FIP-6 PCV Initial Stable Coin Investment

Proposals
1

FIP-6

Title: PCV Initial Stable Coin Investment

Status: Discussion

Author: @Bruno @Eswak @countvidal @Matthew_Graham

Introduction

Fei Protocol’s PCV is currently valued at $1,302,587,677 and is heavily exposed to the $ETH price fluctuation. We propose FIP-X as the initial step to be taken towards diversifying the PCV whilst we continue to explore how best to holistically manage the PCV. We are not committing this to be the only stable coin allocation, just the first PCV investment that can be performed immediately without obstructing future plans.

Description

FIP-X proposes to invest $300M into stable coins (~25% of the ETH holding). The management of these stable coins will be addressed in a separate FIP as the community needs to discuss the cost and benefits of each option with more details.

Based on the current Uniswap trading volume, purchasing $300M into stable coins is expected to occur over a 4 weeks period. We propose purchasing equal weights of USDC, DAI & USDT for the following reasons:

  • Most liquid non-FEI stable coins within the ethereum ecosystem
  • Highly liquid trading pools on Uniswap and SushiSwap
  • By investing in three stable coins we can diversify the idiosyncratic risk, especially the regulatory and operational risk
  • We can execute a large allocation to stables with less impact on the markets by spreading our purchases across three different stable coins
  • These stables are the most used in stable pools such as the Curve Finance 3pool and also in the lending protocols
  • In the risk assessment done by lending protocols, USDC/USDT/DAI are considered the less risky stable coins

Motivation

The PCV currently ~$1.3B comprises 100% of ETH and because of this concentration the PCV tracks the price of ETH closely. The PCV Diversification Tribe will present an investment policy and a risk management strategy to the DAO for discussion. However, it will take time to develop and shall not be rushed as we need to build it with a lot of interaction with the community. As an immediate action, there is a collective thought to diversify into stable coins.

USDC, DAI & USDT are all stable pegged assets with very low volatility. Each token has survived the events of black Thursday (12/03/2020) and is widely supported with deep liquidity within the ethereum ecosystem. USDT no longer has SEC regulatory risk overhang. Maker DAO is committed to maintaining the peg through over collateralised lending ratios and as an actor of last resort by selling MKR on market if required. USDC is backed by Circle and Coinbase. The US dollar reserves for USDC are attested to by top 5 accounting services firms, Grant Thornton LLP, and USDC is used by the likes of Visa. All three stable coins rank highly amongst the most liquid ETH pools on both Uniswap and SushiSwap.

In our view, the three main objectives of PCV management are (i) peg maintenance, (ii) providing liquidity/market-making and (iii) having a sustainable and growing FEI DAO. The stablecoins allocation of $300M represents ~75% of User Circulating FEI and over 520% of the Liquid FEI (user circulating FEI less time locked and staked FEI) at the time of writing. This will immediately help peg maintenance and assist integrate FEI into the DeFi ecosystem. Additionally, it is the first step to be a liquidity provider in a stable coin pool or to lend stable coins on protocols such as Compound and Aave.

Specification

Token acquisitions would be done using the PCVSwapper on Uniswap v2 and Sushiswap proposed by @eswak and we expect to be audited soon. Roughly $100M of each stable (USDT, USDC, DAI) will be acquired over the course of 1 month using the 6 trading pairs.

To be conservative, we think the daily volume created by Fei Protocol should not exceed a certain percentage of the daily volume per pair.

By doing swaps every 10-60 minutes on each of the 6 pools, we will acquire the 300M stablecoins in less than a month (a few days for the most liquid pairs, a few weeks for the less liquid pairs). These swaps shall be small enough to have small slippage in every pool, but not too small as the cost per swap is ~170k gas.

There is a risk of sandwich attacks when the protocol will perform the swaps (a bot decreasing the price of ETH just before our swap, and pushing it back up after our swap), but in any case a backstop is implemented so that if acquisition price is less than 98% of the Chainlink oracle price of USD/ETH, the swap will revert. In layman terms, it means we should not lose more than 2% during the conversion. Both the oracle and threshold are configurable (should be in the 1-3% range, and Chainlink oracle is probably safer than an Uniswap TWAP oracle).

Spreading buys over time is also a good way to “dollar-cost average” our position, because the value of ETH could go up or down.

Anyone will be able to call the swap() function after the 10-60 minutes delay of each pool, and this call will be incentivized with FEI to cover the gas cost of helping the protocol swap its collateral.

The exact parameters for each pool (swap size, swap frequency, maximum allowed deviation from oracle value) will be detailed for the snapshot vote.

Timeline

These are estimated dates that do not depend only on this working group:

  • Initial discussion with community on week of 10th May
  • Audit/code check to be performed and snapshot on week of 17th May
  • DAO Vote on week of 24th May
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I personally think DAI is a good start it is an investment on an overcollaterized product. If the long running goal is for circulating fei to be undercollaterized - it could be a good strategy knowing liquidated cdp’s can be added back to the eth pcv pool at lower price than what pcv originally invests dai in. Its a built in safety net for eth/pcv portion because the effective collaterization ratio of eth/pcv can be a lot lower since dai/pcv can save the day.

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Hi @Bruno ,

I have no adverse comments on the proposal, it is a solid one.
However, is it possible to have a dashboard or report on when/quantity of assets purchased, with the prevailing ETH price and transaction fees? This can be done as a debrief of the operation so further analysis can be done. We should anticipate a further buying strategy in the future so this would be a good pilot.

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I would propose to Swap DAI out in favor of either True USD, Gemini Dollar/Binance Dollar, or some other reputable Stablecoin that is directly backed by USD holdings. DAI faces the very same problem as FEI in that it is shackled at the hip to ETH. DAI has fluctuated significantly at the great market crash of March 12, 2020, and there is no reason why it wont do a repeat of that in a future market Crash.

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Using USDC and USDT could be considered a departure from the decentralized only collateral vision. The main value of using them in my opinion would be a curve metapool using the 3pool liquidity, where we could also potentially earn CRV rewards and have the low slippage trading help with peg maintenance. This is a great benefit because Curve is the leading stablecoin focused AMM.

@redball’s idea of using only DAI is nice because we maintain the decentralized only ethos and could use for example a stablecoin optimized pool on Balancer V2. The DAI could then be redeposited to Aave or Compound using the asset manager for additional yield. However as @cozeno mentioned it does carry similar ETH risk to FEI.

Regarding the use of the Chainlink oracle, I feel it could be good to move in that direction as UniswapV2 liquidity may dry up making out TWAP attackable.

Overall I am supportive, and the Uniswap swapper @Eswak wrote can be used for conversion into any asset that is sufficiently liquid on UniswapV2. We may want to have snapshots dedicated specifically to “do we use any centralized assets in PCV” and how much % of PCV to allocate to stables.

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Nothing to add to this. I’m on board.

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Hey @Bruno and thank you and your team for taking the initiative (and @siddharth for pushing for this previously).

So this will not include the ~200k ETH that is still up for redemption then?

I am not too sure about these two stable coins, because it might mean rebranding FEI as it should be “The Stablecoin for DeFi”.
As I do not seem to be the only one against this part, maybe this is something to consider for you guys.

Love it. :handshake:

I think we can see how urgent this is, as we saw FEI move back down to around $0.94 just recently due to ETH price fluctuations. I hope we can see this implemented asap with the proposed timeline.

Again thank you and your team for the work so far!

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The situation around USDT is worrisome at best.

When you’re saying that in the risk assessment done by lending protocols USDT is considered a less risky stable coin, you’re referring to the overall risk ranking (B+ for USDT). However, if you look into the way they calculate those rankings, you’ll see that this B+ is a (roughly) average for A+ for Market Risk (= huge market cap), A- for Smart Contract Risk (=long history of unfailing service) and finally C- for Counterparty Risk. Specifically:

There are multiple legal investigations on these two companies regarding USDT. Specifically, there has been accusation of illegally manipulating the price of Bitcoin using non backed USDT, as well as legal claims on the usage of the collateralised funds by both Tether Limited and BitFinex. This brings USDT’s trust risk factor down to D+ disqualifying it as a collateral.

Moreover, just on February 23rd 2021 New York Attorney General Letitia James said:

Bitfinex and Tether recklessly and unlawfully covered-up massive financial losses to keep their scheme going and protect their bottom lines. Tether’s claims that its virtual currency was fully backed by U.S. dollars at all times was a lie.

Yes, they settled this particular lawsuit, but the agreement requires Bitfinex and Tether to discontinue any trading activity with New Yorkers (=no Wall Street). Yes, they will have to offer public disclosures, by category, of the assets backing tethers. But do we really want to ignore all the red flags, entrust $100M to these guys and hope for the best? To me this seems more like gambling than investment.

BTW,

USDT no longer has SEC regulatory risk overhang.

No, contrary to some reports this settlement had nothing to do with SEC, the investigation was initiated by New York Attorney General. Whether it will attract further interest from SEC or some other prosecutor (Attorney General of California?) is an open question.

UPD Today’s report states USDT is 49% backed by unspecified commercial paper. There is enough chance it’s a ticking bomb in the making. You can’t ignore that: https://www.coindesk.com/tether-first-reserve-composition-report-usdt

If USDT collapses, it might present a good chance for decentralised/algorithmic stablecoins including FEI. We’d better be ready for that moment. Among other things by steering clear from USDT.

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Seeing the apprehension with regard to USDC and USDT and also preserving the decentralised nature of FEI, what other options do we have apart from DAI?

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What’s wrong with USDC?

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Nothing wrong with it. It’s centralised that’s all.

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I don’t think DAI is that decentralized, or that it’s that dependent on ETH.

DAI relies on USDC to keep its price from going above $1 during market downturns, so it’s also dependent on USDC, albeit to a lesser degree.

DAI can liquidate ETH, so it is less dependent on ETH than FEI currently is. If ETH price drops by 1% every day, FEI will become undercollateralized unless the PCV is diversified. DAI will be okay.

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Great post @Bruno.

I agree with @joey that it is a departure from the decentralized only collateral vision, which is an attractive trait for the protocol. Since it is early days though, I’m not opposed to this for the short-term under the assumption that we transition to decentralized collateral in the medium to long term. However, that may be a slippery slope as to when we’d make a transition back to decentralized assets.

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This is a fair point here. We have such a large treasury that our main viable options are these 3 stablecoins and blue chip DeFi governance tokens.

Going back to the main purpose for PCV is that it is there to drive FEI’s utility and liquidity. Having a liquid stablecoin AMM pool with popular and trusted stablecoins is extremely important, and if we do 300m into stables and match it with 300m FEI that becomes 600m of liquidity. As an additional benefit since FEI’s price has a strong ceiling, that additional FEI would not be entering circulation whereas with the FEI-ETH pool it could if ETH’s price went down.

Our ETH collateralization ratio would still be over 200% if we take this approach. I think given the high collateralization ratio and 100% concentration in ETH currently, the benefits of diversification and potentially additional stablecoin optimized liquidity are very high.

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Glad to see all the comments here. :slight_smile:

As @pavel pointed, it is not possible to ignore the news today about USDT:
Tether Details Reserve Composition for the First Time - CoinDesk
Tether reveals a breakdown of its reserves for first time since 2014 launch

I share his concern as USDT is ~50% backed by unspecified commercial paper and it is not audited by a well-known audit firm. A commercial paper is “a form of corporate debt that can be easily converted to cash – or not, depending on the issuer and market conditions.”. The combination of these two things brings more risk to USDT.

Although USDT is the second biggest lending token in Aave, it is losing space to USDC and it is not accepted as collateral anymore due to counterparty risk as highlighted by @pavel.

The main benefit of buying USDT would be the possibility of providing liquidity with 3pool on Curve. However, the increasing risks within USDT seem not to compensate for this potential benefit.

About the decentralization level, @fei.saver was precise in his comment. If we analyze Dai stats, we can see that 22% of ~$4.7 billion DAI is backed by USDC ( ~$1 billion). The main reason for that is the Peg Stability Module, which was created after Black Thursday chaos and Maker DAO decided to add USDC as collateral. So, we cannot affirm that DAI is fully decentralized. It would be better to talk in terms of decentralization level and not a binary classification.

Additionally, DAI had high volatility for a long time last year and only stabilized after considering more centralized stablecoins:

glassnode-studio_multi-collateral-dai-price-usd-vs-ethereum-price-usd
glassnode-studio_multi-collateral-dai-price-usd-vs-ethereum-price-usd1800×1013 180 KB

As noted by Aave risk analysis, DAI has its counterparty risks:

Following the Black Thursday crash of March 2020, there was some deficit in the backing of DAI which required the minting of additional MKR. Additionally, there are some concerns related to the centralisation of the price feed, with oracles failing to keep the prices up to date during the said Black Thursday.

In order to diversify the idiosyncratic risk of DAI, it is better to include one more stable coin. I see risks in choosing å new, not so liquid and battle-tested stable coin. The premise is to be very conservative with PCV as @cozeno has been highlighting many times.

The USD Coin is considered by the Aave analysis as the less risky stable coin with an overall risk of A-. Another reason to include one more stable is that DAI daily trading volume on Uniswap is US$ 50 M, which is not big considering our US$ 300M purchase. Just for comparison USDC daily trading volume on Uniswap is ~ US$ 170M.

I agree with @Ferdinand_Fuzzgellan that we need an intermediary step in the short term before being a fully decentralized stable coin. We can do that by combining USD Coin, a safer and centralized stable coin, with DAI, a riskier and less centralized stable coin.

As @DioDionysos and @joey pointed we should not lose our vision of being “The Stablecoin for DeFi”. This may involve using put options and other derivate/hedging instruments in the future. They also have their risks and, as far I know, there is not enough liquidity for the position size we would need.

I agree with @joey that we should see this purchase of stables with the aim to enhance FEI utility and liquidity. By acquiring DAI and USDC, we could study the alternative to create a stable pool in Balancer V2 with minted FEI, DAI and USDC and use the new feature of an asset manager that allows lending the capital while it is not being used to provide liquidity. We need to carefully analyze this option, as it is a new feature and not battle-tested.

The PCV Diversification Tribe will consider all the valuable contributions received and bring soon our position as a group.

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We considered all the PCV, but it is a good question about the source of the funds to buy the stables. I think we could move from the 200k ETHDripper. We would need ~80k ETH.

When submitting the proposal to snapshot, we can provide more details about the execution strategy and contemplate transaction fees, eth price, swap size, number of swaps, etc.

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Thanks for pointing that out! I feel there is not enough emphasis on the fact FEI is trying to build a decentralized stablecoin. If the strategy is based on centralized stablecoins we can throw our vision in the same bin :confused:

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A couple of more things.

Regarding preserving decentralised ethos discussed by @joey and @DioDionysos. I think we should separate short-term and mid/long-term goals. In the short term the major objective is to survive possibly coming bear market/eth crash. For this purpose USDC is perfect. In the mid/long run more intricate PCV portfolio is needed. Then not only the decentralisation ethos is important, but if FEI is just a proxy for a basket of other stablecoins, then what’s its value proposition?

@Bruno Thank you for being responsive regarding USDT being unfit as a PCV investment target. And as a follow-up:

Let’s say USDT is swapped out of your proposal. Hence you’re proposing to buy USDC & DAI in equal amounts: $150M each. How do you come up with these figures? At the very least trading volumes (4.5B vs 1.2B) and market caps (16B vs 4.5B) are far from equal for USDC vs DAI, be it for de-risking or market making purposes, or even from the transactional POV.

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PCV Diversification TRIBE Update Week 2

Just a quick refresh of the activities of this Tribe.

May 4 - Kickoff: we proposed the working group and started to work informally

May 12 - Week 1: we posted the proposal of an initial stable coin investment and continue to work on the Investment Policy Statement (IPS), focusing on bringing references and drafting the first version of it.

May 21 - Week 2: we are making some simulations based on the Modern Portfolio Theory applied to crypto to bring a benchmark to PCV management, we advanced in some specific parts of the IPS and discussed some ideas to deploy stable coins (we still need more time to bring a robust analysis to community discussion).

Regarding the IPS, we are considering the following structure: (i) Introduction, (ii) Objectives, (iii) Benchmark, (iv) PCV Cash Requirements, (v) Investment Period, (vi) Risk Tolerance, (vii) Asset Allocation, (viii) Implementation of an Investment Strategy, (ix) Risk Management, (x) Performance Report, (xi) References .

The heart of the IPS is the objectives for PCV management. While we are advancing with other parts of the document, we would like to hear community feedback about these suggested objectives:

Objectives for PCV Management

The three main objectives of PCV Management are (i) FEI exchange rate stability against the US dollar (“peg maintenance”), (ii) providing liquidity for FEI markets and (iii) having a sustainable and growing FEI DAO.

This informs the approach to reserve management, governed by values of, in order of priority, safety, liquidity and return. The portfolio needs to achieve real growth, after inflation, with a level of risk that is appropriate for the PCV’s return and generate a significant amount of portfolio income.

Additionally, by holding tokens, FEI DAO can take advantage of meta-governance and influence other protocols’ decisions. As a stablecoin, Fei has a central role in DeFi, and meta-governance can be valuable to foster a thriving environment with other DeFi projects.

Another front we are working on is the investment in stable coins. After receiving the feedback from the community, we are analyzing two new alternatives:

1) ~25% of PCV on USDC&DAI is an option optimizing for diversification and increasing the liquidity of FEI with major stable coins

2) ~12,5% of PCV on DAI is an option optimizing for decentralization

We need to highlight that the vision for FEI is to be a decentralized stablecoin. Holding a centralized stable coins exposure is necessary to provide liquidity for FEI, incentivizing its use. For the future, it could be good to provide liquidity against a basket of other decentralized stable coins.

We would like to gather community sentiment on these two options.

Considering the liquidity of these two stable coins, both would support the estimated investment amount. We are suggesting having an equal amount of USDC & DAI to diversify idiosyncratic risks. Although USDC has more liquidity, it also brings more regulatory risk.

Considering the current status of PCV, 25% of it would represent ~ $200M (changing very quickly due to volatility).

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Still don’t get it: how do you measure idiosyncratic risks, how do you come up with specific figures? Why not 60/40 or 30/70? Could you be more specific?

And again USDC is roughly 5 times bigger than DAI both in 24h trading volumes (7B vs 1.5B) and market caps (19B vs 4.2B). BTW, the gap is widening – at the time of your initial proposal it was 4x. USDC is gaining market share at the expense of DAI.

Also

Why these specific figures?

1 Like