On Saturday, cryptocurrency investors were busy getting involved in the initial offering of the Fei Protocol, a new decentralized stablecoin protocol backed in part by ether. Last but not least, the project gained attention thanks to a $ 19 million investment round with funds such as a16z, Framework Ventures and Coinbase Ventures.
How Fei works
Fei is based on two innovative ideas: protocol-controlled value and direct incentives.
Protocol Controlled Value
Protocol Controlled Value (PCV) is that the protocol takes over the assets that users contribute to issue the FEI stablecoin. Such collateral cannot be returned. This distinguishes the FEI from other secured stablecoins, where tokens can be converted back into reserves.
To support the FEI during the launch phase, users were allowed to buy tokens at a discounted price starting at $ 0.50. The initial release target was set at FEI 100 million – the developers decided that this would be enough to integrate the FEI into protocols from the decentralized finance (DeFi) space. After that, to issue a FEI for $ 1, you need to invest $ 1 in ETH plus 1%.
This approach allowed Fei to quickly build up large reserves to back up the stablecoin. How these reserves are used is important. On their basis, a pool of FEI / ETH liquidity is formed on the Uniswap decentralized exchange, which immediately provides the stablecoin with a deep secondary market. The Fei protocol itself is the main liquidity provider for its stablecoin, which sets it apart from other algorithmic stablecoins that attract third parties for this through inflation of the token used in management.
Direct incentives
The second feature of Fei is direct incentives. They work to maintain the stability of the exchange rate and encourage investors not to sell tokens if their price falls below $ 1. If the investor decides to sell, part of his FEI will be burned. The volume of tokens burned depends on the deviation of the exchange rate and the volume of sale and is determined by the formula: Penalty = (Distance from $ 1 * 100) ^ 2. If the investor buys the FEI below the peg price, he is rewarded with additional tokens.
Rebalancing
Since even such a system does not guarantee stability, the FEI has a rebalancing mechanism that is activated during extended periods of yaw. In such a case, the protocol will use the assets in its reserves (the aforementioned PCV) to buy out and burn the FEI until the price is restored. This is an important advantage over all other algorithmic stablecoins, which do not have a built-in token buyback function in the event of a drop in demand.
TRIBE Management Token
With the launch of the Fei protocol, a decentralized autonomous organization is opened, governed by the TRIBE token. As an additional incentive mechanism, TRIBEs were distributed through the airdrop to the FEI primary issue participants. The airdrop made up 10% of the total TRIBE supply and was distributed in proportion to the investor’s investment in the FEI.
Something went wrong
During the initial launch, Fei Protocol managed to raise $ 1.2 billion – several times more than the volume of preferential emissions. The FEI-ETH pool immediately became the largest pool on Uniswap with $ 2.6 billion in liquidity. Obviously, this interest significantly exceeded the expectations of the developers, so they could not foresee the events that followed.
Users hoping to profitably purchase a stablecoin actually bought it at an inflated rate. Many immediately rushed to sell the FEI, thus causing a depreciation. Because of this, further liquidation now entails fines, that is, the burning of investors’ tokens. Currently, the penalty is 30-35%. By selling $ 1 at the FEI, you can get $ 0.67 in ETH.
In addition, one of the main reasons why investors participated in the Fei campaign was the TRIBE airdrop. The logic is simple: if the Maker token for managing the Dai stablecoin is trading above $ 2,000, then the TRIBE can go up. However, with such a large investment, the airdrop was highly dispersed among the participants.
Since the start of trading, the TRIBE rate fell from $ 3.18 to $ 2.04. This may be due to the fact that some investors took advantage of a loophole and exchanged their FEI for TRIBE, in order to then withdraw to ETH. The FEI transfer to TRIBE is not subject to a penalty, so as a result there was even an opportunity for arbitration where it was possible to buy the depreciated FEI with a bonus and withdraw them through TRIBE without penalty. At the same time, TRIBE naturally lost in value. Subsequently, Uniswap began to send applications for the transfer of the FEI to TRIBE via ETH, so this method has lost its meaning, since now such a transfer is also subject to a penalty in addition to fees.
Moreover, during the release phase, the FEI had the option to pre-purchase TRIBE for them through its own protocol mechanisms. The protocol itself determined the price of TRIBE according to demand. Thus, $ 383 million was exchanged.
What’s the bottom line? Investors who have invested in the FEI cannot withdraw about $ 1 billion without a large fine, and the compensation received as an airprop was insignificant. The liquidity in the $ 2.6 billion pool cannot actually be used as there is a strong incentive built into the protocol so that FEI holders do not do this while the token price remains below $ 1. TRIBE investors simply hold the depreciated token.
In general, an interesting mechanism for keeping the price of a stablecoin with the help of direct incentives has actually become a factor in increasing volatility. Over time, a rebalancing will be launched, but taking into account the volume of invested funds and the desire of investors to return them, the situation risks repeating itself. Many now expect developers to rethink the direct incentive mechanism in order to reduce the speculative component and give users a less painful exit.
The winners are the bot owners who are versed in the intricacies of algorithmic stablecoins. One of them, for example, took part in the campaign and was the first to sell TRIBE, turning 3,000 ETH into 3,650 ETH in one transaction, rightfully earning $ 1.3 million on this. For retail investors, seemingly low-risk investments in a new stablecoin turned into a disaster …
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