While the veFXS locking was beneficial in a bull market, it is currently at best net neutral and at worst net negative for the Frax protocol - but is still being paid for from the Frax protocol profits. If instead of single sided FXS staking, the whole veFXS system was designed around locked staking of FXS-FRAX LP it would be a net positive to the protocol during both bull and bear markets, and worthy of receiving the protocol profits. Let me break down my thought process on this and maybe if it seems like a worthwhile change the discussion could begin for an actual proposal.
Locking governance tokens like veFXS was a great idea when we were in a bull market. When the FXS were locked they decreased the liquid supply, causing new buyers to raise the price more than they would have otherwise. This was undeniably a good thing - however - the lessened liquidity is now coming back to bite us as every unlocked FXS holder who sells into the open market is similarly causing the price to go down more than if we’d left the locked FXS unlocked. While it’s true that maybe it’s keeping some people who locked their FXS from selling right now, generally these are the people with the highest conviction about Frax as a protocol and it’s future. And currently they have no say on the price, and price discovery is being left to the speculators who generally have less conviction of Frax’s future when compared to the veFXS lockers. So in a nutshell veFXS holders are currently extracting rents from the protocol while having a net neutral to negative impact on that very protocol. There should be a better way to do it.
Now, if instead of locking FXS those same participants had locked FXS-FRAX LP tokens then it would be a different story. The same way that the protocol is able to use Curve liquidity to maintain the price of FRAX, having locked FXS-FRAX liquidity would allow FXS to hold it’s value better when people begin selling like they have the last few weeks.
Some rough math to illustrate this point:
-The UniswapV2 FXS-Frax pair had $125M in liquidity May 1st with FXS at a price of $23.70
-Over the course of the 20 days since then about 2.5m FXS was swapped out for Frax, causing the price to lower to $6.14
-On May 1st, there was about 41m FXS locked as various forms of veFXS which at the time was worth about $980m
-If that $980m had been split into an FXS-Frax pair on UniswapV2, then absorbing a 2.5m FXS sell order would have only caused the price to fall to around $18.
-There would have been 20.5m more FXS unlocked and available to dump, but we can account for this as well. As it happened there were about 27m unlocked FXS (previously emitted but non-locked) of which 2.5m were sold through Uniswap as I mentioned.
-So proportionally that would be another ~2m FXS dumped for a total of 4.5m FXS sold through our newly beefy $980m TVL FXS-Frax pool, leading to a price of… $15.75
The result is FXS holding on to close to $1B of total value. Frax’s #1 goal is to maintain the peg of our stablecoin, but maintaining the value of our Algorithmic collateral is just as important for maintaining that peg.
Now Disclaimer #1 on all of that is that obviously Uniswap is not the whole market, but just like how Curve is the place where the most Frax liquidity resides and where price discovery takes place, if we locked that much FXS-Frax then FXS price discovery is liable to happen where the most liquidity is. Oh, and we happen to have our own AMM now so it wouldn’t even involve locking on another protocol. Just like how the Frax protocol owns most of it’s Frax through the Curve AMO and profits from people trading in and out of it, we could profit off of the trading done on FXS (which would partially get passed back to the LP stakers themselves).
There’s a couple tradeoffs with this change. Locked liquidity would be split halfway between FXS and Frax, that means less FXS locked - as in controlled by the protocol - and it wouldn’t be taken off the market completely as it is now. In a way it becomes less of a bet on FXS’s future value (at the risk of more pain if that value is lower) and more of a bet on FXS’s current value. I’m all for flywheels but for a stablecoin protocol it’s hard not to like a dampening influence on it’s algorithmic collateral’s volatility. FXS price will rise naturally with demand for Frax and as protocol profits grow, we don’t need a flywheel to pump that to the extreme. A downside would be that stakers are exposed to impermanent loss, though I’d argue we are paying them for their locked liquidity so it makes sense for them to take on some risk for it, and compared to veFXS where they’re really not contributing much to the protocol by locking vs just hodling, now they’d be actively contributing to the protocol health at all times, which is worth paying for. It’s less ponzi/apenomics and more of a sustainable approach IMO. Did I mention it would also mean a bunch more locked Frax too? We’ve seen how helpful that is recently for maintaining the peg.
The big elephant in the room is that this would be a huge change, and there’s already a number of Defi legos (cvxFXS for example) built on top of the current veFXS model. I’m not a coder so I don’t know the feasibility of a switch, though I’d argue whatever loops we’d have to jump through for it to happen now as a 10 figures protocol are much less than in the future as a 11,12,13 figures protocol.
I’d like to hear everyone’s thoughts on this because I’m sure there are elements that I’m missing, really it seems like a no-brainer to me. The veModel was made for a bull market and protocols with only one token which had no need to explicitly hold it’s value. Frax has two tokens that by design need to hold their value - why not incentivize people to help them do so?
One more note, yes I know we have an incentivized FXS-Frax UniV2 pool, but it’s incentivized with FXS inflation vs the protocol profits for veFXS, two totally different value propositions for a potential staker. And one day we will stop emitting FXS altogether while the profits are (hopefully) here to stay indefinitely.