FIP-41: Acquire LUSD through a Balancer auction

Proposal: FIP-41

Status: Last Call

Summary

Acquire 100M LUSD through a Balancer auction, which represents 9% of Fei PCV and 15% of LUSD total supply.

Motivation

With Liquity USD pegged stablecoin (LUSD), Fei can earn yield (currently around 16% APR + liquidations gains) and better protect the $FEI peg.

Lending Stablecoins have scaling challenges as they depend on demand for leverage. However, in a crash scenario, liquidations help them to hold the peg when the market is deleveraging. Lending Stablecoins are a good fit for Reserve Stablecoins like FEI, helping the latter to protect the peg in extreme scenarios. For more info about that, take a look at the article: A Guide to Decentralized Stablecoins.

Liquity is a decentralized borrowing protocol that allows you to draw interest-free loans against ETH used as collateral. Loans are paid out in LUSD and need to maintain a minimum collateral ratio of 110%. In addition to the collateral, the loans are secured by a Stability Pool containing LUSD and by fellow borrowers collectively acting as guarantors of last resort.

Liquity launched in April 2021, the current market cap is $671M and possesses a total collateral ratio of 275%. More stats about Liquity can be seen here: Dune Analytics

Liquity is governance-free and has multiple decentralized front-end interfaces giving it more resilience and censorship resistance. It is very aligned with Fei in relation to decentralization.

In a next proposal, the LUSD could be allocated to Liquity native stability pool. By depositing LUSD to the Stability Pool, Fei can earn LQTY rewards and liquidation gains (in ETH). The APR is currently at 16%. This is an estimate of the LQTY return on the LUSD deposited to the Stability Pool over the next year, not including the ETH gains from liquidations.

If we stake the LQTY, Fei can earn the fee revenue paid for borrowing or redeeming LUSD.

Specification

Open a LUSD bonding curve with 100 million FEI.

Bonding curve parameters:

  • Scale 100M FEI
  • Mint cap 150M FEI
  • Discount pre-scale 0.3%
  • Premium post-scale 2%

EDIT: Acquire 100M LUSD through a Balancer auction

P.S.: Thanks @Fishy for the comments.

5 Likes

After further reflection, I think we should acquire LUSD through a Balancer auction and not through a bonding curve. This has the following benefits:

  • earn swap fees
  • “forcibly” aquire with as little of a discount as possible (auction)
  • no reliance on oracles

Also, Fei v2 will likely have a much smaller set of “peg stability modules” than the current amount of bonding curves (probably just ETH and DAI at launch), and the investment pool will be used to get specific assets into PCV.

2 Likes

This is interesting. And we could use a similar code to the one used to TRIBE buybacks, right?

1 Like

The Balancer pool very publicly rebalances and in doing so encourages arbitrage across the ecosystem.

I am assuming the reweighed pools are to be used to acquire LUSD. So as soon as the pool rebalances such that LUSD is worth <$1, it provides an incentives for traders to deposit LUSD and take out FEI.

The pools have pre-determined start and finish dates, with linear rebalancing. Although, I think the later can be altered and tailored. The effect is a more gradual acquisition of LUSD.

Applying this to a TRIBE buy back, mmm. Each buy back would need a new pool to be funded. What would be the benefit of using this type of pool v bonding curve for acquiring TRIBE on market ?

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yea, these are the current mechanism for TRIBE buybacks. in addition to the advantages listed by Joey (swap fees + minimize discount + no oracles), theyre also less susceptible to MEV and will create a continuous pressure instead of producing periodic price shocks. they can be set up so that each auction starts as soon as the previous auction ends so that it’s a continuous pressure at all times. it’s also like a DCA instead of doing it all in one big blast

these Balancer auctions are spiritually similar to TWAMMs and similar tradeoffs apply (less operational complexity, less disadvantage from telegraphing large trades before they happen)

2 Likes

Im still of the opinion that this move is premature, perhaps better done early next year. currently 1. 100M DAI is more than sufficient as an insurance policy against plunging ETH prices. This opinion is echoed by many whom ive conversed with in the community.

As we are talking in Discord, the idea would be to use minted FEI to acquire LUSD, so we would continue significantly long in ETH. Collateralization ratio of 407% at the moment is capital inefficient. By acquiring LUSD we can earn some yield, further integrate with other DeFis protocols and increase the stable portion of PCV.

2 Likes

I think this is a good time to do it. The FEI liquidity is sufficiently deep that it is unlikely to affect PCV size much beyond the increase of LUSD holdings

2 Likes

I think this is a good idea as well just like Joey has signaled. One thing to consider is that FEI can get the leverage style stablecoin benefits by leaning into optimistic approval of more FEI mints into Fuse pools/Aave+other lending markets rather than rely on another stablecoin itself to gain that benefit. If the goal is to have synergy with a stablecoin that likely goes >$1 during an ETH price drop then FEI’s flexible gov process can simply put a lot more FEI to be lent out cheaply so that during an ETH crash there is FEI demand (aka ETH lever longs get liquidated and dollar longs were the correct market position). Essentially, Fei Protocol is long ETH mechanistically. The most efficient way to reduce the long position isn’t to intake another stablecoin but to allow users to short more FEI to neutralize the protocol’s long ETH risk.

I understand that during times that ETH crashes, LUSD peg is likely to go up rather than down as debt is auctioned for LUSD and/or people rush to repay debts before liquidation (thus buy LUSD from the market and push the price up), but it is not as symbiotic as it might seem at first. FEI being one of the largest holders of ETH anywhere in the entire industry already exposes it to systemic risks of a large plunge in ETH price like the $1T market retraction in May 2020. In such a case, LUSD itself might have issues being able to cover its backing since it services ETH debt as low as 110% due to its unique/innovative trove mechanism. It would be more prudent to simply let more people short FEI (aka borrow it in lending markets) to hedge the protocol.

But overall, I think stablecoin project camaraderie is also worth intangible positive value so I would support this FIP on the basis that it helps both FEI and LUSD. That’s also why I’m here as well :slight_smile:

2 Likes

Thanks for sharing your thoughts, Sam! It’s a good point. I think the combination of minted FEI and our lending stablecoins holdings (DAI, RAI and LUSD, if approved) can help holding the peg in these scenarios.

Snapshot created: Snapshot

1 Like

Hey all!

This is an exciting proposal and a nice example of project camaraderie among stablecoins as mentioned by Sam. :smiley:

While there’s a chance that an ETH crisis might indeed have an upward pressure on the LUSD price, it’s worth noting that unlike Maker’s auction mechanism, Liquity’s Stability Pool can also act as a liquidity buffer, mitigating liquidity crunches. Beyond directly absorbing liquidated debt (in LUSD), it can also serve as a LUSD reserve from which depositors can quickly withdraw LUSD if its price exceeds $1.

The closer LUSD gets to $1.10, the higher the risk that stability providers lose out in case of liquidations, and the larger the gains they can make from withdrawing and selling their LUSD. So, stability providers have an incentive to sell their withdrawn LUSD on the open market, which should help pushing down the price (for more details see On price stability of Liquity. Soft versus hard pegs | by Robert Lauko | Liquity | Medium and the note in Ariah et al.'s paper “While Stability Lasts: A Stochastic Model of Stablecoins” on page 20: )

We appreciate that the 100M LUSD bought by Fei are supposed to be put into the Stability Pool as that contributes to the protocol’s health and stability. Without understanding Fei’s governance, is there a (fast) way to withdraw the 100M the LUSD from the Stability Pool if need be?

3 Likes

Thanks for chiming in Robert! Exciting to get our communities working together more with this proposal.

We are going to be including a PCV Guardian in V2 which can withdraw and liquidate PCV in an emergency.

2 Likes