FEI Protocol: What actually happened? Can it be fixed? Investors demand answers.
“It was the best of times…and the worst of times “— wisdom, foolishness, belief and incredulity.. all available in a new stable-coin.
SUMMARY
A new stable coin ($FEI) was launched with pre-investment from Coinbase and Andreesen Horowitz amongst others. The launch successfully raised over US$1BN but some retail investors cried foul as they lost money on the launch (see below) and the stabilisation mechanism struggled (and continues to struggle) to keep the value anywhere near US$1 per token.
**UPDATE — see end of article — the vote is in!**
STABLE COINS — HISTORY
In the beginning, there was ‘Crypto’ and it was volatile. With almost clockwork regularity the price of crypto changes on a daily basis with swings of 3–6%. You can look at this compared to some typical currency pairs over time on this useful website. The consequence of this is that crypto currency as a ‘means of payment’ is practically useless, as the price changes in the time it takes to write this paragraph meaning that anything agreed in crypto-pricing will have almost certainly changed (in fiat terms) by the time the trade can be executed, leading to uncertainty and very few business models, deals or goods being sold with actual crypto currency pricing.
Some thought the best solution was to create ‘stable’ coins which were pegged to (almost exclusively) the US Dollar. The $FEI creator mentions these predecessors in the white paper, highlighting the weaknesses of the prior stable coins. In the case of fiat-backed stable currencies (like USDC & USDT) , this is ‘centralisation’ meaning that just like in the case of ‘Napster’ , men in suits could appear one day and switch the power off. In the case of DAI and sUSD the limitation is that in order to deal with the potential of a 20–30% drop in a day or so there has to be a significant ‘reserve’ of untapped liquidity and even then when there is a large price drop, things can become very difficult meaning the DAI price has touched extremes of $1.05 as well as $92.5 but has been more stable in recent months.
FEI PROTOCOL
So, to create something better than both of these stable coin methods along came the ‘FEI protocol’, brain child of Joey Santoro , which promises to be both decentralised and capital-efficient. This introduces ‘Protocol Controlled Value’ ( PCV) where the Protocol actually controls the pricing of transactions on ‘incentivized’ addresses — in the first instance being the massive $2Bn ETH/FEI liquidity pool.
This allows ‘incentivised-pricing’ where rewards or penalties can be applied to the traders in order to manage the FEI price and keep it within a reasonable range of the $1 peg. This is known as ‘Mint’ and ‘Burn’ ;
The net effect of this is that when the price drops, sellers are BURNED and buyers get MINTED with the plan being that this mechanism keeps the price close to the peg.
This is in contrast to the normal functioning of the UNISWAP (V2) liquidity pools, which use a constant product formula without any ‘penalties’ or ‘rewards’ meaning where a large price disparity appears between the pool and external pricing, participants are free to close this gap without penalty.
FEI GENESIS LAUNCH
All good so far? Next comes the launch which was detailed here. This set a target of 100M Fei with a starting price of $0.50 and topping out at $1.01. The governance token ($TRIBE) was also set with100M limited as an allocation linked to the ‘Genesis’ participants. There was also the chance to ‘pre-swap’ $FEI for $TRIBE before the launch. The sale was a spectacular success and over $1Bn $FEI was sold. How did that affect the bonding curve limits and the TRIBE allocations? Well, it made the $TRIBE allocations completely different from planned and some investors ‘made out like bandits’ (650 ETH in this case) and others got ‘rekt’ .
At first the champagne corks popped, UNISWAP total liquidity jumped by $2Bn and the new FEI coin was born. With around $500m the FEI/TRIBE pair and $2.5Bn in FEI/ETH the project had launched almost instantly and had almost US$1.5B (effectively) in circulation.
Then the cracks started to appear with the earliest contributors complaining that they as the most loyal supporters had effectively paid $3.20 for their $TRIBE tokens instead of the launch price of $1.30. Most detailed explanation here . It feels like the calculations were all done for a raise up to US$100m but the huge oversubscription wrecked the planned dynamics of that allocation and the smarter swappers made money and those who just ‘bought in to a good project’ appear to have lost out.
One of the challenges in launching a new coin and especially a new ‘boring’ stable coin is how to get your first hundred million — why would anyone trust your coin to be stable? What incentive could there possibly be for buying a $1 coin for well… $1? There has to be a promise of ‘free stuff’. In this case it was the $TRIBE token and an allocation of that for all Genesis (launch sale) subscribers. The subscribers could opt for 0%, 50% or 100% pre-swapping of $FEI into $TRIBE. Because of the over-subscription and the penalty / incentive mechanics there was an opportunity to sell immediately on launch before the price changed and the penalties made this punitive. As might be expected, the bigger, smarter sellers did just that, with this one contributing 3000ETH to the Genesis pre-sale and then immediately selling everything to get 3650ETH back. It did cost $10k gas to do it — but totally worth it I am sure.
It is nothing personal and just business being ‘what markets do’. Mercenary capital turned up and overloaded the launch to make a fast return because why not?
Then, as all the cashing out closed the price started dropping and investors who were not so quick or were just ‘believers’ in the cause, were soon trapped by the large penalties to get out.
More explanation from a Cornell University Professor, here. To summarise his comments the token escaped from its ‘price feasibility envelope’ and at this point liquidity dried up because no-one wanted to move or they would get ‘punished’ and this affects both buy and sell. So the algorithmic method for balancing stopped working. At this point there was an imbalance of US$200M between ETH and FEI in the pool (here is a snapshot);
(All being well, the amount of FEI and the amount of WETH in dollar terms should match or close to it)
Between the 5th and 6th of April, a vulnerability was discovered in the ‘incentive calculation’ and for a while both ‘burn’ and ‘mint’ incentives were turned off, meaning the pool behaved normally and the price equalised with the external prices.
As at the time of writing, the pool is almost in equilibrium at a price of US$0.7941 and getting closer;
This is good, but still miles away from the $1 value intended for the token and the intended zone for automated stabilisation.
To echo the sentiment of the Cornell Professor — “this was a fascinating experiment from a well-intentioned and good team… There are countless ways to recover from here.”
The team are working on these now and have not ‘run away’ or run off with the money and have been transparent in their efforts to fix things. The good news ( and I realise that this is of little comfort to buyers of a $1 stable coin sitting 21% down) is that there is still plenty of PCV and liquidity in the pool (almost $2Bn at this point) meaning there is no massive panic.
The latest is that the team have offered a proposal for the TRIBE token holders to vote on as a path forward which involves sacrificing up to 300K ETH (~$630M) of the locked PCV to exchange for FEI at $1, $0.90 or not to proceed. Currently the voting looks as follows ;
Some users are hesitating on the basis of “why trust the team this time?” Others are more understanding and see this as a willingness from the team to offer a democratic and equitable solution.
Time will tell — click here to see the latest vote update which finishes at 4pm Pacific time on Tue 13th. More to follow on this article.
*UPDATE — The vote is in!**
The vote has closed with the following results;
Having looked at the addresses which voted, I can confirm that the majority of addresses, voted roughly in the same proportions to the token count.
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Credit: Written by David Henderson for Novum Insights.
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