Chain Reaction Host Tom Shaughnessy hosts Sam Kazemian, the Founder of Frax Finance to discuss the project.

Episode Highlights

 

Chain Reaction Host Tom Shaughnessy hosts Sam Kazemian, the Founder of Frax Finance to discuss the project. This is the second in a series of podcasts on Algorithmic stablecoins. The two discuss Frax’s creation, technicals around expansion/contraction of supply, competition, risks and much more including why Frax could be the most stable vs its competitors. The full interview transcript is available below!

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Show Notes

(2:02) – (First Question) – Sam Kazemian’s Background.

(4:37) – Frax Finance Elevator Pitch.

(10:39) – What is being used as Collateral in Frax.

(15:50) – Frax Stablecoin vs FXS governance token.

(18:23) – Relation between USDC and FXS / Insights about the process.

(21:11) – Insights about the Value Capture.

(23:34) – The growth process.

(25:33) – Where is the Collateral pool kept.

(28:48) – What happens when the price of FRAX goes sub $1.

(33:18) – How do people earn more of the Governance Token / Rewards Walkthrough.

(36:11) – How APY could offset Impermanent Loss.

(38:21) – How the Supply of FXS could get absorbed.

(39:27) – How many people are Time Locking their Stake.

(42:04) – Once you use all the Yield Farming Rewards, What’s next.

(47:42) – The Dichotomy between ESD and Frax.

(54:35) – Where to find Sam Kazemian.


Music Attribution:

  • Cosmos by From The Dust | https://soundcloud.com/ftdmusic
  • Music promoted by https://www.free-stock-music.com
  • Creative Commons Attribution 3.0 Unported License
  • https://creativecommons.org/licenses/by/3.0/deed.en_US


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Interview Transcript

Tom:

Hey, everyone. I’m your host, Tom Shaughnessy, and welcome back to Chain Reaction, a research-driven podcast that’s a part of Delphi Digital. If you’re not on Delphi’s research portal, you’re missing out on the critical analysis read by the top minds in the crypto space, so be sure to check it out.

Tom:

One quick housekeeping item. Nothing said on this podcast is a solicitation to buy or sell any security or token or to make any financial decisions. I may personally hold tokens mentioned on the podcast, and you can view our show notes below for our complete disclosures. With that, let’s jump into the episode.

Tom:

Hey, everyone. I want to tell you about our new podcast sponsor LVL. LVL is releasing the first free Bitcoin exchange in North America. The LVL mobile app allows you to buy and sell Bitcoin with no trading fees or hidden spreads. With LVL, you get free Bitcoin trading, a hosted Bitcoin wallet, an FDIC insured personal checking account, wires checks and direct deposits, and even a MasterCard debit card. If you use their premium account for $9 a month, you get autopilot automatic trading, chat with a dedicated private banker, and even a metal MasterCard. Check them out at lvl.co or check them out in the show notes below. Now back to our show.

Tom:

Hey, everyone. Welcome back to the Delphi podcast. I’m your host, Tom Shaughnessy of the Chain Reaction segment. Today I have on Sam who’s the founder of Frax, which is described as the world’s first fractional algorithmic stablecoin. It’s the second video in our algorithmic stablecoin series. Sam, how’s it going?

Sam:

Great. Thanks for having me, Tom. I’m really excited to just talk about Frax and ALGO coins in general, which are the hottest thing right now in DeFi basically.

Tom:

Yeah, no, you’re right, we got to stay on top of it. So, Sam, give us a quick background on yourself.

Sam:

Yeah. So, I actually got into crypto and stuff like that around 2013, 2014 while I was a college student at UCLA. I got into kind of mining and other kind of stuff back during the script boom, during Dogecoin, I was one of the first miners and stuff like that. Now it seems really, really long time ago, but that’s when I first got into crypto. After graduating UCLA and everything, I started Everipedia with a few co-founders, which is like a decentralized version of Wikipedia. That’s going really well. We’re one of the largest decentralized applications. We’re built on iOS, although we’re building other cross chain implementations now and kind of becoming cross chain agnostic and things like that.

Sam:

And then in 2019, early 2019, I had the idea of what would become Frax. And essentially, back then I was also telling people, “I think algorithmic stablecoins are going to be kind of the next big thing.” It’s almost two years now, right? Early 2019.

Tom:

It’s been a while.

Sam:

Yeah. And a lot of people, A, didn’t understand it, or didn’t believe it. That was around when Basis was working on stuff before they kind of shut down and things like that. But that’s when the first idea of Frax came out in terms of… It was actually originally called Decentral Bank, decentralized central bank. And then we’ve been building Frax since then. We actually recently released the full implementation exactly a week ago, December 21, 2020, we released Frax. It’s been going great, thankfully. Obviously, it’s only been a week so we’ll see how things go. But so far, everyone is really excited about how unique of a design it is, what it is, and it’s been going great. So, hopefully, we’ll keep gaining attention, minting more Frax and into circulation through the protocol, and keeping that really stable peg, which actually, one of the things that I take pretty good confidence and good signal in is that the peg has been quite tight in terms of algorithmic design. So, it’s been good.

Tom:

That’s great to hear, man. It’s great to see that you’ve been working on this for so long and that you hit the scene and things are going well. So, we’re going to dive into a lot of technicals on the podcast, but just give us the elevator pitch on Frax. What exactly is it? What does it mean to be a fractional algorithmic stablecoin? And if you can give any color on how large the protocol is today, that would also be helpful.

Sam:

Yeah, of course. So, the idea that we kind of invented and brought out that’s getting a lot of buzz is that we came up with the idea that, why don’t we let the market set a collateralization ratio of a stablecoin? Which is totally unique in terms of how you think about it, which is basically the amount of a stablecoin that’s actually backed by collateral, whether it’s volatile collateral or like we use USDC to make the visualization of the collateral ratio stuff pretty easy, why don’t you let the market set that at whatever the market needs for the stablecoin to remain at $1? Right?

Sam:

And so that’s the unique concept, which we call fractional algorithmic, which is part of this supply, part of the proportion of Frax is basically stabilized algorithmically, the second token, the Frax share token, which we’ll get into. But the main kind of breakthrough or unique idea that we’ve kind of brought to market is, market sets collateralization ratio, this elastic collateral ratio that only the amount of a stablecoin that’s possible, currently, by the market to allow it to be algorithmically stabilized, basically unbacked, not backed by anything, should be algorithmic to keep the peg really tight, right?

Sam:

And so the thing that a lot of people, when they hear about Frax, that they’re like, “This is really cool,” is that they’re like, “Yeah, that’s a good point. Why is there like Fiat coins and over-collateralized stuff like that and then 0% back?” Fully, there’s not a single amount of collateral and stuff like that. “Why wasn’t there this fractional algorithmic middle ground where you actually let the market decide what that collateralization ratio is?” And it’ll go down as the market is more confident in the share Seigniorage stabilization mechanism, or it’ll recover and go back up if there’s a period of… I don’t know, bear market speculation and stuff around the Seigniorage assets token and stuff like that, right?

Sam:

And what’s really cool is we’re seeing a lot of projects like ESD V2, which I think you’re going to have on the show, or maybe you already did, or something like that.

Tom:

[crosstalk 00:07:07].

Sam:

Yeah, awesome. It was Dan, right?

Tom:

Yeah. Dan, and Lewis.

Sam:

I love Dan and yeah, Scott. They’re super smart, super awesome guys. But that’s what I mean. The cool thing is in V2, I’m sure they talked about they have this hybrid design, but it’s all in the same ethos, right? It’s all in the same ethos of like, why is there a 0% and then 100 and over collateralized percent? What’s in this middle ground that… Right. And so that’s where we actually get our name, Frax. We decided to name fractional algorithmic currency, right? So, Frax comes from the idea that we’ve kind of invented. And that’s the unique insight. And so you can build the other stuff around it, right?

Sam:

We’re going to have bond tokens and these debt mechanisms later on in 2021 Q1 or maybe Q2 or something, but you can build them around this central idea of fractional algorithmic, and I think that that’s how you keep the peg of this stuff stable and you don’t see crazy things like &1.30, 1.70. Right? Like $1.15, 1.84. And one of the main things that I think is a really good test to ask yourself is, would you ever use any of these so called algorithmic stablecoins currently on the market in place of Dai, USDC, or USDT? And every day that goes by, the answer is continually no, right? Okay, well, one day they share the graph of the variance of hopefully it’ll become less unstable and stuff like that, but it’s like, but why? Why build it where it’s like maybe it’ll become less unstable? Why don’t we build a protocol that actually from the beginning, it’s just very flat and adjusts dynamically to what it is?

Sam:

And that’s what’s cool about Frax, is so far… I’m not saying there’s been a success or anything like that, it’s been one week, right? There’s about 25 million stablecoins in circulation. And obviously, a Genesis, Frax is 100% collateralized, and it’ll go slowly lower. And I think as of this podcast right now… I can actually take a look on the front end, Frax right now is about 96% collateralized, and that basically means 96% of Frax stablecoin, so 96 cents of that $1 value is backed by collateral. We actually started with USDC, which is also another stablecoin, but it’s to be able to visualize how much of it is basically backed or not, if it was. You can build this protocol with volatile crypto, and we will hopefully get there in like V2 or V3, but it’s easier for people to obviously understand the premises and stuff like that.

Tom:

And Sam, just to dive in. That’s a great overview and it makes a lot of sense. Like, we should have something algorithmic. I told Dan and Lewis on my last pod, “Think back to the MakerDAO days when we were all on a weekly governance call or daily to decide the stability fee was terrible. But getting back to Frax, what exactly is being used as collateral? I guess the first question. And then the second question is, when you’re putting up this collateral, you’re getting FRAX, that stablecoin, and then the FXS as the governance token, if you can get into the differences between those two as well, that’ll be helpful.

Sam:

Yeah. So, the basic mechanics are actually fairly elegant and simple once… it’s like you kind of distill the core concept of it. Frax is not debt based. So, the first thing a lot of people have to get out of their mind is like, “Oh, do I build a debt position or a vault or something like Maker and then generate Frax?” No, not at all. In fact, it’s more similar to swapping stuff like Uniswap. It’s more similar to swapping collateral and share tokens and things like that than building a debt position and then having interest rates on it, and then having these slow liquidation auctions on chain and stuff like that. Frax actually is very fast. It’s swap based. We take a lot of design inspiration from AMMs and stuff to build these stability mechanisms.

Sam:

So, the idea with Frax is that, on launch, it’s 100% collateralized. It’s super boring to mint one Frax, you put in one USDC or tether, but we only accept right now to keep things simple, USDC. We could have done Dai or whatever. And then that’s fine, right? One Frax is backed by one thing. You mint it like that, you can go redeem it at any time like that too. There’s just a bunch of pooled collateral and then there’s a bunch of circulating Frax, right?

Sam:

As it becomes more and more algorithmic, as that collateral ratio goes down, and the way that happens is that the idea is, as the price of Frax slowly nudges above $1, so like $1.01. We actually try to keep a very tight bound. As it goes to like $1.01 or $1.02, the idea behind when it would do that is like people are maybe buying up a little bit more Frax on Uniswap, or something like that, or it’s integrated in a curved pool and people are trying to fill it up and things like that. That signals there’s a little bit more demand than there are circulating Frax, right? And so that means the collateral ratio actually goes down by one step, which in the protocol right now, it’s set to 0.25%, just a fourth of a percent. So, it’ll go down to like 99.75 or something. And so what this means now is that every single Frax stablecoin is only backed by $99.75. If everyone went to go get it, the way that this would happen is that there’s not going to be 100% collateral backing it.

Sam:

So, the next question about that is, okay, what happens to this Seigniorage value, right? If someone’s going to go and put in 99.75 of collateral, not a 0.9975 USDC, and they get out one Frax, isn’t that value leaving the system? You’re giving them one Frax, it’s trying to be stabilized at a $1, they’re not giving 100% collateral. And the answer to that is that extra value is actually used to buy back Frax shares, the FXS token and actually capture that Seigniorage value. So, the second token, the Frax share token, the governance token, the Seigniorage token is basically, whenever there’s Frax that’s only partially backed, the amount that’s partially backed, the free Seigniorage, the Seigniorage value actually goes to buying back Frax shares and burning it from circulation. So, the free Seigniorage is always being captured by the Frax share token.

Sam:

So, as you can see in this example, right, let’s say it goes down to 99% collateral ratio, right now it’s 96, right? Every single Frax that’s minted, you only have to put in 0.96 USDC per Frax, right? So, what happens to the remaining four cents of free Seigniorage that’s trying to be free money, right? That value goes to buying back Frax shares and burning it.

Tom:

Got it. That’s super interesting. So, basically, just to summarize what you’re saying, and it’s awesome. So, when the price goes above one, the collateralization ratio automatically adjusts down to incentivize people to mint to then potentially sell to bring the price back down to one on Frax?

Sam:

Exactly, right. So, you can always mint Frax in the system, right? So, that’s how the peg is very tight compared to other algorithmic coins where there’s epochs and there’s every day, or every eight hours, or every 12 hours or something, there’s one expansion, sometimes it’s too big and it undershoots and it goes under $1, and then it bounces up above. Not at all with Frax. You can always mint Frax, you can always redeem it, just kind of like trading on Uniswap, right? So, that’s how we keep the price so tight at all times. It’s almost like the mechanism, it runs per block, because you can always swap it every single time.

Tom:

And Sam, the difference that you talked about, so let’s say we’re above one, let’s say the collateralization ratio is sub 100%, and somebody’s putting up, per your example, let’s say 0.9975 USDC to get one Frax, where exactly is that difference coming from exactly, because somebody’s not putting up the difference, right? Where does that come from?

Sam:

Oh, you mean where’s the Seigniorage being captured or something?

Tom:

Yes, yeah, to burn the Frax shares.

Sam:

Yeah. So, there’s two ways we could have implemented this, and one of them is kind of like Maker or something, where we would run an auction for the floating amount, like the unbacked Frax to buy back Frax shares. We actually don’t do that. What we do is actually we force the person minting the actual Frax to go buy Frax shares on the open market and then actually burn it in the minting process. So, the actual kind of buy back and Seigniorage capturing step is all done in the minting process.

Sam:

So, for example, let’s say Frax is 90% collateralized, and I want to mint 1,000 Frax, $1,000, right? That means that basically $900 worth of collateral, 900 USDC I have to put it, right? What happens to the $100 of free Seigniorage, right? Those are basically unbacked Frax, right? Well, that value has to be captured by the Frax share distribution, right? And the way that we do that is that the person actually coming to mint on the open market, because the price is above it, that person, before they’re able to get their Frax, has to go and buy $100 worth of Frax shares and actually burn it in the same minting transaction.

Tom:

Got it. That’s so elegant. It’s so simple when you explain it. That’s why I love talking to founders. So, basically, if we’re above $1 on Frax to stablecoin, I can come in and put less than $1 worth of USDC to mint Frax share so I can make that ARB, but I also have to purchase FXS, the governance token, in the real world and burn that, which basically drives value to your governance token.

Sam:

Exactly, exactly. And so done in one step, minting and then the share capture of the Seigniorage, it’s super fast. There’s no need for like on chain auctions or something like that, keeper auctions, and it’s super quick, and the peg just comes right back to it all.

Tom:

That’s awesome. And I missed this because I was thinking about it, but what’s the link between the amount of USDC I am going to use to mint Frax and the amount of FXS I need?

Sam:

Yeah. So, the amount of FXS is like the dollar value of the Seigniorage, right? So, going back to our example of minting 1,000 Frax at a 90% collateral ratio, you obviously need 900 USDC, because that’s the amount of collateral, and then you need $100 worth of Frax shares at the current TWAP price to burn, because that’s how much of Seigniorage that’s captured, right? And so since the price of Frax shares is highly volatile, it’s capturing value, or it’s going down or up in speculative markets and stuff, you have to go buy it, and then the TWAP price, the TWAP dollar price of the Frax shares is used to make sure you’re actually burning $100 worth of that Frax share.

Tom:

That’s incredible. And this whole process… I’m on your site right now. I’m on app.frax.finance, and I’m putting in an amount of USDC, the FXS is coming right up. So, you guys handle all of this in one step?

Sam:

Yes. And the minting process is all just abstracted in a front end, right? So, you can actually see exactly what you need, you can actually see the current dollar value of it and all this stuff. So, it’s pretty elegant. You can just do it in one step.

Tom:

Damn. Yeah, no, this is cool. It’s clicking it. The thing I like is it’s just so easy to stabilize and you’re embedding value to FXS during the process, and people don’t even really have to worry about it, which is pretty cool.

Sam:

Yeah, exactly. And the thing about that is that we actually… So, the Genesis supply of FXS is 100 million tokens, and if you actually look on Etherscan, the actual amount as of right now is 99,986,000, which means Frax shares have been burned, right? It’s deflationary as long as the Seigniorage capture of the system is increasing, right? And so it’s working perfectly. It’s only a week again, so I don’t want to… but it’s working exactly as intended. It’s a much faster value capture than the Maker token, which has these periodic stability fee burns or whatever. It’s just instant, right? It’s just, oh, we need a bunch of Frax in circulation. Well, we need to burn some Frax share at that collateral ratio.

Tom:

That’s awesome. And yeah, just full disclosure, I have to say that I do own some FXS, because I’m playing around with it right now, but I agree with you on the value cap, which is pretty interesting.

Tom:

I guess, while I have you, what else did you guys look into when you were thinking about value capture, right? I mean, one of my favorites is just building up a balance sheet, but you obviously run into a lot of regulatory questions there. Did you guys look at any alternatives? Is this something you’re married to? I think it’s awesome, but just wondering your take there.

Sam:

Yes. So, one of the things we try to issue out of Frax is active management, is that basically we don’t like… Obviously, stuff like Maker and stuff like that has their own point of making it cool and stuff, but we don’t like the meet on governance calls and stuff like that. We try to have a very algorithmic approach to this stuff. And so we try to basically have, right now, just one collateral, but we can actually have more even volatile collateral. The collateral ratio might slightly bounce a little bit more and things like that, but basically, we try to make sure that right now, we keep it simple, we don’t have a lot of active management.

Sam:

The one thing I kind of compare Maker to is that it feels like an on chain bank, which there’s nothing wrong with it, it’s better than a bank, because it’s so transparent, right, that everyone can become a token holder and stuff like that, but it doesn’t feel like the kind of Bitcoin thing of like, “This is the social contract, these are the rules, you hold this thing, and this is the social contract that you’re adhering to” right? We’re trying to make sure with Frax, it’s an algorithmic Bitcoin basically, right? So you can know that this is the social contract, this is what it’s going to do and all that stuff. So, we can add collateral, we can actually do a lot of other stuff, and we will with governance action stuff, but we don’t want to have an active management type of approach to it. That’s one of the things we’re trying to make sure we don’t do.

Tom:

No, I totally agree with you. As governance light as you can get this, the best, because most people don’t care about governance until they have to, and if there’s a big vote on something, let people come together.

Tom:

Sam, just a couple other questions for you on the points you’ve brought up. I know we’re going off the question list, but this is more interesting. The collateral is in USDC. If Frax becomes as large as you want it to be, how exactly do you outgrow USDC, because it seems like it gets a little recursive there where you’re relying on it but you want to outgrow it? How does that happen?

Sam:

Yeah. Well, the first thing with Frax is that you can outgrow it, right? So, the whole point of algorithmic stuff is like, if there’s a market demand, then it’ll become algorithmic, right? And basically, one of the things that I like to say is, like, a lot of people say, “Well, you’re just like wrapped USDC right now, right? The collateral ration is like 96%, and then maybe it’ll go up to 100 to recover the price, go back down like 90 or whatever.” And my first answer to that is, I would rather the protocol be like an elastic USDC than dump 40 cents on the dollar of your stablecoin, right?

Sam:

If you’re trying to create good stablecoin mechanism design and you’re like, okay, you have two options. Go back to being wrapped USDC for a little bit, or go to 50 cents in this weird like debt cycle thing for two weeks and then obviously, it’ll come up and stuff like that, right? And that’s not good design, in my opinion, right? I think that one of the things about that is that it’s important to keep stability tight and basically make sure that people can actually rely on this thing, right? Even if it’s like, oh, right now it’s like 96% literally USDC and 4% algorithmic, what that means is that it’s still tied around the PEC, and so that’s what’s really important, in my opinion.

Tom:

No, no, I agree with you. And your points keep bringing up the fact that you want this stable from the beginning, which is important, and I like to hear that you keep bringing that up. And then just on the other side, the collateral pull itself, where is that kept? Is that just in like a multisig or is that something people interact with? I guess I’m just wondering from more of a security standpoint.

Sam:

Yeah. So, they’re part of the system contracts. So, one of the cool things with Frax is that right now, obviously, we have owner keys to update the contract. We don’t have owner keys to mint infinite Frax or Frax shares or take the collateral or anything, but we have keys to update some of the code, and it’s not code that can just take everything or anything like that. But for example, we can deploy a new contract that slightly changes the minting mechanics. So, for example, like the type of Oracle it looks at for like the FXS price or something, we actually recently improved that. So, if you actually go back to minting Frax and stuff, you’ll see the collateral pool contract, there’s USDC V2, and then USDC deprecated, which is actually we’ve already improved the original contract. And they’re held on chain, and literally anyone can redeem against them, right? It’s almost decentralized, but just a few weeks of kind of training wheels, that we make sure everything is working and update stuff.

Sam:

One of the main things we’re trying to work on right now is that TWAP prices, they’re kind of slow, right? And in fact, Frax’s swap based system is super quick, and the TWAPs don’t really update as quick. We use a 15 minute TWAP for FXS and then an hour swap for the USD price of Frax and stuff like that. And a lot of the times the TWAP is actually one to 2% off, and the the actual peg of Frax is actually better. It’s just not reflected in the TWAP. Right now, the Frax price is pretty good. It’s like 98 something, it’s almost back to 99, and just [inaudible 00:27:43], right? It’ll get up back to almost perfectly $1. But the TWAP shows 97, just because TWAPs are off, the time weighted average Oracle price.

Sam:

And so one of the things is our swap based stability mechanism is a little bit… actually maybe you could say too early for Oracle’s currently on chain. So, some people are like, “Oh, the Oracle price says like 97.00,” like yeah, but on Uniswap, it’s actually 0.999. Someone’s already [inaudible 00:28:13] and stuff like that. So, one of the things we’re making better in new contracts are getting the right TWAP prices down and making sure like, for example, if someone is arming something or burning FXS and stuff, it’s a more accurate price, right? That the right amount is being captured in Seigniorage engine and stuff like that. But those are just implementation design things, that means the theory is working, the implementation needs to improve better.

Tom:

No, I love the color, just digesting it. And we brushed over one thing, just the other side of the collateral ratio. Can you explain what happens when price goes sub $1 real quick? I just didn’t want to forget this while we’re talking.

Sam:

Yes. So, technically, right now it’s slightly under $1, if you look at CoinGecko or something like that. So, then what happens is the collateral ratio increases. So, let’s say, like right now it’s 96.5, in the next hour, if the price is still slightly under $1, then what happens is that it’ll go to 96.75. So, any Frax that’s minted or redeemed and stuff, you get a little bit more collateral. So, you can see it’s actually backed more now, so confidence in the collateral portion of it should increase because the ratio is actually increasing, less of it is backed algorithmically. And that’s how basically confidence is recovered. And it’s done really well in terms of like being earned back.

Sam:

And sometimes you can see it kind of goes down a little bit, and then it goes back up to 99 or 100%. And it’s only been one week, so we don’t know how quickly or slowly the system will react. And right now it’s at 96 something, it’s actually been going down because there’s been a lot of use in farming, and we have some good meetings for integration and different things, cream, sushi, compound, all of the good stuff, we’re talking curve and things like that. So, as it gets going, you can see it go down, and sometimes it might go up. There might be periods of re-collateralization where the collateral ration is increasing. And like I said, some people are like, “Well, then you’re going more and more towards wrapped USDC or Dai or whatever else we use as collateral.”

Sam:

And the idea is, yeah. As long as you can really rely on Frax being tightly at $1, like 99 cents, $1, $1.1, instead of like 75 for like four days, or like $1.20 for like three days or something, that’s fine. That’s the preferable option. And if the market is ready for a 50-50 stable coin, right, 50% algorithmic and 50% collateralized, we’ll get there. We’ll get there in hopefully two months, maybe if not, the mark is already for months, right? But all the while that’s going on, Frax is being integrated places, the community is growing, people are learning about it. And so even if it’s 90% backed, still, you can integrate it in places, you can lend it, you can use it.

Sam:

We actually have some really good stuff in our roadmap that we haven’t really released yet, but one of the things that we’re possibly thinking of is either seeing if there’s kind of a partnership possible with Tornado or even kind of building our own implementation where it’s the first privacy-centric algorithmic stablecoin, fractional algorithmic and anonymous, which would be really cool. It would be a big undertaking but I think it’s actually possible, because from a technical perspective, for people watching this, the way Tornado works is that you have this anonymity set, right? You put in your ether and then you wait as people put in their ether, and then you take it out from another address, or even the same address, and people don’t know which anonymity set, which one you are from the set, right?

Sam:

And so if you think about how Frax works, minting and redeeming is kind of a big anonymity set, right? People are arming and minting and redeeming from this set of pooled collateral and shares being minted and burned and stuff like that. And so that’s a really good chance we have of creating something really unique there that I think it’ll be hard from a technical perspective, but in theory, it’s actually already there, and in theory, it’s already ready to kind of be a algorithmic and anonymous privacy-centric stablecoin in terms [crosstalk 00:33:11].

Tom:

That’s incredible, and I hope you guys roll that out. That’s really cool. And just to get it to the other side of this, while we have time, how do people earn more of the governance token? So, I’m on the site, and you could stake various Uniswap LP shares. Can you kind of go through how to stake what you can stake and what the rewards are and the unit that the rewards are in?

Sam:

Yeah. So, obviously, the rewards are in Frax shares. We have a really generous and early farming bonus in the Frax FXS pair, which is the stablecoin against the governance token, the classic kind of pool kind of thing. And if you look at it, the stats and everything are all on the front end. We tried to make the front end kind of like a big control panel, like the enterprise, like the Star Trek of algo stablecoins. And right now the API is just under 600%, which is pretty good in terms of it’s right there, in terms of high yield things, and we have about 10 million TVL in just that pair, just that pool.

Sam:

So, if you look at the other ones like Frax USDC. Now, the Frax USDC, one is only “yielding” 130% API, and it has 20 million value TVL, and a lot of people, a lot of farmers that kind of are like, they’re ESD or DSD farmers and they’re getting high three digit or four digit yield and stuff, they’re like, “130%. This is not worth my time or whatever.” But if you actually think about how stable Frax, the stablecoin is, as of right now it’s actually 95-ish percent USDC, that’s the truth, right? Against USDC, right? That’s the pair. That’s insane APY, right?

Tom:

And Sam, to your point, I mean, the 3,000% a year return on ESD and DSD that people are getting, I mean that war doesn’t take into account externalities. What if you earn that reward and then you go and you burn it for coupons and you lose your money because you’re not above one, then your yield is pointless?

Sam:

Yeah. Or literally, when something goes to 50 cents and you need to like exit, but you’re like, “Oh, geez, I’m like I aisles deep. I’m really hoping this recovers back to something so I can get out.” Again, the market dictates it, right? There’s 20 mil TVL here, and people are enjoying the 130% APY. The market’s not wrong. That’s what they like.

Tom:

And Sam, so the FRAX/FXS, so the stablecoin over the governance token Uniswap pool is like 4X the APY of the USDC pool. Do you think that that APY offsets the impermanent loss or the value of just holding it on its own? Because, for me, I would probably go into that pool, but if I think FXS is going to do well, I might incur a lot of impermanent loss. So, I’m kind of wondering your take there.

Sam:

Yeah. I mean, it’s always, you have to model out those things, right? Because the way of holding and being an LP and something that you’re long, you have to do the curve and see where you gain more. But I will say that we have an early farming and adopter bonus, that’s why the APY is so high, and it runs for another full week. We have a very unique thing called a collateral ratio boost. So, actually, the rate of FXS emitted for rewards across all of these pairs slowly increases as the collateral ratio goes down, so as Frax becomes more algorithmic.

Sam:

And the reason for that is, if people are starting to use Frax and stuff like that but it’s becoming less and less back, they might be like, “Oh, this kind of scares me a little bit, right? This might start becoming really loose around the peg. It’s going to 80% collateral ratio, 70, 60, 50 or whatever,” we actually incentivize people to provide more liquidity and get rewards so that it still becomes highly liquid, and as it becomes more algorithmic, people’s confidence can stay in step, because liquidity won’t disappear and people can be pretty confident because the admission slightly go up. It’s about the CR boost.

Sam:

So, if Frax is fully algorithmic, which I’m a pretty conservative person, I don’t think that’s going to happen anytime soon, and I don’t think it should because one of our very good value propositions is we never sacrifice stability, right? The whole point is the market sets the collateral ratio. We never sacrifice stability. I don’t think we’re going to get down there for a long time. Some people think it’s like a month or two or three. I think that it’s going to be at least a year, at least. But that’s okay.

Tom:

But Sam, just one quick question there, and not to cut you off, but just so I don’t forget. So, as you become more algorithmic or as basically get to a collateralization ratio near zero, the rate of admission of FXS increases by up to three times, but I mean, wouldn’t that mean that the supply of FXS would get used up pretty quickly?

Sam:

Yeah. So, it means also like the farming schedule speeds up because the protocol is growing and getting to its end state. So, we have the token distribution and all of the farming schedules and stuff, which is a pretty long term farming schedule. It’s like between one to three years, it’s a variable depending on how quickly it gets submitted. And we’re not like a lot of these anon launches that kind of distribute a lot of their token in the first month or two and then kind of don’t have any dry powder, don’t have any sedimentation. We like to think of this as more of like Bitcoin mining, right? It’s a long term game. And yeah, it does increase the admission rate, but it’s already modeled after like three-ish years, give or take, so it’ll last for a while.

Tom:

That’s awesome. I love that. And is there any way to tell how many people are time locking their stake, because I know that they could stake for up to three years, you get a bonus? Is there any way to show that? I know that it’s been big for Cream and Curve and others to do lock staking.

Sam:

Yeah. We took inspiration from them because I think it’s actually very important for people to be able to signal their long-term orientation of it, and no one is forced to do it, right? So, you can just stake and then unlock and leave and earn your awards and stuff. But if you want to be like, “Hey, I’m super long term on this. I want some more FXS submission.” I obviously have my personal farming stash three-year lockup.

Tom:

Good for you. That’s good to hear.

Sam:

And depending on the yield, the actual quickness you make back the principal becomes three times as quick. So, even if you think of it as something crazy, like, “I’m going to burn this.” You’re not, right? You’re going to get it back after three years. But in three years, crypto, everyone knows it’s like three decades, right? But if you even think about it, like, “If I burn this, I’ll never get it back,” it still is not that crazy of a calculation, because if you, for example, earn back your principal in the high yield Frax FXS pool let’s say in 100 days or something like that, if you 3X boost it, you’ll get it back in a month, 33 days, right? So, even if you’re just basically like, “Okay, that’s permanently gone,” which is not, you’ll get it back.

Tom:

Yeah. Those rewards are released automatically? Like if I decide to lock for three years, the rewards I get are not vested, I can use them, which is more of an incentive to lock?

Sam:

Yeah, yeah, exactly. So, you could actually just withdraw them at any time, do whatever you want with them.

Tom:

That’s pretty interesting. Yeah, no, it’s cool because most of the projects, I know like SNX, I don’t think they did boosted locking, but those forwards were obviously invested for a year, which is pretty cool.

Sam:

Well, the thing we think about is the thing you’re signaling is providing long term liquidity, and that’s enough to kind of show your commitment to it so that rewards that are continually coming to you, you can spend them, you can invest in them, or you can trade them for other stuff, because you’re already dug in, right? If you lock them, you’re providing liquidity basically, so yeah. So, we took inspiration from Curves locking and Cream.

Tom:

I like that. And Sam, just a couple rapid fire questions for you. I know I’ve had you for a while, but this is awesome. What happens in your mind when you get close to that supply cap being reached? Obviously, farming incentives would come to a halt, but the network might be… Basically, your rewards are algorithmic in a way, because if yield farming happens too fast, your protocol grows, if it’s too slow, you have more time for rewards, which is cool. But in your mind, what happens the day that you use up all your yield farming rewards?

Sam:

Yeah. I mean, like I said, we want to take a really long term approach to this, so we’ve obviously tried to make that last, but this is actually a Bitcoin question too, right? A lot of current Bitcoin design says, what happens when the block stuff is gone, right? What happens when transaction fees are the only thing keeping miners mining and their transaction fees are so variable, right, there’s no flat block subsidy?

Sam:

I think one of the cool things about Frax though, or any algorithmic design, to credit all of them, Basis, Cash, ESD, DSD and then Frax and stuff, is you’re an algorithmic central bank, right? So, if you have a governance action that’s like, “Hey, we’re going to issue bonds as incentives or something like that, or we’re going to issue more shares,” right? Because the share is already expanding and retracting in supply and capturing Seigniorage, you can do that much easier than something like Bitcoin, where kind of like the supply tap is part of the main enshrined social contract where it’s like, even if it becomes a very tough question, you really can’t go towards that too much. And one of the things is that, I think that with Frax we’re thinking of releasing a bond design in 2021, and it’s going to be much different than the current ESD coupons or the Basis Cash bonds and stuff like that. It’s going to auto convert to Frax on maturity. And we’re thinking of a highly liquid bond token so that we can encourage Uniswap pairs and liquidity for the bond token.

Sam:

So, right now, the issue with a lot of these bond designs, like ESDs and stuff, is that they’re not liquid, right? Actually, they’re not ERC-20 compliant, it’s like a balance in the smart contract that’s given to an address that burns ESD and stuff. We want to completely change the game in terms of our bond design and actually think of it as a debt primitive of an algorithmic central bank, right? And so we’re calling it the FXD token, which is basically… that should hopefully, if we design this right, make the bonds fungible, make them convert to Frax on maturity and get all these design things correct. It should be a highly, highly liquid debt primitive in this algorithmic system that should keep everything just as elegant as how it currently works, but then there’ll be a share token, FXS, which all final value accrues to. That’s the whole goal of having a share component. A debt component, which basically helps the system, kind of softens the hit of share inflation, right?

Sam:

Think of how debt works in the corporate world. You issue debt when you don’t want to have equity financing, right? And then there’s the stablecoin, the actual cash, Frax. And so that’ll kind of complete the whole system. And credit to the original Basis guys, Nader and Josh, and now whatever the Basis Cash guys are, they did think of a very elegant system in the sense that it does have debt, equity, and currency. I really do applaud them for that, is that it’s a good idea that none of the primitives are missed, right? You’re not just jamming a bunch of stuff into one thing.

Sam:

And one of my personal thing with ESD and the DSD, ESD design and stuff, and I’m sure they have the biggest galaxy brands there, and so they have a reason to do this, but just my personal take is, the stablecoin itself being used as the incentive for speculating on future growth of the protocol is self-defeating. If you’re trying to build a stablecoin that is hopefully going to, over time, have people confident to use it over USDC or whatever, why would you try to stabilize… it’s like speculation itself on top of the stablecoin. You want to actually extract as much speculative activity, as much trading other than it being used as a stable unit of account out of the token, right? You want to literally extract as much of the speculative value, put it in a value capturing token, a governance token and share token, some of it structured as debt for different types of investors or something like that.

Sam:

But that’s the main issue with DSD and ESD, is like it’s really powerful in terms of how quickly it can grow because stablecoin bootstraps itself, that’s the best way. But then the problem is the stablecoin is the thing that you speculate on the so called stablecoin growing.

Tom:

I think I know. I’m glad you bring that up. I definitely agree, in part, with you, and we could have a whole nother podcast on it. I do think it’s novel that they could kind of attract value to the token itself, it’s kind of simple, etc, but your risks are well noted. I guess my question for you is one step down the line. The whole goal of this is to have the most used, most adopted stablecoin around the world that is also stable, right?

Tom:

So, in my mind, when I’m looking at you guys, and look at ESD, just a high level view, it’s like, okay, ESD is rewarding so much to speculators that they can get to such a large supply quickly, and then hopefully, it’s adopted all over because the supply is so big. On your end, you’re more stable from the beginning but yields are lower so there’s less incentive for investors. That dichotomy between the two is super interesting to me because I’m trying to think of the end result of you guys kind of win because you’re more stable, but on the flip side, what happens if just they get there first and they permeate everything?

Tom:

So, I’m sure you think about that a lot and your your answer pretty much covers it, but I’m wondering if you had any thoughts on, I guess, just who gets adopted first, right?

Sam:

Yeah. I mean, well, the first thing is I love the guys at ESD and the biggest Galaxy brain is there, Scott, Dan, Will-

Tom:

They are, yeah.

Sam:

… plus Mike, who’s the guy leading the depth. So, they’re in the Frax community telegram group. They’re super smart. And actually, one of the things I always say is like, I don’t think the current algo stablecoin space is a zero sum game, because the pie is increasing in terms of mindshare and people realizing this is likely the next big thing in terms of design space in crypto, but everyone is gaining if they work together. Even if your slice of the pie of algo coin market share is staying the same, the pie is increasing super quickly.

Sam:

And so we have a really good opportunity to actually work together instead of kind of be tribal or beat each other down and stuff. My personal thing with ESD is they get the adoption thing, but the difficult thing is the speculative thing of making it stable, even though people are speculating on it, right? I try to talk to them and we share design decisions and things like that. And I think that everyone wins if we’re actually not being competitive, but we’re being cooperative. Frax share value, mint of Frax will increase over time, same thing with ESD.

Sam:

And one of the things I actually thought about with the recent Yearn mergers or kind of partnerships, whatever people consider them as, I could totally see some spectrum of formal merge partnership collaboration and stuff between the current three leaders in the algo stablecoin space of like Frax, ESD and Basis Cash currently it’s super cool and stuff, and there’s no reason why we can’t be very, very cooperative in terms of designing this kind of stuff. Now, the only non ANON team, I guess not a founder of any of the three projects is Frax, but-

Tom:

That’s a big deal, though. I mean, look, I had ESDon and I said the same thing, or Dan brought up a good point. He’s like, “Look, the whole space is built on an anonymous founder, Satoshi,” and I totally agreed with him, but in DeFi, I get scared because the founders just pick up and walk away. You’re on a pod here with your face out here, it goes a long way because you built Everipedia, you have a person and a brand, and I know you don’t want to lose that.

Sam:

Yeah. And also, people say ANON launch or that kind of stuff is way better, but you look at like Etherium right and how successful that’s been, there’s definitely the right ways to do it, right? And so for example, like Andre, all of his stuff, Wire and things like that, he’s not anonymous, and he can show up on these podcasts and talk.

Sam:

And the other thing is, as long as it’s clear that this is a protocol where we’re giving most of the tokens away to farmers, the team, obviously, is incentivized, we have both team tokens and some investors and backers, but most of the vast majority is given away to farmers. We’re here, we’re not anonymous. We have few owner keys for the first week or two or whatever, and you can probably be pretty sure, compared to everything else, that we’re not going to [inaudible 00:52:39] or something like that, right? And so the thing is you can’t be sure about that with ANON stuff, like you said. And so I think there’s good and there’s disadvantages, right? So, the disadvantages are like, I guess, what would you do in terms of regulatory stuff?

Sam:

I think that the whole goal with Frax is get it to a point where even if I got charged or something or whatever, I can’t actually do anything about it, right? Vitalik always says like, “If you put a gun to my head and say put edit Ethereum’s code or whatever,” it’s not going to do anything, right? And so that’s kind of what I go for and stuff. Same thing with Andre. If he was being told or coerced or even… I don’t know, legally told to-

Tom:

He was hacked at one point, and I mean, we all found out about it pretty quick. It was all over Twitter. Yeah.

Sam:

Yeah. It’s like you can’t do anything and it’s properly decentralized. Some people say, “Hey, why don’t you put your team or face on the frax.finance site and stuff like that?” And one of the things we like to say is like, that’s not the kind of vibe we go for. Everyone knows who we are, I’m here and stuff, but we don’t want it to have that like ICO vibe of like, “Meet the founder or whatever.” Andre doesn’t put his face on his-

Tom:

You guys are walking a fine line of like, “Here I am. I’m Sam the founder, but also my face is on the website because it’s a community on project.”

Sam:

Exactly.

Tom:

Yeah, that’s awesome. Sam, it’s been incredible having you on. I have to say, I did not understand the depth of Frax until I had you guys on, but I’m more of a learner from talking to founders. So, really appreciate your time. I hope I could have you on again soon, do an update, and just plug how to follow you and where to get involved with Frax while we’re at it.

Sam:

Yeah. I’d love to be on again. It’s fun. Huge Telegram community. I’m more of a telegram person than Discord, although we’re starting a Discord.

Tom:

I love that.

Sam:

I’m always on telegram, always on Twitter. Same username, Sam Kazemian. I’ll never DM you for crypto. And to reach me, I’m super available, Twitter, Telegram, soon Discord, Frax Finance, everything Frax Finance, myself at Sam Kazemian. So, thanks so much for having me on. Always a pleasure.

Tom:

Awesome. Thanks again, Sam.

Tom:

Hey, everyone. Thanks for listening to the podcast. If you enjoyed it, please support the show by hitting subscribe on iTunes, writing a review, or sharing this episode on Twitter and LinkedIn, and stay tuned for our next episode out soon.

Jan 5, 2021 | 56 minutes | Chain Reaction

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