Users continue to enjoy uninterrupted access to decentralized platforms, while major protocols such as Frax Finance lay out their plans to build for the winter months ahead. However, it’s not all sunshine and rainbows across the decentralized multichain-verse.
The Future of Frax
A couple of weeks ago, Sam Kazemian, the founder of Frax Finance, highlighted some of the latest plans and features for the Frax protocol during his latest interview on MarketCapping, a DeFi-focused podcast. While we highly encourage you to give the podcast a listen yourself, here are some of the juicy nuggets of alpha within so that you know what to expect from the Frax ecosystem in the near future.
FraxBasePool
Due to the recent setbacks caused by Luna’s demise, the long-awaited 4Pool on Curve, which was supposed to consist of UST, FRAX, USDC, and USDT, did not come to fruition. Frax had to go back to the drawing board to create a similar mechanism. The result - a FraxBasePool where various protocols and DAOs can pair liquidity between their project’s token and the FraxBasePool.
In the initial stage, the BasePool will just consist of a FRAX-USDC pair, which carries the least risk. The difference between the FraxBasePool and the current Curve 3pool is this: When projects pair their tokens with 3pool, the onus is on them to subsidize the rewards for the 3pool, which effectively means they’re renting liquidity from Curve; With the FraxBasePool it’s the opposite - projects that pair their tokens instead receive a proportionate amount of rewards based on the demand generated by the combined pool. Meanwhile, liquidity providers (LPs) can earn yield from these different pools without exposing themselves to other stablecoins, just by depositing into the FraxBasePool, which minimizes their price risk to just FRAX and USDC.
While the proposal has been outlined by Sam Kazemian during the podcast, it still needs to make its way past Curve’s formal governance process. For the FraxBasePool to be deployed fully, the following steps need to be undertaken:
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The BasePool needs to be deployed by the Curve team, as per the proposal
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Once the BasePool is officially launched, an on-chain proposal would be created to support the addition of a Curve gauge to the FraxBasePool.
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After that, the CurveDAO will vote on whether the FraxBasePool should be added as an alternative base pool.
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Finally, there will be a vote to allow Frax to lock their CRV. Once this has passed, Frax will be able to use their veCRV to vote for increased CRV gauge rewards on the BasePool, which means more yield can be distributed to LPs and to projects using the pool.
As of the time of writing, the first 2 proposals have successfully passed and the third proposal is currently in the voting process. A short aside: Once Frax has the ability to channel emissions using its own veCRV, it will be interesting to see how bribes for users on Votium and other similar protocols will be affected. While we may see a decrease at first, ultimately we may see a rise in voting incentives as Frax redirects proportional rewards back to pools that make use of the FraxBasePool. This also has the added benefit of less CRV selling pressure from Frax.
FraxSwap
While FraxSwap is already live, the story behind its creation is a rather interesting one. As the Frax team was figuring out a way to periodically repurchase Frax shares (FXS) and contract the supply of FRAX, they wanted to approach it professionally and created a new type of product for that purpose. With that, a new type of AMM was born, which includes the total-weighted automated market maker (TWAMM) feature, allowing Frax to buyback FXS over time with the protocol’s earnings to better manage the supply and rebalance the collateral backing of its stablecoin. In other words, Frax will have better automated control over their stablecoin’s collateral ratio, compared to previously where the buyback and re-collateralization functions needed to be called by FXS holders.
FraxSwap TWAMM function (Source: Frax Finance)
Beyond Frax using TWAMM to buyback FXS, the TWAMM feature is a way for users to purchase small amounts of tokens at every block for a set period of time. You can think of it as an automated dollar-cost-averaging strategy that can be used for any ERC-20 token beyond FRAX, FXS, and its other native tokens. At the moment, FraxSwap currently uses a traditional AMM price mechanism (x*y=k), but the team is working on adding custom curves and concentrated liquidity. Additionally, FraxSwap is built with a fee switch that can be enabled to distribute trading fees to FXS holders.
On attracting and retaining liquidity, Sam mentions that the TWAMM function will mainly focus on protocol-owned liquidity. Any DAO or project can easily rebalance their treasuries or strategically acquire a specific token through FraxSwap. Besides that, FXS gauges will also be implemented to redirect future FXS emissions to liquidity pools on FraxSwap. By voting for specific pools, veFXS holders will be able to earn bribes and incentives through platforms such as Votium or Redacted’s Hidden Hand protocol.
FraxLend
Isolated lending pools such as Rari’s Fuse pools and SushiSwap’s Kashi lending pools are becoming more popular and Frax is looking to create its own via FraxLend. Anyone will be able to access FraxLend to create isolated lending pairs and customize them however they want.
For even more safety and risk mitigation, users can customize LTVs and lending pairs for more prominent or credible entities. For example, you can create a lending pair that only whitelisted parties will be able to access, with tailored LTV ratios to suit. Furthermore, as part of the Frax ecosystem, the earnings generated from FraxLend will also be channeled back to FXS holders.
Now, that’s certainly a lot to look forward to from Frax, and they’ve definitely got their work cut out for them. But at the end of the day, Sam’s vision is to build a fully-fledged economy and ecosystem around FRAX and its sister tokens. Once they’ve accomplished that, then perhaps a Frax roll-up or chain may be on the cards? Well, only time will tell.
Curb Your Governance
While the whole point of having a decentralized autonomous organization (DAO) is to empower protocol users to have their say in the decision-making process of the protocol itself, recent events in the last week seem to suggest otherwise. Several major DAOs have encountered what could be called “governance crises” last week, where founding teams and institutional backers seem to wield outsized, (almost) veto powers in the protocol despite the presence of a DAO. These events have called into question whether DAO governance is, at this point, nothing more than decentralized theater.
Rari
The first situation that we are drawn into surrounds the exploit on Rari’s Fuse pools which happened last April. As a result, $80 million were stolen including funds from Fei Protocol, which had already merged with Rari Capital in December 2021.
On May 13, 2022, a proposal was made to reimburse users affected by the attack, essentially meaning that the Tribe DAO will provide $80 million of its own funds to make Fuse users whole. FIP-106 was then put up for voting on Snapshot and unsurprisingly, the majority voted in favor of the motion, while only 25% of voters wanted alternative actions.
However, little to no progress was made following the vote’s outcome. While a subsequent proposal, TP-112, was made to determine the next steps to return the funds, a few voters had a different plan in mind. A veto on TP-112 was quietly passed with only six major participants, which nipped the reimbursement plan in the bud (Note: TribeDAO had designed a veto process where any proposal can be vetoed as long as it collects 10M votes in favor).
Recently, the proposal has found its way on-chain and is back for consideration under a more direct title, but it seems that the masses are singing a different tune now. The voting period has since ended on June 18th, with more than 58% voting against the repayment, while only 40% are choosing to approve it. The interesting part here is that Fei Labs, the creators of TRIBE and the Fei Protocol, and one of its investors, Buckley Ventures, were amongst the ones that voted against this proposal.
With the way things turned out, and in such a short timespan as well, one would be quite suspicious of whether there was any ‘decentralized autonomy’ at all within the Tribe DAO. Within a little over a month, decisions were reversed without any further recourse, and of course, whales with ridiculous amounts of voting power were there to make sure that their interests were protected.
Tribe NopeDAO proposals (Source: Tally)
In previous veto votes, quorums were not reached due to a severe lack of participation but the veto for TP-112 drew in more than 10x the usual number of votes, and it was the only one that passed. Smaller TRIBE holders who may have wanted to put up a fight probably didn’t stand a chance. Ultimately, does the average voter get any say when whales (and founders) come out to play?
Solend
The governance kerfuffle which arguably stirred the most controversy was from Solend, a money market protocol on Solana.
On June 19th, the Solend team published a governance proposal titled ‘SLND1: Mitigate Risk From Whale’. This proposal was in response to the threats posed by the largest user on Solend who holds an extremely large margin position which was close to liquidation. At the time, the whale held 5.7M SOL worth ~$170M, with ~$108M (1.5M USDT and 108M USDC) borrowed against that. The liquidation price of their SOL collateral was at $22.3, while the price of SOL at the time was ~$32.
In essence, the problem that presented itself was that if SOL were to drop to $22.3, 20% of the whale’s borrow amount (~$21M in SOL) becomes liquitable. The team claims that this could strain the Solana network, as it would be difficult for the DEXs to absorb this selling pressure. Selling SOL on DEXs on-chain would result in extremely large slippage, possibly affecting other Solend collateral positions and leaving the protocol with bad debt. On top of that, flurries of liquidation activity have historically been a factor for a Solana chain outage, which would exacerbate the problems at hand.
Meanwhile, the team had made efforts to contact the whale to no avail. This risk led many users to withdraw assets from Solend, spiking the USDC & USDT utilization rate to 100%. This meant that depositors of USDC and USDT could no longer withdraw, and positions collateralized by USDC / USDT could no longer be liquidated until the utilization rate came down.
The team decided via SLND1 that the best course of action would be to enact special margin requirements for large users representing >20% of borrows, where a liquidation threshold of 35% is required; if enacted this would immediately liquidate a portion of the whale’s collateral before it reached its original liquidation price. Additionally, the team requested emergency powers, which would be enabled via a smart contract upgrade, to temporarily take over the whale’s account so that liquidations could be performed OTC to avoid the fallout from liquidation occuring on-chain.
SLND1 was controversially passed with 97.5% of votes in favor. The catch was, one single user held ~88% of the votes in favor, which was among other things sparking outrage and suspicion amongst the community. The other factors that angered the community included the fact that the Solend DAO was only created <24 hours ago at the time, and that the voting period for SLND1 was restricted to 6 hours, stacked on top of the fact that the governance front-end was down for roughly 3 hours.
However, due to the enormous amount of backlash that Solend faced, another proposal (which eventually passed) - SLND2: Invalidate SLND1 and Increase Voting Time - was whipped up within the next few hours. As the name alludes, SLND2 proposed to repeal SLND1, while also changing some governance parameters such as increasing voting time from 6 to 24 hours. This proposal meant that the Solend team would pursue other ways to mitigate risk without resorting to the account takeover.
At time of writing, SLND3 - which proposed imposing a temporary account borrow limit of $50m - was in the midst of voting. But in a sudden turn of events, the whale in question finally responded and began discussions with the Solend team. While part of the emergency has been abated for now, this whole incident has undeniably set a precedent and triggered many heated discussions regarding decentralization. On the one hand, the Solend team decided that being granted emergency powers and changing protocol rules was the best course of action for mitigating threats from a single, large user. Some users support Solend’s actions as necessary in the name of user protection. From this perspective, the means justify the end, where the “irresponsibility” of a single whale that could jeopardize regular users’ funds was grounds for drastic preventative measures such as an account takeover.
On the other extreme of the spectrum, some regarded such an action to be outright theft. How such a proposal was passed so quickly, with a single voter holding the power of where the decision swayed, again highlighted the current problems with tokenholder-centric forms of voting. Understandably, some decisions may be deemed too time-sensitive to be left to a two-week voting period. However, the fact that the Solend team could even take over an account also raised eyebrows, much less whether they did or did not. The fact remains that the whale did not break any rules and was using the protocol as it was designed. Nevertheless, some argued that with great power comes great responsibility; the whale may not be at fault for the failure of graceful on-chain liquidations, but should they be responsible for its potential consequences, which include regular users getting hurt? For many, the answer to this question is an unequivocal no, as the means do not justify the ends.
This is reminiscent of the time when Curve spun up an ‘emergency DAO’ to curb Mochi Finance (now Mochi Inu) from gaming the Curve system (we covered this briefly in an earlier article here). The Curve emergency DAO consists of 9 members appointed by the main Curve DAO, and have power to take action without consulting Curve DAO members. In this instance, the utilitarian philosophy of greatest benefit to the greatest number of users justified the existence and actions of the Curve Emergency DAO to intervene with Mochi. Now with Solend however, the majority does not seem to be in favor of intervention for the sake of (short-term?) utilitarianism.
Bancor
While not a governance controversy per se, the following incident with Bancor highlights however the importance of having some form of community participation within protocol decision making. Bancor is one of the older names in the DeFi space, having launched mid-2017 (check out our latest article on Bancor V3 here). In Bancor’s V2.1, the first vested iteration of impermanent loss protection was introduced in 2021. Bancor’s V3 launch slightly over a month ago introduced a new feature for ‘instant’ impermanent loss protection on selected pools.
However, in a rather ironic twist, Bancor has announced that its Impermanent Loss Protection feature would be temporarily paused due to adverse market conditions. The Bancor Team cited the reasons being a recent sell-off of reward emissions that had been accumulated over the last 1.5 years, coupled with several adverse market events including the insolvency of “two large centralized entities” who had to liquidate their BNT, as well as withdraw their large, long-term liquidity provisions on the platform. At the same time, a large short position was also opened on an external exchange by an “unknown entity”.
These details provided by the team quickly led members of the Crypto Twitter community to connect the dots that 3AC and Celsius are the likely alluded-to entities. It was further speculated that Celsius was the entity that had pulled liquidity from the platform, and was dumping the IL rewards collected while at the same time shorting BNT on FTX.
However, the root problem seems to not be mercenary actors but the IL protection design itself. Essentially, the problem is that Bancor’s IL protection is provided by compensating users with additional BNT emissions, which inflates token supply thereby causing its price to depreciate. Meanwhile, a drop in BNT value results in additional IL on the network. You start to see how this is easily a self-perpetuating vicious cycle - which calls into question how sound the IL protection design was in the first place.
The response that may be more in line with the crypto / DeFi ethos may be simply to do nothing - let mercenary actors capitalize on the IL protection feature and dump BNT rewards, and continue business as per usual. However, this would still not address the flaw present in the current protection feature. Things may work fine in bull markets where token prices continue to appreciate and users are happy to HODL rewards; however, it’s likely that this IL protection mechanism not only did not not take into account mercenary behavior, but also bear market “down-only” scenarios which is where users would need IL protection the most. Additionally, the Bancor team labeled this selling behavior ‘manipulative’, but selling BNT reward emissions is obviously rational by nature of its incentive. Large entities aside, in bear markets it would not be unlikely that Bancor users of any size would also be quick to sell off BNT rewards to de-risk / recoup losses.
Our Thoughts
It’s no secret that DAO governance currently has many shortcomings. These are but a few examples that highlight the fact that crypto governance still faces many growing pains, and has a long way to go. Perhaps like real-world off-chain governance, there will always be enough complexity that we won’t ever arrive at the perfect model. However, we see that few projects are already experimenting with different governance systems which could address some of the current issues we face, such as the two-house model which Optimism is adopting. Meanwhile, other iterations of the DAO model such as the decentralized autonomous company (DAC) model had been popularized by Metis, although they have not gathered significant traction so far.
It’s difficult to say if we can ever iron out all the issues - as long as humans remain in the picture, there will inevitably be unique situations that call for a lot of subjectivity in decision-making. Perhaps in the next few months or years, future DAOs would be able to learn from these lessons and implement a more robust form of governance that provides a good balance between decentralization and efficiency.
An aside: depeg szn continues
On June 8th we covered Tron’s rise to become the 3rd largest chain by TVL, with credit to USDD for its growth. We also called for caution, as circulating claims at the time regarding USDD’s collateralization ratio could be misleading.
USDD price & volume chart. Source: CoinGecko.
Less than a week later, USDD started depegging from its $1 value. It slid to a low of $0.93 on Monday but now trades at $0.95.
To summarize the ongoing development thus far, on June 13th USDD veered a little off peg while the TRX token faced massive short-selling pressure on centralized exchanges like Binance for several days (funding rates reached as high as >700% APR on Binance). From June 13th to 18th, a number of actions were taken by Justin Sun and the Tron DAO Reserve (TDR), ostensibly to defend the USDD peg.
To counter short sellers, $2B was deployed to purchase TRX in a stepwise manner, and 5.5B TRX was withdrawn from CEXs and DeFi lending platforms to reduce liquidity for shorting. Additionally, about $1.5B worth of reserves has also been injected into TDR to increase the collateralization ratio of USDD, with ~$1B of this in USDC alone.
USDD metrics - total supply, collateral & collateral ratio. Source: Tron DAO Reserve.
In our last USDD update, we brought to attention that discounting ‘burnt’ TRX and TRX in TDR’s reserve, USDD’s collateralization ratio sat at around ~95%, instead of their published >200% figure. Now however with the latest infusions, USDD is overcollateralized even solely by its stablecoin reserves. Discounting TDR’s TRX and BTC reserves, the 723M USDD in circulation (at $1 peg) is overcollateralized ~170% by its USDC and USDT holdings, which is a key difference from a couple of weeks ago. It’s also worth noting that the TRX-USDD burn/mint mechanism is not identical to LUNA-UST’s, whereby ‘burning’ TRX to mint USDD actually does not send it to a burn address which removes it from circulation forever, but instead a multisig smart contract.
So, with its generous collateralization, why is USDD still unpegged? One key factor is the fact that the burn/mint mechanism is only available to TDR and whitelisted addresses for now. The USDD-TRX burn/mint mechanism is not live for the public and seems to be due for implementation later this year according to its whitepaper, therefore arbitrageurs cannot currently take advantage of USDD’s drop below $1. As several accounts on Twitter have noted, Justin Sun/TDR can easily restore the peg with only a small % of their holdings, but have so far for reasons unknown, not acted decisively to restore the peg.
This article was written in collaboration with Win Win. You can follow him on Twitter at @0x5uff3r.
Wendy is a research intern at CoinGecko. Follow the author on Twitter @alfalfawm
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