actually increase the ammunition for a potential attack by lending out FRAX, putting the peg at risk.

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Where did you get that from? Of course not.

Again, from scratch:
Let’s start from now,
now, with the liquidity that the AMO owns, we are effectively solvent.


Idk what you mean with locked liquidity, locked FXS? FXS supply expands during recollateralization, those newly printed FXS get sold for collateral, if liquidity is thin that is not a PRO for FXS’s price but, anyways:

-Fraxlend goes live → Lending happens
-People will supply collateral in excess to the credit extracted (FRAX) from the Money Market to meet Collateral Requirements. (Regular overcollateralized lending.)
-the Collateral Requirements would be dynamic in the sense that the protocol would request as more collateralization as there is protocol liability on the Seniorage side, at the moment of opening new CDPs.
-UCR and OCR balance must be met in $ terms, ofc this must happen gradually @ first, but practically having a “REAL” CR of over 100% definitely will allow us to achieve it, we are just getting more and more secure as lending grows.
-Holding an oversupply of collateral into the CDP positions (vs credit lent out in FRAX) can justify an interest rate hike up to the tot value of that collateral -1$ in an absolute worst case scenario. (this is already how overcollateralized stablecoins work)
-People can obviously redeem at anytime but if IR are hiked paying is not an option.
You cannot go “I refuse to pay so I colse” so the protocol is able to extract as much value as needed
-If people redeem FRAX’s supply contracts as it should be.

As you can understand, covering Seniorage’s liabilities with lending would only make us MORE collateralized because, basically, you can assume IR would be paid.
Max pain scenario you can hike as much as there is overcollateralization happening in fraxlend.

The inflection point can happen when OCR fails to be balanced with UCR, thats the top of an expansion phase, IR are low but then liquidity exits from Fraxlend bcs collateral requirements are too high and demand for leverage fails to keep up with seniorage debt.

You see, low /high IR are an incentive/disincentive to borrow in the long run.
Lower/higher Collateral requirements @ CDP stipulation are an incentive/disincentive to borrow immediately.
This acts as an anti run mechanism:

As liqudity gets out of the MM, Seniorage prints FXS to recollateralize and collateral requirements drop as IR hikes while FXS price dumps aka borrow now

This doesn’t even take into acount what I wrote about creating a Collateral Reserve from IR (you just count it ouside the CR of the Seniorage as we are doing now with that extra liquidity that puts us over 100%CR) by selling FXS on a TWAP in fraxswap to acquire collateral during the expansion phase and while FXS price is surging due to Seniorage requirements for minting as we decollateralize.

If I’d be able to edit something about my OT would be the part about FXS price floor, which isn’t accurate.
It’s more of an FXS selling pressure dampening, king of like a forward guidance sort of thing.

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That is super cool, taking the good parts to what went bad in other protocols and use it to upgrade an existing one will create a new performing and more stable asset

Keep up with the good work! :grin: