THE FEI STABLE COIN AND HOW TO EVALUATE IT
FEI is an algorithmic stable coin that uses game theory incentives to move the price of the token in the direction of a price target.
You should definitely start paying attention to the stable coin ecosystem.
Everyday I get myself marveled by the wonders that Ethereum can produce. Everyday is a new application, a new way of applying technology, a new game theory applied to a new market. One very fundamental problem of Ethereum is that it can’t see things outside of its environment so, to get around that, tokens were born. You can make a digital representation of anything in the form of a token. It’s not surprising that dollars are one of the first assets that needed to be represented inside Ethereum which makes it one of the most popular digital representations in Ethereum today.
Just in the last year, stable coins have had an incredible growth mainly driven by fiat-backed stable coins. Despite its popularity, centralized stable coins are very susceptible to regulatory and counterparty risks and its own nature is against the decentralized principle of blockchain. In face of this fundamental issue, many projects are trying an algorithmic approach to stable coins. An algorithmic stable coin is a token that uses game theory incentives in order to move the price of the token in the direction of a price target.
The game theory behind FEI
Fei was born out of a necessity to create an algorithmic stable coin that was at the same time decentralized but not overcollateralized. In order to be fully decentralized, Fei protocol cannot rely on any fiat-collateralized stable coin, like USDC or USDT.
FEI token will be a stable coin pegged 1:1 to the dollar. FEI derives its stability from a single vault where all the ETH used as collateral lays and which the protocol has control upon. This single vault is called PCV (Protocol Controlled Value). This is in contrast to Maker’s approach in which every user manages its own individual vault.
In order to expand the FEI supply, users deposit their ETH to the PCV, abdicating any right of it and, in return, the protocol mints FEI that worth the same amount to the user (except during the phase that the protocol is bootstrapping its liquidity). The ability to buy FEI straight from the protocol assures that in no circumstance the price of FEI will be above the one dollar peg since any arbitrager can take advantage of inconsistencies.
Right from the beginning PCV will be used to bootstrap liquidity, so anyone can exchange it for other assets, in a Uniswap ETH/FEI pool. The amount of collateral provided will be paired to the same amount of FEI minted to get to the 1 peg price.
The protocol has two mechanisms to contract the supply of FEI during low demand periods. The first, directly applies incentives to the Uniswap pool during a trade. The incentives only apply to trades when the spot price is below the peg. If the price is below peg and a user decides to sell FEI to ETH (what would exacerbate the price decrease) the user will incur in a 4% penalty fee applied in the token contract level. The opposite trade (that pushes the price up) will be incentivized with a 2% bonus. The difference between the upward bonus and the downward penalty is net deflationary, removing FEI out of circulation. The protocol depends on arbitrage to disseminate the same incentives in other exchanges.
The second mechanism is a reweight in which the protocol uses its ETH in the PCV to push the price back to the peg. It makes the following actions in only one transaction:
- Withdraw all protocol owned liquidity from Uniswap.
- Push the market buying FEI with protocol owned ETH back to the peg and burn any excess FEI.
- Provide liquidity back.
Reweights are a drastic measure but also very effective due to its psychological aspect. A user wondering if he should sell below the peg might think twice as, if a reweight event occurs, he can sell at the price peg and even without incurring in penalties.
TRIBE Token
Fei protocol will have a two token model approach. The second token, TRIBE, will be responsible for the governance of the protocol and will be in control of the PCV. TRIBE holders can add new types of collateral or adjust price functions of existing ones, allocate PCV in new markets or define destination to any protocol excess.
Fully diluted supply of TRIBE will be 1 billion tokens. At genesis only 30% will be issued and put into circulation. Token distribution is shown below:
Total value locked (TVL) and Market Cap
The fundamental approach to a valuation in DeFi space is how much money the protocol can collect. The first FEI will be issued in a crowd sale event known as the Genesis Period. During the Genesis Period any user will be allowed to buy FEI straight with a discount price following curve:
After the scale amount of 100mi reached any other FEI released by the protocol will be priced at the one dollar peg plus a 1% buffer, totalizing $1.01. All the users participating in Genesis will buy at the same time and the price paid will be the mean of the curve.
The total value locked (TVL) will be the same as the protocol controlled value (PCV) and at genesis will be the value of ETH provided.
As an additional incentive for the participants of Genesis, 10% of the total TRIBE supply will be distributed pro rata.
In Genesis, a FEI-TRIBE pool on Uniswap will also be created for an IDO (Initial DEX Offer). The Uniswap pool will receive 20% of the initial TRIBE supply and FEI minted by the protocol to set so the fully diluted valuation of TRIBE equal to the amount of FEI purchased on the bonding curve at Genesis.
To avoid front-run and a gas war, any user that took place in the Genesis, can also pre-swap any percentage of their FEI received at for TRIBE when the liquidity pool is initialized just after launch. Using total value deposited by every user and the amount pre-swapped, a final TRIBE price after the genesis can be determined.
In below, is possible to see four scenarios for different TVL and percentage of FEI exchanged by TRIBE during pre-swap and the resulting FDV, MCAP and the fraction between them:
The numbers above can be compared to other projects. An important distinction is that the TVL in Fei Protocol is fully under control of the protocol and is a revenue-generating asset for its holders different from other projects that the TVL belongs to users and are fully controlled by them.
Present Price/Earnings (P/E)
PCV will first be assigned to an Uniswap pool. The liquidity of this market will be the double of the PCV value, since the PCV only represents the ETH value side. FEI side will be minted to take the price to the peg making the other side of the liquidity.
Stable coins are among the top 15 pairs on Uniswap and generates fees from 4–40% yearly. PCV in the Uniswap pool will be receiving fees from the trade right in the beginning of the project.
Estimating the fees generated between 5–15%, the scenarios for market cap above could also estimate an initial P/E.
Fei Protocol comparison to other algorithm stable coins
Fei protocol will be competing with other algorithm stable coins such as DAI from Maker, Rai from Reflexer Labs and FRAX from Frax Finance. RAI is not pegged to the dollar, which is a major drawback from a user experience when dealing with traditional assets, nonetheless it remains relevant due to its algorithm nature.
One major advantage is that FEI will not be dependable on any fiat-backed stable coin as collateral like Maker’s DAI and FRAX. The permissioned, centralized nature makes the underlying collateral value dependent on the trustworthy behavior of the central entity issuing these tokens and also means that users or the protocol itself can be blacklisted and censored.
Both DAI and RAI stable coins are over-collateralized by crypto assets, which makes them less capital efficient and create scaling problems. Frax and Fei on the other hand have a partial asset collateralization (“fractional reserves”). The trustworthiness of this scheme remains to be tested at large scale, but Frax has already a 111 mi circulating supply at around 86% collateral ratio.
Another positive point of Fei is its governance minimizing approach for sustaining the peg. Different from DAI and RAI in which governance has to decide control parameters and stability fees to keep the peg. Fei peg stability is only dependable of direct incentive percentages and reweights criteria.
The drawback is that Fei protocol is using a novel model of incentives to keep stability, so it remains to be seen whether it will succeed in practice. Mainly during contractionary cycles, in which the FEI needs to come out of circulation, it highly depends on the two incentives mechanisms described above. If the demand falls sharply, those incentives might not be enough, taking FEI into a reflexive state, in which the price falls, decreasing demand, amplifying even more directional momentum.
Conclusion
Stable coin landscape is evolving quickly. Fei Protocol uses novel protocol mechanics to overcome some of the downfalls other projects have had in their concepts. It allows very widespread market forces like arbitrage and direct incentives drive the token price towards the dollar peg. That way, FEI has the potential to build out a robust value proposition in a market where opportunities are immense.
