FIP-(TBD) RWA FRAX staking pool

FIP-?? RWA FRAX staking pool

Author
4 years locked.

Background
Over the last few weeks we have seen a big influx of RWA protocols approaching FRAX protocol for funding, but lending funds to these protocols comes with its risks. The main risk is that FRAX could not recall its assets in the event of a bank run.

TLDR
I propose we build a FRAX (single coin) locked staking pool that retail investors, the FRAX protocol and other large investors can stake and lock their FRAX tokens in.
The assets backing the FRAX tokens in this pool can then be used to fund RWA lending.

Proposal In Detail
I propose we build a FRAX token (single token) locked staking pool with a long lock time frame, 1 month - 3 years time range.

Retail investors, FRAX protocol and other major investors should all be able to stake funds into the pool.

The pool has one job and only one job, that’s to confirm that a set amount of FRAX is locked and for a set amount of time. With this information FRAX protocol can calculate what amount of assets it can deploy to RWA lending protocols and for what amount of time.

If there is $100m FRAX locked in the pool for an average of 2 years then the assets backing that 100m FRAX ($89.5m non-frax stables) could be loaned out to RWA protocols with the condition that FRAX protocol can recall the assets before the 2 years ends.

Example
An investor buys 1,000 FRAX via the curve pool (curve pool increases by $1000 in other stables and the AMO mints 1,000 more FRAX to balance the curve pool). The investor then stakes his 1,000 FRAX in the locked pool. Once this 1,000 FRAX is staked the FRAX protocol can remove $2,000 from the curve pool (curve pool is now back to where it started). The FRAX protocol now has $1,000 in non-frax stabes and 1,000 FRAX. The 1,000 FRAX gets burned leaving $1,000 of non-FRAX stables that can be deployed into RWA lending protocols. The 1,000 of non-FRAX stable coins is then used to create a pool of funds that RWA lending proposals can bid for.

RWA lending protocol bidding process
FRAX protocol builds (or funds the building of) an auction site that’s used by RWA lending protocols for the bidding process.
FRAX then auctions the non-FRAX assets in the following packages.

  • $1m - 30 days
  • $1m - 60 days
  • $1m - 90 days

FRAX controls its risks by controlling the number of packages it offers.
As the average lock time of investors goes down FRAX can offer more 30 day packages and less 90 day packages.

The bidder offering the highest amount for each package wins that funding package.
A governance proposal must be passed for each RWA lending protocol to get the clearance to bid in the auction including any upper limit to the amount of funding each RWA lending proposal may be granted
.
Any RWA lending protocol may have its bidding privilege removed if it has reached any limit or cap set out in its governance proposal.

Any RWA lending protocol may be removed from the bidding process if they are found to be a bad actor.

Supply and demand
The assets backing the locked FRAX should not be removed from the liquidity pools unless there is clear demand for the packages in the auction.

This should increase FRAX liquidity and protocol earnings when demand is low for RWA lending

The Default insurance fund
The Default insurance fund is a fund that can be used to insure the investors against the risks of a RWA lending protocol defaulting on payments.

FRAX protocol will allocate $10m to a default insurance fund on day one and can withdraw this $10m once the fund has had time to build up.

The FRAX protocol team may use the insurance fund for low risk liquidity providing and any rewards / profits from this will go to the FRAX treasury.

Adding the FRAX pool to the gauge

The FRAX single token pool should be added to the FRAX gauge so investors can earn a cut of emissions.

The lock liquidity and loans offer FRAX protocol a source of income and investors in this pool should be welcomed into the rest of the FRAX ecosystem.

The Incentive for investors and FRAX protocol

  1. 12.5% of all bids go to the insurance fund.
  2. 12.5% of all bids are used to buy FXS and distributed to veFXS holders. .
  3. 75% of all bids are used to buy FXS on the open market and are distributed to the investors that are locked in the FRAX token staking pool.
  4. Investors in the locked pool get gauge emissions.

Proposal extension
Looking forward I see no reason why a FPI single token pool cant be created and used in the same way.

Voting options

For = action this proposal
Against = do nothing

2 Likes

This seems like an interesting proposition for undercollateralized/uncollateralized RWA lending (eg. Centrifuge, Goldfinch, Endlabs etc.). Any thoughts on overcollateralized RWA lending (eg. CitaDAO)? What kind of evaluative framework could we adopt for them?

That is an interesting idea, I am wondering if we can implement it by designing a specific term sheet in Fraxlend, it should be a lending pool that its collateral is Frax and lending asset is USDC and the borrowing CR is equal to our universal CR, liquidity provider is Frax, collateral providers and borrowers are not the same (locked frax owners and RWA lending protocols)… :thinking:

1 Like

Tokenized duration deposits (crypto-CDs) make a lot of sense to us. There’s no other currently available way to reconcile the duration mismatch of overnight deposits vs. 1-12 month RWA loans.

Strongly endorse.

This is a great idea!

1m - 3yrs is quite broad in terms of duration (from a TradFi/RWA standpoint).

Requiring a condition that the non-frax stables can be recalled anytime before the 2 years essentially nullifies the point of locking in the capital (for the RWA borrower). Basically, assuming that a recall must be made at least 30 days in advance, the duration of this capital source will essentially be 30 days (or whatever number of days in advance a recall notice must be issued). Perhaps a better approach would be an allocation of the total amount of non-frax stables across different duration buckets, such that the weighted average duration of the RWA investments is managed (i.e. have some RWA assets that turn over and can pay off in 3 months, but other RWA assets that take much longer to turn over/pay off, but the weighted average turn over period would be < 1 year). A combination of the duration management and the Default Insurance Fund should be enough to absorb any liquidity events.

The rationale for this suggestion is that keeping everything as short as 1 month will limit FRAX to only a very specific subset of RWA assets, with either a high risk of negative selection, or money market-type returns (in which case, why bother with RWA? Might as well just put it in very short duration Treasuries).

Instead of setting a nominal value to the default insurance fund, perhaps it may make more sense to make it a target percentage of RWA assets (can be even more fine-tuned by risk-weighting the RWA assets to increase/decrease the size of this default insurance fund). That way, as Frax scales, and the RWA allocation of collateral assets scales, the default insurance fund will also scale in tandem.

Additionally - this structure would result in a non-FRAX denominated RWA loans (assuming that the RWA being onboarded is a loan). This isn’t necessarily a negative, but would be forgoing the benefit of having another potential buyer to help support FRAX if and when FRAX depegs (i.e. if the loan is denominated in FRAX, then the borrower will likely explore options to buy FRAX on the open market to pay down their FRAX-denominated debt line at a discount; also, periodic interest and principal payments denominated in FRAX results in regularly scheduled purchases in the fiat off-ramp process). However, in order to capture this benefit, there would be a need for fiat on-ramps (FRAX to fiat), hence that the benefit would come with requirements.

If you look at the deal structures that are being done on Goldfinch and Centrifuge (for most of the pools), these are actually not undercollateralized nor uncollateralized. The overcollateralization structure just happens to be off-chain.

Disclaimer - I work with END Labs.

Instead of coming up with evaluative framework for every single type of asset class, and attempting to automate the execution of that evaluation (not so feasible), it may make more sense for Frax to delegate this task to RWA/TradFi experts with experience in that asset class, and to act on behalf of Frax in the operational and administrative duties (i.e. ensuring distributions are correct, analyzing/assessing/monitoring credit, managing any amendments to deal structures, etc).

1 Like

Hi all, I’m the co-founder of Goldfinch, and an FXS hodler. I really like what Frax is doing, and we are excited to collaborate with Frax on future endeavors. This is an interesting idea with good kernels, but as one of the RWA protocols that FRAX would likely consider, and also as a veteran DeFi builder, I thought I’d share some thoughts.

TLDR
While the spirit of this proposal is good, I think it is overly complicated for an initial version and doesn’t properly take into account how these protocols and RWA borrowers in general actually work. I also think it optimizes for yield through a bidding system, which is absolutely the wrong metric for FRAX to optimize for at this stage. I’d like to offer some constructive feedback. To summarize some key issues I see…

  • FRAX must to give up the requirement for guaranteed instant on-chain liquidity, or the whole RWA initiative wont’ work (and manage liquidity in other ways)
  • Any FRAX RWA pool should consider non fixed duration (ie. evergreen) opportunities. I explain more, but I think index-like, evergreen products are probably something that is better for FRAX anyway, so any design should be able to accomodate that.
  • Insurance should be dropped. It’s much better as an opt-in individual product, rather than a protocol level thing
  • The bidding system should be dropped as it optimizes for yield when really FRAX should be optimizing for safety and scalability at this stage, as long as they hit low but reasonable return targets.

While I won’t outline a whole alternative proposal here… at a high level, I would instead suggest vastly simplifying and doing something like…

  • FRAX starts a RWA fund (not fixed rate system as this proposes), which anyone, including the protocol itself can invest in with FRAX (could be non FRAX collateral too).
  • FRAX governance whitelists certain addresses (which could be RWA protocols, or pool delegates, or even smart contracts with rules) to use the funds from this pool, up to some cap per address.
  • FRAX receives a variable interest rate, like an LP in a fund would receive.

But leaving my general outline aside for a minute… see below for specific commentary on this proposal

A couple RWA specific things

  • As @jkim pointed out, Goldfinch (and other RWA protocols) are not in fact under or uncollateralized. They are over collateralized with off-chain assets and income. I actually wrote a whole thread about this here if you’re curious. We prefer the term “credit protocol”.
  • I also want to echo what @jkim mentioned around “recalling the assets before X time period”. This is not a good idea. There is no free lunch. You could do this, but you’ll limit yourself on what is possible and reduce returns substantially. Which brings me to my next point…

Regarding liquidity…
From what I see here, and from what I’ve read in the docs, Frax the protocol generally wants to be able to withdraw everything on demand always, on-chain. This is understandable. Who doesn’t? But I’m just gonna say this right now, if this is a hard requirement for FRAX, then they simply should not enter RWA at all. There is not much point, because people in the real world have to, ya know, actually be able to use the money.
But once you move away from requiring instant on chain access, I think the window opens up significantly because as far as a “liquidity crunch” situation goes like we’ve seen in the last few days, it’s pretty much “instant” or it doesn’t matter. Liquidity costs are like an iron rule of finance. They call it the “liquidity premium”. If you need instant liquidity, you’re going to pay for it with essentially no return. This is why Compound returns essentially drop to zero in the bear market. There is basically no risk, and instant liquidity, so returns must be near zero.

That said, of course I think Frax should enter RWA protocols, so I think this requirement for perfect liquidity has to be relaxed, and Frax should manage this holistically in a different way (eg. maybe a cap on total percent of Frax collateral that can be locked up – in an RWA protocol or otherwise – over X time frame, and Frax just generally knows that not 100% of collateral can be redeemed at all points in time, and manages expectations and plans accordingly). Perhaps 10-30% could be redeemed instantly, and the rest over time. Compromises can be made. But they are always just tradeoffs. I do want to point out, that having assets backing your token that will pay back (such as loans), is NOT at all the same things as being “undercollateralized” or “insolvent”. If the loans are good, and there comes a time when Frax needs that liquidity, someone should be willing to step in and be the extra liquidity for a small premium. The secondaries for FRAX would know this, and arbs should keep things in order.

If FRAX can get comfortable with something like that, then your’e onto individual investors liquidity preferences, which have more options. At Goldfinch, we have to deal with this same issue. We manage this with two types of investors and two types of pools. One, the “backers”, are less liquid, but they know that going in, and get a higher yield for it. The other, the “LP’s”, invest in a Senior Pool, which is more liquid (though still not guaranteed), and more secure, but they get a lower rate of return. Also, there are secondary markets on Curve for the Senior Pool, so if liquidity doesn’t exist on the Senior Pool, than people can pay for liquidity now by accepting some slippage on the Curve pool, and arbitrageuers can pick up the spread. We’ve seen that work in action over the last few weeks.

I might actually say you should more or less copy the model that our Senior Pool has, which is also what AlloyX is doing with their pool. Basically, you have underlying fixed or variable rate loans, but allow for the net yields to investors to be variable (or just lower up to a cap), by allowing extra capital to come in. This basically balances returns and liquidity by giving you some liquidity which can handle most withdraw needs most of the time, but not guaranteed liquidity. Again, there is no free lunch and no way to get both.

Currency mismatch
It should be noted that not all borrowers on RWA pools will want to necessarily take loans in FRAX. Or perhaps it’s a deal that was already done in USD terms, and is now being tokenized (this is how Centrifuge usually works IIRC). I don’t think this is a blocker at all, but FRAX holders who invest in such a pool should be made aware that they could be taking on depeg risk of other assets (even other dollar denominated ones like USDC, DAI, or USD itself)

Timeline restrictions and specific deals?
It seems like this pool is coming from a place where it must invest in specific deals with a specific duration. Which is of course a totally valid way to do things. But I just want to note it’s not the only way. In fact, we created our Senior Pool for exactly a situation like this. It is evergreen. It has no lockups, and continually represents essentially a trust weighted index of what’s on Goldfinch. It is also “senior” to all the other lenders, making it the first to be paid back, and thus the safest. So Frax could supply money in there, and have much better liquidity, much lower risk, and still earn solid yields (currently just under 8%).

Beyond Goldfinch, we know that IndexCoop is working to integrate with multiple RWA protocols, and places like AlloyX are being built on top of Goldfinch to abstract these things like durations away (AlloyX is making an ERC20 version of our Junior Tranches, to offer a more liquid version of our Backer Positions)

This approach also changes the trust dynamics. Instead of trusting one delegate or one company for one deal, you trust a system (ie. the Goldfinch Senior Pool, or IndexCoop’s governance), which is much more scalable, evergreen, and less work.

Since these products seem like they would be more attractive to FRAX than fixed duration assets and specific deals, I would think any design should be able to accomodate them easily. Perhaps even prioritize them.

Insurance
I think you should eliminate this. It adds a lot of complexity, and while it is valuable, I think this is the wrong place and time to do it. You want to get a V1 launched. This is a nice to have or a V3 feature at best. Even in principle, I don’t think this is the protocol’s job. Really you should just pick good borrowers, and good protocols and let individuals buy insurance if they want, rather than force this cost on everyone (most of whom will not participate in this pool). There are entire protocols being built to handle credit default insurance. (eg. Carapace finance which I’m actually an investor in).

Also, if you do the math, you will never be able to maintain a reasonable amount of cash as protection. Like either you have to put up a lot to actually make it a meaningful amount of protection (which seriously impacts your yields), OR you put up a “reasonable” amount that actually only protects investors from like a 1-5% loss, and just doesn’t move the needle much anyway, so you why bother? This is much better suited as an individual product IMO.

Bidding
I also think this is overly complicated, and should be eliminated. If I understand correctly, this is a fixed yield bidding system, vs. allowing more of a fund structure. Borrowers want to be very very sure you have the capital well ahead of time before entering into a deal. Introducing a bidding process will A.) Add risk to whether a protocol will actually have the money for a borrower, or B.) Force the protocol to do the bid and then take on risk and cash drag that the deal might not actually go through.

Perhaps most importantly on this, it seems to optimize for yield and I feel very strongly that yield is not what FRAX should be optimizing for. Do you really want to bring your investment decisions down to someone offering you 0.1% more yield? Probably not. The real world is complicated, and yield is not always well risk-adjusted (how long did you need to get Anchor’s 20% to make that worth it?). There’s obviously targets and zones you want to be in, but it needs to be weighed against a host of other factors.

What FRAX should optimize for is safety, and hitting “reasonable” return targets. (maybe 3-5%). Seriously, that might sound low, and hopefully you could do better, but I think y’all should be thinking indexes, and diversification, and senior assets. FRAX is acting a bit like a bank, and so should be thinking low risk with any customer funds. Especially if this is to scale to the size that FRAX wants to become, it’s not time to quibble over 1%. Get a system that works and can scale, and be happy hitting reasonable targets.

Fin! Hope that’s helpful! Happy to discuss more!

3 Likes

Speaking as a member of a potential RWA partner, Centrifuge, I think this proposal is a good step in the right direction, but ultimately has some challenges to long-term viability. @blakewest has provided great in-depth analysis, and I’d happily co-sign his post as being reflective of my opinions and the best perspective. His points regarding liquidity, structuring, and duration are truly important in how to think about the RWA opportunity.

There is quite a bit of good discussion on these exact topics in the recent Centrifgue AMO proposal. I’d recommend reading through that for those who wish to wrap their heads around RWA.

Before going further, I think it’s important to reiterate the principal value of real-world assets - providing improved risk-adjusted returns. While there is a wide variety of differences across the RWA protocols and approaches, they collectively present Frax with an opportunity to achieve various sustainable yields for an approriate level of risk.

My recommendation is to build the RWA capacity progressively, to best develop comfort with the liquidity nuances and individual intricacies of each platform and provider. For Frax to best interface with these opportunities, whatever the final structure is, should incorporate a per-protocol approach that allows governance or management teams in Frax to deliniate the capacity allocated to each protocol and/or the corresponding pool. As Frax and the community develops more comfort with the capabilities, risk and return, and collateral/issuers/managers associated with each protocol, a more programmatic and autonomous structure can be incorporated over-time.

Ultimately, collateralized, on-chain credit investments represent some of the best yield-bearing opportunities over the near-term, potentially drawn-out bear market. The return, diversification, and potential long-term stability present unique opportunities for Frax. They should be incorproated into a larger strategic framework, that provides the appropriate amount of balance sheet exposure, in a way that addresses the specific risks up-front , with a long-term view on scaling and automation.

2 Likes

Agree with the above comments from @blakewest, @Khan and @jkim when it comes to RWA lending framework and I think they’ve done a great job at highlighting some of the key variables and trade-offs for stabelcoin protocols looking to expand into RWAs, so I will leave that where it is for now.

I believe most of the responses here though are written in a view of FRAX investing directly from the collateral reserves used to back the peg, highlighting the risks/opportunities that this would constitute for the protocol. however, I don’t think the above proposal is really suggesting that FRAX contribute funds that are directly backing the peg. I believe the way the proposed pool is designed it is segregated from the FRAX collateral base and relies on external investors and only discretionary investment from FRAX’s owned liquidity (the FRAX protocol wouldn’t mint FRAX directly into this pool nor contribute USDC reserves).

In that light, the pool would be an aggregation of liquidity from various investors that want exposure to RWA. The liquidity would be locked in for a duration and is essentially auctioned off to the highest bidder. In this model the RWA risk would be mostly siloed from the broader FRAX protocol.

If I am correct, what I would like to hear more opinions on is why investors would lock funds in a FRAX pool instead of the underlying RWA protocols themselves? Perhaps it’s the expectation they can earn a higher yield up-front vs accruing through the auction mechanism as protocols may be inclined to overpay for growth, maybe not a bad assumption, but perhaps the bidding RWA protocols would then be incentivized to approve riskier opportunities to recoup funds.

2 Likes

the insurance fund is for default insurance only, it is not to be used as liquidity. ifits used as liquidity its likely to be lost during a default, which is when its needed most.

im trying to build a system that limits the risk to other FRAX users / investors that dont want to take on the RWA risks. if we scale up the insurance fund then we are scaling up the exposure to the other investors / users. this is what im trying to avoid.

There are 2 sides to this, it would help FRAX hold peg when they are buying back, but it would also cause selling pressure when they take out their loan. if we assume that in 5 years time we have $1b loaned out that would mean there has been $1b more in sell pressure then there has been in buy pressure. i think its best to shift this sell pressure on to other stable coins and avoid FRAX selling as the amount loaned out grows.

this proposal is already pretty complex, building a fiat on/off ramp would only make it more complex and this is not needed as other stable coin project have already build this for us, so we just use them.

@Arlo @jkim

please see this thread for RWA protocol evaluations

https://gov.frax.finance/t/how-can-we-better-evaluate-future-borrowers-both-on-chain-and-rwas/1630/3

Agreed, and if given the choice between,

  1. taking on a de-peg risk + RWA loans

  2. having a secure peg and not having RWA loans

I would chose option 2 every time.

you are correct, the aim of the proposal is to silo the RWA risks to the investors that want to take on the risks and not affect the rest of the FRAX ecosystem.

my reason for this is simple. if the FRAX protocol loans out a massive amount of protocol owned assets to RWA lending and they default. The liquidity pools will be able to pay out all the unlocked FRAX at 1-1, but that liquidity will be dried up when the locked FRAX investors have their FRAX / random coin LP unlock. this means all the long term locked investors are taking on all the default risk if they agree to or not.

Due to the bidding system the investor would get the best return from all the RWA protocols that can make a bid and as demand grows their funding will see more demand and should see higher bids and more return.

the RWA protocols that can place a bid would have to be voted in by FXS holders so would have had some sort of vetting (https://gov.frax.finance/t/how-can-we-better-evaluate-future-borrowers-both-on-chain-and-rwas/1630)

if RWA protocols choose to invest in things that are not in line with the agreement made when they were given permission to bid in the auction then they will be flagged as a bad actor and removed from the bidding process going forward.

1 month is the minimum , not the maximum