Direct redemption is the simplest and most desirable guarantee for a stablecoin. Holders want to know that at any point in time, a stablecoin can be exchanged for its face value. A direct redemption mechanism is the simplest way to make this happen.
Many stablecoins such as FEI, FRAX, and LUSD use a redemption system as part of peg maintenance. FEI’s other peg maintenance mechanism, reweights, suffers from a number of drawbacks such as high implementation complexity, delayed response times to price shocks, and allowing some MEV through sandwiching. As such, Fei V2 will remove reweights in favor of direct redemptions.
Redemption will thus take on the full burden of peg maintenance. The primary way that redemptions are currently used is in risk-free atomic arbitrage. When FEI is trading below $0.99, arbitrageurs can buy FEI and redeem it for $0.99. However, standard DEX fees of 0.3% make this trade less efficient, and only risk-free when FEI is $0.987 or below. As such, keeping FEI above $0.99 requires raising the redemption value to at least $0.993.
Beyond peg maintenance, there are also utility and narrative benefits to raising the redemption floor. A stablecoin is more useful if it can be redeemed more closely to its face value. Raising this backstop would make FEI more competitive with other stablecoins that have similar redemption mechanisms.
To determine whether this fee range is reasonable we can look at fee ranges of other stablecoins that allow for redemption:
- LUSD redemption fee: >= 0.5% (dynamic)
- FRAX redemption fee: 0.55% (redemption allowed when FRAX < $0.9933)
- Current FEI redemption fee: 1.0%
- Proposed FEI redemption fee: 0.5%
These other protocols have been able to thrive in this fee range without issue.
Raise the reserve stabilizer redemption floor from $0.99 to $0.995.
Please share any thoughts you have on the above proposal.
previous discussion of backstop: FIP-23: Raise Reserve Stabilizer Backstop to $0.99