By EeFi Richard

 

Foreword

 

Following a brief discussion on Elastic Finance and Elastic Ecology, a new series will be started: The Road to the Holy Grail. This series will focus on the whole Stablecoin market, study and discuss different interesting (still alive) Stablecoins, the differences (advantages) and possible complementarities (challenges) between them and Elastic Finance. 

 

Stablecoin designs such as PSM mechanism of DAI, AMO mechanism of FRAX, and Tranche mechanism of AMPL and ButtonStable will be discussed and studied. The reason why this series is entitled "The Road to the Holy Grail" is that perfect decentralized Stablecoin is hailed as "the Holy Grail" in AmpleForth documents.

 

This article will be divided into three parts:

 

• Core mechanism of FRAX and SPOT

 

• Pain points of FRAX and its potential cooperation with SPOT

 

• Experience brought by FRAX to Elastic Finance

 

 

 

Core mechanism of FRAX and SPOT

 

FRAX.Finance, according to its official definition, FRAX is the first and only Stablecoin being partially backed by collateral and partially stabilized algorithmically, or the first fractional Stablecoin protocol.

 

"Partially" or "fractional" comes from CR, i.e. Collateral Ratio. Because FRAX is still a collateralized Stablecoin, we need to use collateral such as $USDC to mint $FRAX. How many $USDC are needed to mint one FRAX is the collateral ratio.

 

The basic logic of FRAX is that the collateral ratio depends on the market price of FRAX Stablecoin. If the trading price of FRAX is higher than $1, the protocol will reduce the collateral ratio. If the trading price of FRAX is lower than $1, the protocol will increase the collateral ratio. The minting of FRAX needs corresponding $USDC of collateral + burning of corresponding $FXS according to the collateral ratio of the current system.

 

 

 

For example, in a current 89.5% collateral ratio, 100 FRAX minted requires 100 * 89.5% = 89.5 $USDC of collateral, and burning $10.5 of $FXS. In addition to the above expenses, users also need to pay a 0.2% minting fee.

 

$FXS is an equity token issued by FRAX, which is used to mint FRAX, yield farming and hold rights to governance. In order to stabilize credit and boost growth, a novel AMOC (Algorithmic Market Operations Controller) mechanism has been introduced into FRAX V2:

 

An AMO module is an autonomous contract that enacts arbitrary monetary policy so long as it does not change the FRAX price off its peg. This means that AMO controllers can perform open market operations algorithmically, but they cannot arbitrarily mint FRAX out of thin air and break the peg. In other words, FRAX of different modules will adjust the monetary system by increasing or reducing liquidity, so that the overall collateral ratio will not be changed while solving local problems (similar to central banks and commercial banks), as shown in the figure below:

 

 

 

As for Elastic Finance, in a word, it is a financial application whose supply changes with price changes. Based on the concept of Elastic Finance, decentralized Stablecoins include SPOT and ButtonStable under development, among which SPOT is the inflation-resistant digital cash currently being developed by the AmpleForth team. The core logic of SPOT has two points:

 

 

 

The Rebase mechanism: a smart contract that automatically executes elastic supply. Rebase is executed once a day in the AmpleForth protocol, which compares the Oracle price with the target price. If the Oracle price is higher than the upper limit of the target price, the supply will be expanded according to the holding ratio. If the Oracle price is within the target price range, the current supply will be maintained. If the Oracle price is lower than the lower limit of the target price, the supply will be contracted according to the holding ratio.

 

For example, in the past 24 hours, the Oracle price was $1.376, and the target price was $1.119, so the inflation rate on that day was + 2.33%, meaning that the holding of each AMPL account on that day had increased by 2.33%. For more information, please refer to its official documents.

 

The Tranche mechanism: a smart contract that stratifies risks. Taking SPOT as an example, SPOT is generated through stratifying AMPL. According to its two-tier structure (let's assume SPOT is two-tier structure for now), if divided AMPL into safer A-Tranche and leverage Z-tranche, thus, the part of $0 to $0.2 is converted into A-Tranche (the value of each A-Tranche is $0.2). As long as AMPL does not fall below $0.2, there is no supply fluctuation.

 

The part of above $0.2 is converted to Z-Tranche (if AMPL worth $1, 1 - 0.2 = 0.8, then Z-Tranche worth $0.8), it enjoys all supply volatility, and will return to zero if AMPL falls below $0.2. Put five units of A-Tranche together, and a SPOT is produced, a perpetual bond worth of $1 (5*0.2 = 1).

 

Please note that SPOT has not been officially launched. What we know now is that SPOT has no rebase and does not need a price prediction machine. Its price may fluctuate rapidly within a certain range, but as long as the underlying elastic currency does not fall below $0.2, its value can be maintained. There is no need for sovereign or organizational credit endorsement, fiat or stable coin collateral. With the help of the ERC-20 standard, it can cross chains and circulate normally in a decentralized world.

 

For a full explanation of the Tranche contract, please refer to:

 

 

 

Pain points of FRAX and its potential cooperation with SPOT

 

FRAX develops rapidly and successfully, but not perfect. Below is one of its pain points I want to elaborate:

 

• Betting big on Curve, FRAX faces the threat from Curve Stablecoin.

 

At present, the actual collateral of FRAX Stablecoin is not pure USDC. As can be seen in the figure below, most of it is LP in the Curve pool (included in Curve AMOs). This does have several advantages: obtaining CRV LP rewards, stabilizing the credit of FRAX, seizing voting advantages in “Curve War”, and finally having the opportunity to create its own Curve Basepool, so as to control the Curve platform to some extent. In terms of anti-regulation, as long as platforms like Curve are not sanctioned, FRAX is very safe.

 

 

 

 

 

However, the founder of Curve recently claimed the plan to issue its own Stablecoin, which may challenge the current layout of FRAX. After all, if its own “crvUSD” goes online, Curve will inevitably allocate a lot of resources to its own Stablecoin. At that time, FRAX may face an awkward situation. We will continue to analyze Curve Stablecoin in the next article.

 

What’s more, in FRAX V1, the dominant collateral is USDC, which is a centralized Stablecoin with significant potential censorship risk. After all, when a decentralized Stablecoin chooses a centralized Stablecoin as collateral, it is not good for its decentralization. By the way, DAI also sharing the same problem, which will be elaborated in future articles.

 

If cooperating with SPOT on collateral, FRAX's problems above can be well solved. Cooperation includes but is not limited to the following methods:

 

• Establish SPOT AmpleForth Geyser AMOs, i.e. provide liquidity of FRAX-SPOT trading pairs on different platforms, so as to obtain additional stacking rewards of AmpleForth Protocol. This can be treated as one of FRAX Liquidity AMOs.

 

• Add the option of using SPOT to mint FRAX, so as to reduce the current proportion of $USDC in FRAX collateral.

 

• If SPOT gets launched on the Curve, it can also join FRAX's own Curve AMOs. 

 

• Add SPOT or AMPL options on FRAXLend.

 

Experience brought by FRAX to Elastic Finance

 

• Sustainable revenue is an important factor for the growth of Stablecoin project.

 

If we observe the evolution of FRAX, we will find that the novel AMO module following the launch of FRAX V2 has stimulated the growth of FRAX, helped it to obtain revenue in different businesses, and rapidly increased its MarketCap from between 200 to 400 million USD to over 2 billion USD. The core lies in that the increase of continuous revenue channels encourages more users and institutions to join FRAX's ecology, achieving a win-win situation.

 

To be more specific, we can see that the revenue channels of FRAX are mainly long-term ones, such as the dominant CRV liquidity pool rewards. FRAXLend is scheduled to go online, which will bring FrxETH and FrxETH AMOs as a validator of ETH, continuously stacking rewards of ETH, and increase the credit of FRAX. ALL these mechanisms are designed to provide positive feedback with a view to long-term sustainable revenue. FRAX also has lending AMOs specialized in lending, but it has long been in a low proportion. If extended to $USDT, $USDC whose collateral consists of many US Treasury bonds, which also means low-risk, stable and sustainable bond maturity yield.

 

 

 

The sustainable revenue channel is a catalyst that cannot be ignored in the growth process of the Stablecoin protocol. Back to the AmpleForth protocol, only Geyser can be called a sustainable revenue channel at present, providing trading or lending liquidity rewards. However we need to note that apart from trading liquidity, lending on AAVE is not a sustainable revenue channel, but a short-term lending business (the mode of AAVE lending determines its nature of short-term borrowing and lending), which is equivalent to encourage shorting of AMPL in disguise.

 

In short, the current revenue channels alone cannot well support the long-term healthy development of the protocol. AMPL has transformed from experimental coin to utility coin, which requires steady growth in MarketCap. Increase sustainable revenue channels through AMPL derivatives to attract users and institutions, that’s a topic need to dive-in after the official release of $SPOT.

 

Note: AAVE lending is equivalent to encourage shorting of AMPL in disguise. Specifically, this means borrow AMPL from AAVE when its price is relatively high, then sell it, and buy AMPL back when its price falls relatively low, and return AMPL to AAVE. While not losing collateral, it earns a profit on price difference, which is equivalent to short selling.

 

Please note I do not advocate a radical way of stacking mechanism, but I support a sustainable revenue channel based on AMPL derivative innovation.

 

• Improve capital efficiency and make the best of it.

 

The capital efficiency of FRAX is commendable. In the Stablecoin projects, the capital efficiency refers to the ratio of collateral minted to Stablecoin. In an excess collateral mode, for example, if $ETH with a value of $100 can only mint Stablecoin of $40, then the capital efficiency is 40%, which means that only 40% can be converted into Stablecoin for safety reason. For FRAX, if the collateral ratio is 90%, it means $USDC with a value of $100 can mint $FRAX of $111. Through the AMO mechanism, $USDC collateral can categorized as Investor AMOs, and further generate rewards on platforms like AAVE.

 

Back to SPOT, if the tranche ratio is 2:8 and market price for each AMPL is $1, i.e., the part of AMPL from $0 to $0.2 is converted into A-Tranche, and five A-Tranches are combined into one $SPOT, then the capital efficiency is 20%. This means that the Ampleforth team needs to explore more profit scenarios of A-Tranche and Z-Tranche to optimize the use of capital.