Move Collateral Ratio to 100%, institute Credit Ratio

Governance Proposals Miscellaneous
22

Thanks. You bring up some excellent points.

  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.

Moving to a credit ratio, in lieu of a collateralization ratio, still allows for additional efficiency due to the fact that a 10% Credit Ratio would allow Frax to utilize that additional FRAX on top of the collateral deposited when minting.

  1. 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).

I agree that the peg is safe, which is a testament to the model. But black swans happen, attacks (clearly) happen. Why not obviate ourselves from this risk as much as possible while still retaining the same benefit, via full collateralization?

If FRAX becomes fully collateralized by on-chain highly liquid and accessible assets, as it should be, then defending the peg becomes a profit-making operation conducted by the protocol, at best, and an arb opportunity for anyone else in the other case.

FXS would still be used in the case of writing down bad loans, hacks, etc., but this would also likely protect FXS from being market dumped in times of high vol.

Thoughts?

23

Can you elaborate more on the mechanism of the short term bonds? Unclear to me how it works. From your post something like the following occurs:

  1. Give 1 USDC and receive 1 FRAX
  2. Protocol creates a “short duration illiquid Frax Loan at the current Credit Ratio”
  • What makes the loan illiquid? Secondary markets determine liquidity not protocol
  • What does issuing “At the credit ratio” mean exactly? If credit ratio is 10% what part of the loan does that affect?
24

I totally understand the motivation that moved the author of the topic to start this discussion and I deeply respect the intent, to the point that I have to say I found myself on the same spot, left reflecting on peg stability, security, scalability and further business sustainability issues brought up by the current market downturn and UST depeg.

This is a very constructive topic to be dealt with and this is absolutely the right time to do so.

This said, I have to say I respectfully disagree with the vision of basically turning the undercollateralized design of the FRAX stablecoin into an overcollateralized one.

In regards of the design of the protocol, by removing the Seniorage process and focusing over emissions produced solely through lending, we’d just turn to the other side of the spectrum.

Besides the fact that the fractional reserve model invented by FRAX’s team is brilliant and completely fascinating, we also wouldn’t address any of the scalability and design issues that overcollateralized, or lending/moneymarket’s stablecoins encounter, namely:

  • Governance vs Users: In overcollateralized stables, 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

This misalignment of incentives is what drives profitability and scalability problems for overcollateralized stablecoins in terms of adoption, security gaurantees are met though.

Seniorage, or undercollateralization, on the other hand, is capital efficient and as we all know, pthe FRAX’s business is extremely profitable.
This is because Incentives are aligned correctly for growth and adoption but as the business scales security fails to keep the pace.

I believe the intent of making each FRAX 100% collateralized is achievable without giving up the Seniorage process.
I also believe that 100% collateralization is the way forward to gaurantee security as we scale.

I’ve come up with a design that allows redemtion to happen through Seniorage at 100% gauranteed collateral value though the use of fraxlend, dynamic credit requirements for CDP openings and interest rates paid in FXS.

Undercollateralization meets Overcollateralization = Endgame
Each of the flaws of the respective designs are fixed by the strenghts of the counterpart.

I’d would be very happy if the community would take the time and consider reading these two posts in which I accurately describe my idea:

I will also produce another thread to treat the topic in further detail and provide the most specific picture for every possible market condition.

Thank you.

25

Hi Drake, thanks for the q’s. The Frax team has done much more work on this than I have, but my thought is the following:

  • It would be credit extended to the Frax protocol, which would be on T+1 settlement or something like this. So it’s really just the protocol loaning itself some level of credit (in the form of newly minted $FRAX) that could be called back by itself based on certain risk parameters (i.e. contraction in hard collateral)
  • “At the credit ratio” would just relate to the max amount of $FRAX that could be minted into these short duration instruments. $1b FRAX @ 10% Credit Ratio = $100m to be minted.

Does that make sense?

26

Thanks for sharing your thoughts Liscivia. A lot to unpack, and I definitely won’t have all the answers, but will respond to those that I think I can.

We would not be overcollateralized on FRAX minting; new FRAX minting would happen at 1:1 for other stables, and I’ve outlined some ideas (on TG) as to how we could ultimately start to undercollateralize over time using protocol balance sheet made up of vol assets, increasing capital efficiency in a safe manner.

Frax could remain extremely profitable in the proposal I make, while also being more secure with 100% collateralization. Right now we have $1 for every $.8725% of capital; if we went to fully collateralized + Credit Ratio (say 15%), we’d have $1.15 for every $1 ($1 of hard collateral covering the minted FRAX + $.15 of credit loaned to the protocol to use in operations). Of course you could factor in the $.1275 FXS for some added capital efficiency on the undercollateralized model, but I still think the elegance of the fully collateralized model wins in the end.

I don’t entirely understand what you propose, given the lack of details on Fraxlend. I’d like to understand it further, and there is zero reason we couldn’t lower the Collateral Ratio sub-100% in the future as we decide…but, simply put, I think that rather than adding more complexity to our stable model, we should seek to simplify by just going 100% CR, as the market will be skeptical of any/all algo-stables for quite some time, regulators will be targeting undercollat in particular, and people are more likely to use/trust something they understand. 100% Collateralized is easy to understand.

1 Like
27

Being partially collateralized is in the DNA of Frax, I don’t think that should go away. That’s what drew me to this project early last year - the idea that Frax could let the market determine what the best CR was, acknowledging that no one person knows what the best amount of backing is at any time but that market forces could determine it organically.

That being said, I would like to empower the protocol with something that can be faster reacting when it needs to adjust that CR. The current CR only starts changing when the Frax token is already starting to be pushed off it’s peg, which works well usually, but if we start experiencing a run I think that could be inadequate and an additional mechanism should be used. The idea of a safety switch that kicks on at some point.

(Disclaimer: I’ll refer to the pariah UST/LUNA, not because I think it’s a 1:1 representation of what would happen with Frax, but because I think it’s a useful data point) Looking at the way the UST/LUNA went down, UST was within $.01 of it’s peg for the most part until midday May 9th. That also lines up to within hours of when the amount of LUNA available to back UST in $ amounts crossed to below the amount of UST issued. Their market caps crossed (yes I know this is oversimplified, there is only a certain amount liquid at any time etc. etc.). I would argue that this was the catalyst that if nothing else caused a few people to derisk and exit and led to the death spiral. This is very valuable to know. It’s more complicated with Frax’s AMOs, especially the curve AMO (which imo saved us so far) but at a basic level, ~12.5% of Frax is backed by FXS. That means we can find the point where Frax breaks and a bank run ensues: when the total value of FXS in existence no longer covers that ~12.5% of Frax’s value.

I think we can use this to create a safety switch that allows Frax to be undercollateralized, while still being 100% collateralized when it matters most - when we are about to experience a UST style, undercollateralized bank run. If there were a module (or even a part of the CR controller) that monitored Frax as if it was overcollateralized by the value of FXS, ie [USDC/Crv3pool/etc. + FXS mcap > FRAX mcap] then it would be able to tell when we were approaching a failure point and rapidly change the CR so FRAX would be fully backed if FXS crashed beyond the failure point. With the UST/LUNA example I’d say the instability began May 7th when LUNA was worth 1.4x the amount of UST out there, and it took less than 48hrs for it to fully begin it’s collapse. So the switch would look if [USDC/Crv3pool/etc. + (FXS mcap/1.4) > FRAXmcap] and raise the CR, maybe just straight to 100% or in big steps. If UST/LUNA had 48 hours to react with it’s size and centralized market making team, then we may have even less time and should prepare accordingly. The CR ratio adjusting naturally with the Frax price value is a strong dynamic for most of the time but I’d argue .25% every hour is too slow to be fully collateralized when we need it - UST spent much of the 48 hour lead time trading close enough to peg that it wasn’t the best indicator.

I think the Curve pool mechanic saved us this time, but at a certain points its no longer effective. Frax has been pulling liquidity out of Curve rapidly the last few days in response to market pressures - it becomes less effective at holding the peg the more we do this. I know that previously people could have dumped >$1b frax into it without losing the peg, right now that number is closer to $200m. From Seba’s dashboard you can see there are >$300m Frax in the ‘Rest’ category alone, that’s unlocked Frax on Ethereum that doesn’t need to even withdraw from another protocol or bridge to be dumped into Curve. Having something available when we’re out of Curve bullets would be a good idea.

I’m a big fan of Frax, and I’ve invested accordingly since early last year. I think we’re at a bit of a crossroads right now but very bullish on Frax going forward, the fact that we’re even discussing 100% backing right now with an algostable shows a very strong ability to react. I just don’t want us to overreact and lose part of our market edge.

TLDR: Yes 100% CR right now probably but I don’t think giving up on partial collateralization is the right move, we could protect ourselves from a UST-like run by monitoring + reacting to the market for FXS

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29

I get your point, and it seems to be something others feel strongly about as well.

That being said, I think we’re partially debating language. Whether we’re undercollateralized or fully collateralized + credit lines, we’re essentially in the same position, save for the fact that FXS is the shock absorber for loans that go bad, rather than using it to fund undercollateralized FRAX.

It’s really just splitting hairs, but it completely alters the perception of what FRAX is and how safe it is. And in this market that matters above so much else.

As I’ve said in a number of responses, I think we could divert some protocol profits into a pool fund that builds a treasury, which could then be used to offset liabilities should we ever wish to go <100% collateral ratio on newly minted FRAX.

This proposal is really about getting to an island of more safety and security in a sea of volatility. From there we can explore ways to expand capital efficiency.

30

FIP-68 ELI5:
With current CR =87% or less, Collateral can only be $USDC ; With CR = 100%, anything on chain (or after bring real life assets on Chain) can be voted as collateral. Frax protocol closes side window, open the front door.

31

Hi. I don’t have anywhere near the level of knowledge of most guys here. I’m just a small brain guy. However what I do understand is, if it ain’t broke, no need to break it!

Frax has never depegged. It works fine. No need to make wholesale changes just because another protocol with a similar design (but actually very different and much riskier) failed.

Frax/ FXS is the best of both worlds. No need to change anything. No one in their right mind is pointing fingers at Frax. Any changes now would be an overreaction and there’s no need to worry so much about perception when you have a rock solid protocol.

As long as Sam doesn’t turn into an arrogant overconfident prick who makes everything about himself and continues to be the thoughtful measured individual he is, let’s have the confidence in this protocol and grow our way out of this.

32

This isn’t very clear to me either:
15% “credit ratio” means either 15% undercollateralization (in case credit isn’t covered by any collateral or covered by FXS) or 15% overcollateralization (in case the credit is covered by collateral assets) this moves the needle of the protocol design towards undercollateralization or overcollatralization, doesn’t actually provide full backing.
Like I explain in my recent proposal both designs ain’t scalable on their own.

This is why I think it isn’t healthy for FRAX to abandon the Seniorage process but I think, to target and achieve a desirable 100% backing, we need to overlap the undercollateralized design (keeping Seniorage in place) with the overcollateralized design of a money market stable (backing the undercollateralized part with the oversupply of collateral coming from the money market, trough the use of Interest Rates PAID IN FXS and Dynamic Collateral Requirements )

1 Like
33

Agree …these people are afraid of stablecoins legislation. Better use usdc , these all are scam
.

34

I like this. No reason you couldn’t adopt what I’ve proposed (moving to 100% CR) and then adjust it based on what you proposed, all while still implementing the credit line (based on the credit ratio), which would actually create more efficiency…right?

35

I’ve read this entire thread and want to offer some thoughts:

I agree with the proposals of both @dds and @Liscivia_Honey_DAO; In the near-term, the best thing we can do to change our narrative and create confidence in this market is to move our CR to 100%. By doing this, we move the General Public’s perception from being “partially collateralized” to “wholly collateralized”.

Perception, especially given the macro picture surrounding both the equities and crypto markets, is going to be key in winning over new supporters. In addition to this, by moving to 100% CR, we can stop the incorrect but FUD driven dialogue of "omg the same thing that happened to UST/Luna is going to happen to Frax/FXS ".

People aren’t taking the time to understand how our product works, and it’s incumbent upon us to shift our narrative in the near term to: “Yes, Frax is 100% collateralized, and you can see that on our dashboard.”

–

My question is as follows:

Frax currently brings in around $150M per year without any of the new products that we have on our horizon (e.g. Fraxlend); By moving to 100% CR, what does that do to our revenue? For this exercise, lets assume that we are working with the same parameters that we have today; how does this impact us?

Thanks!

1 Like
36

Is the whole point for the 100% USDC backing to deploy that USDC back into loans? And if so, what kind of 3 day loans?

If you’re thinking of other crypto-backed loans, then wouldn’t that make the collateral directly correlated with the very market that $FRAX operates in?

If you’re thinking of RWA to eventually back $FRAX, then USDC makes sense - we’re not living in a world (yet) where TradFi institutions can transact/lend/operate in $FRAX (or any other stablecoin), so fiat on/off ramps would be an important part of the equation (and USDC inherently comes with a built-in fiat on/off ramps). However, there aren’t a lot of RWA opportunities with 3 day durations that generate any kind of significant return (you may as well just buy into something like Arca’s tokenized US Treasuries fund for collateral). Any other RWA asset class with that duration (US Treasury strips, Money Market bonds, Bond Repo Contracts, etc) would likely require some active manager managing $FRAX RWA collateral (resulting in centralization). Perhaps the ideal RWA asset class would be something that has size/scale, allows for relatively passive management/allocation, and is not mark-to-market.

I think regardless of what sort of loans are chosen as $FRAX collateral, the excess interest can either be used to buy back $FXS, but as an alternative, could also be retained (or swapped out for more loans) to increase collateral in times of high market volatility (i.e. nowadays).

37

Why not have both?
In times of high market volatility/stress, where having a stablecoin be wholly collateralized is very valuable, perhaps any excess interest on the collateral loans would be retained, increasing the collateral ratio. When the market stabilizes or shows positive growth, the excess interest can be released to the FXS holders.

Determining what constituteds “high market volatility/stress” vs “market stability” could probably be debated for hours/days/years, if there is some metric (or set of metrics), i.e. standard deviation of a basket of crypto/FX/real world rates as a parametric trigger to flip the interest retention/distribution switch, that may capture the best of both worlds.

38

**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.

1 Like
39

I’m fairly new to this project and coming from TradFi, so please feel free to correct my mistakes.

Even though we are in a macro environment of tightening credit and increasing interest rates, I don’t see a reason for panic. At least not based on the current coverage ratio of FXS, and how that compares to what it has been in the past.

I am looking at the Dashboard (app.frax.finance). As I write, the FRAX market cap is 1.489b, with a collateral ratio of 88.75%. Therefore the USDC value of the uncollateralized fraction is (1 - 0.8875) * 1.489b = 167.5m. The FXS circulating market cap is 580m, so the FXS coverage ratio is 580 / 167.5 = 3.46.

As a comparison, here is the FXS coverage ratio on other auspicious dates in the past:

5/8/2022 4.32 UST still at 0.995
4/2/2022 6.27 FXS hits its maximum circulating market cap
12/16/2021 3.40 FRAX market cap was the same as it is now
10/18/2021 2.97 FRAX collateral ratio hits its minimum of 82%
5/23/2021 0.18 With UST at 0.92
5/14/2021 0.29 Shortly before UST last lost its peg

The coverage ratio now is 19x higher than it was in May 2021, so I was scratching my head to figure out why FRAX didn’t crash and burn right then and there. Also, the last time the FRAX market cap hit 1.498b was Dec 16, 2021. The FXS circulating market cap was 40% higher than it is now. Taken together, there is obviously something else pushing FXS down right now.

In TradFi, a distressed bond investor would decide whether a company could service their debt by looking for an interest-coverage ratio of 2x. In other words, a company’s annual cash profits should be double their annual interest expense. There is a graph titled “Accrued Profits” on https://app.frax.finance/amos. It says the “Investor” AMO lost $64 million from April 4th to May 14th, which was over 55% of all protocol profits accrued up to that time.

If that’s accurate, then that’s the problem right there. The protocol doesn’t need 100% USDC collateral to maintain the market’s confidence, it needs to terminate or severely restrict that loss-making Investor AMO. There are a large number of full-risk investments listed on that page, including major recent losers like gOHM and “UniV3 LP FRAX/UST”. All of those risk assets will drop during a general downturn like this one, and those losses will threaten the stability of FRAX at the worst possible moment. It looks to me like FRAX is not a stablecoin protocol at all, it’s a maximum-risk hedge fund with no hedges.

Cut off the Investor AMO. Refocus on the consistently profitable lending operations. Seigniorage is only a one-time gain during FRAX money supply expansion, but turns into a boat anchor when FRAX supply is pushed lower. Invest it wisely in stable assets. The yield may be small, but the steady upward earnings trend will draw in more use and investment. Only then will FXS market cap reach the net present value of future cash flows calculated with a nice low discount rate, as envisioned.

40

If I understand it right, the protocol itself can mint FRAX at the Credit Ratio without any collateral? If so, it comes my question. How would the protocol use these FRAX? Could you provide some examples? You mentioned ‘interest’, who will pay the interest?

Btw, I think the protocol already have much flexibility with AMOs to print FRAX without putting aside USDC first. Say, the 100M FRAX poured in Tokemak. Not to mention the fantastic Curve AMO. Sam gave a good explanation in tg regarding this mechanism. What new features will your new design bring to the protocol?

I notice many community members say fractional collateralized being the DNA of FRAX, which makes me doubt how the market values FRAX/FXS. The fact is FRAX already evolved a lot and majority of FRAX issued were not in fractional collateralized style (FRAX v1), which even some big brains/influencers did not understand correctly. So, does the market values FRAX/FXS mainly based on its unique fractional collateralized narrative or its flexibility and profitability with its AMOs? And I think the former and the latter are independent.

1 Like
41

Yes, the protocol could mint FRAX without any collateral, aside from what we already use now for the “unbacked” portion, which is $FXS.

The point of this proposal is largely focused on ensuring that FRAX maintains 100% of any collateral used in minting FRAX (not minted by the AMOs) to manage redemptions. This should take away the concern over solvency and notion that Frax is always undercollateralized.

From there, things like Fraxlend, AMOs, Fraxswap, etc. can create additional revenues that go towards supporting FXS.

What I’m proposing is not radically different from where we are today, though I think it has been interpreted as such. If the CR was 95% today it wouldn’t be that much different than 88% today.

42

@dds In simple terms I see it like this - does it capture the spirit your proposal?:

Every user minted FRAX should always be redeemable with 100% hard collateral, e.g. USDC, inverse hedged ETH/BTC etc. → This will greatly reduce potential bank runs (just think 5 years ahead - FRAX is at 50bn market cap and only 50% “hard” collateralized, market is crashing and FUD is spreading… you know the drill)

Of course this will not stop the FRAX protocol to mint protocol owned FRAX partially or fully backed by FXS/other protocol owned assets to earn income through lending, providing liquidity etc. The only limit to that is the peg of FRAX since that protocol minted FRAX can be pulled from the market any minute if needed (when push comes to shove).

As usual, all profit goes to our utility token FXS which only needs to back the protocol owned FRAX but also serves as the last backstop for any unforeseen events.