The Capital Creation with Fractional Reserve Banking

Good Day Community,

I am frustrated that this organization is looking to push toward 100% backing, neglecting the fact that there is so much power in fractional reserve banking. The lessons of Traditional Finance should not skip you at all.

As a person who has seen finance in both practice and theory, I feel that this is a grave mistake. This community is the best and brightest in stable coin & banking innovation because it is an auditable fractional reserve and we should not cower from that.

Ethereum has to grow up some time soon and protocols have to begin to stop being scared of the boomer overlords that plague the world. The Federal Reserve is a beautiful tool and we should take lessons from them and every other bank in the world.

We’ve learned the biggest lessons, which are quite simply don’t manipulate monies and markets. That is a wise decision. But only Frax has learned the lesson of the last 500 years. Fractional Reserve Banking grows economies.

Ethereum is an economy. From NFTs to borrowing, we’ve got it covered. What we lack is capital creation and strong inflationary currencies. We need inflationary currencies to live & breathe and pay bills. Currencies that are stable in the short run but lose value in the long run.

The value in cryptocurrency comes from the strong commodity monies we depend on every day to shield our value. In our current model, Ethereum is reliant on decentralized stable coins that are over collateralized. This does not promote growth in the long run. In fact, only the wealthy can really take advantage of this system. This reminds me of the gold standard where capital creation is left only to those brave enough to dig in the earth.

Frax is that currency. But how do we create capital with it? Frax depends on the Frax Share Governance token & USDC to shore up its reserves. Yet another vector of centralization. I have done a lot of thinking and I am looking to offer an alternative idea to the Frax community.

I will say, I own only 500 FXS and I am not a whale by any means. I just would love to see better systems built in our world to help us innovate and prepare for whatever may come.

I believe Frax should open up borrowing facilities, much like Maker DAO. Collateral Assets should only include: Ether, Frax Ether, & Staked Frax Ether to start. I have many more idea on the second & third, and if this is established I can release them to the public. All in all, let’s start thinking like bankers.

An Ether, for our peace, is worth 1,000 Frax tokens. Frax is at 95% collateralization. Frax Ether is worth 1 Ether & staked Frax Ether is worth 1 Ether as well.

If any of these coins are presented to the borrow facility, they can mint up to 1000 Frax tokens. These tokens would be backed 100% by the collateral. Liquidation could occur when the value of the debt to collateral is less than the Frax Collateralization. In this case these minters could bond their ether for a time, run off into whatever.

Upon liquidation, these assets should be added to the treasury in the form of Staked Frax Ether. In this moment the tokens are still backed, the treasury grows and the supply of these tokens grows as well.

While the Treasury would love to show this is backing the currency, after a liquidation event, algorithms should encourage the burning of Frax tokens & the repayment of debts to reduce the dependency on the Ether in the treasury. This makes the Ether an asset, rather than collateral.

Furthermore, under collateralized lending could be implemented too at much higher interest rates. If a borrowers were to set their own limits so borrowing classes (Class A borrows up to 70%, Class B up to 90%, Class C up to 110% etc.) could be made, the amount of frax that could be minted could always be known.

If this were the case, I’d encourage a second liquidity pool of Ether to simply further back these borrowing facilities. In a black swan event, we could ensure that the currency is backed. Of course this pool would be one that allows entry and exit, so long as the potential frax minted can be always defended. So yes, I am a fan of a locking the pool.

I would like to see the Treasury bond some of its holdings, from past liquidations, to bolster this pool.

Interest, in the form of Frax can be paid into this second pool. So a portion of the Frax interest earned will be used to purchase frax ether to pay this pool. I would prefer if the entire pool were frax ether. These bonders would have the opportunity to get a constant dividend on their ether.

The interest paid should be natural & algorithmic, like all the other facilities in Decentralized Finance, but the amount of Frax that can be minted in this facility should be at the discretion of the Frax Community. Likely, originating between 1% - 5% of supply, expanding slowly to an osscillating range of 20% -30%.

In the history of Frax, I have seen the stable coin as low as 85% collateralization, and it has risen to 94% recently. In bad times, I would imagine the community would lower collateralization and raise debt facility limits in good times. In bad times, the community should raise collateralization and lower debt facility limits. Rates will be directly influenced by the collateralization ratio of the token.

Sadly, I cannot write a smart contract so I’ll leave much of this for the developers, but these facilities would increase the demand for all Frax Ether & Staked Frax Ether by increasing utility. It provides new revenue for the treasury. It could reduce the dependence on USDC, and it increases the amount of stable coins in the market for degenerate activities.

I have further thoughts on staked ether, but I will wait on how to best provide lending with this. I have simply transplanted the logic of a State Run Bank, into decentralized finance and I would love to see this on the test net to stress test it and help the team build it. While the term “state run bank” may conjure images of communism, it would not be the same because the holders of FXS would command the bank rather than a few poorly intent individuals.

This is not an easy task as we know humans always find a way to mess a beautiful system up, but providing a second way to mint Frax can offer versatility for the treasury and it further tests the bounds of decentralized stable coins.

The ability to borrow at 100% collateral is not possible without a fractional stable coin. The very nature of Frax will offer us the ability to innovate on the future of finance.

I have long bickered to my friends about it and today is my birthday. Inspired by peer pressure, the cover of night & Tennessee Whiskey, I have submitted these ideas to the DAO. I’ll be muting this out of fear of judgement.

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