Analysis of the Fei Protocol <> Ondo Finance LaaS Program
The Treasury Working Group will provide a review of Fei Protocol, Ondo Finance, and the implications for PoolTogether if 1.5mm in POOL is allocated for the LaaS program.
In each section, we’ll talk about the core protocol mechanics for both Fei and Ondo, the use of oracles in each protocol (if applicable), security measures taken by each protocol, and any underlying protocols used in the LaaS program.
If you’d rather not read the analysis, you can scroll to the bottom and read the TL;DR summary.
Fei Protocol Overview
Fei Protocol was launched with the mission of creating a decentralised stablecoin that is backed by decentralised assets held as protocol controlled value (PCV), or assets that cannot be redeemed by users. On October 6, 2021, Fei Protocol announced Fei v2, which provides upgrades that will improve the stability, efficiency, and scalability of FEI within the DeFi ecosystem. Fei v2 is slated for launch on December 15. This launch will be more of a rollout according to storm | Fei.
With Fei v2, users are able to redeem FEI for ETH or DAI on a 1:1 basis. The functionality to redeem for ETH was implemented after FIP 26 was passed, which enabled users to redeem FEI to ETH with a 0.5% spread. Anyone can go to Fei Protocol and exchange FEI for ETH; there is a limit to how much ETH is available on this page, which is displayed in the dApp. Fei v2 targets 100% reserve ratio, which is set through governance. As new FEI is minted, reserves are brought closer to the 100% target ratio.
We outline the makeup of Fei’s PCV in the sections below, but there are a variety of assets held by the protocol that back FEI. Of the assets held by the protocol, 75.5% are productive assets with 15.8% in total provided as liquidity across Uniswap V2 and Tokemak; ETH and DAI deposited in Compound make up 30.3%; ETH deposited in Aave make up 20%; and stETH makes up 9.4%.
A Balancer V2 investment pool will be used to manage volatility risk, though this pool is not yet live. Balancer’s Smart Pools allow for the creation of dynamic pools that can serve a variety of use cases. In Fei v2, a Balancer Smart Pool will be used to rebalance into stable assets like DAI/RAI algorithmically as the collateralization ratio moves closer to 100%. As the collateralization ratio moves higher, the pool can rebalance into other assets like ETH, stETH, DPI, AAVE, etc. The Balancer Smart Pool integration is expected in Q1 2022.
This method replaces the original bonding curve mechanism used when Fei Protocol first launched. By using a Smart Pool and holding a diverse amount of assets, with ETH being the majority of the backing, Fei Protocol has a strong system in place to ensure FEI does not de-peg. The PCV includes a variety of low-risk productive assets, which allows the PCV to steadily grow over time.
De-peg Risk/Use of Oracles
Fei Protocol uses Chainlink oracles for price feeds. In the Fei Protocol documentation, they show addresses for ETH-USD, FEI-ETH, FEI-USD, DAI-USD, DPI-USD, RAI-ETH, and RAI-USD Chainlink wrapper oracles. According to Eswak | Fei, the protocol only uses Chainlink oracles. In this comment, he also says that the protocol has limited proxy contracts and indicates that contracts are replaced as the protocol is upgraded.
Given that Fei uses decentralized price feeds and primarily uses immutable contracts, the protocol has robust protections against potential attacks. Their upcoming use of Balancer Smart Pools will enable the protocol to algorithmically rebalance into stable assets as the collateralization ratio approaches 100%. When coupled with 1:1 redemption for ETH or DAI, the peg mechanism appears to be quite strong. The greatest threat to a decentralised stablecoin is a potential situation where the stablecoin becomes undercollateralized, given Fei’s model. The upgrades coming with Fei v2 will provide robust protection against a de-peg event.
However, in a situation where Fei de-pegged, PoolTogether would see considerable losses. It would be highly improbable that FEI would go to zero unless a catastrophic failure in the protocol were to occur where the PCV was completely lost. In a more realistic scenario, FEI would de-peg according to the collateralization level.
With the information included in Fei’s v2 posts, the model in place should provide robust protection to ensure the FEI achieves a 1:1 peg.
Security
The protocol has been audited previously. Audits were conducted by OpenZeppelin and ConsenSys Diligence. Fei Protocol has a bug bounty managed by Immunefi with a critical vulnerability payout up to $1,000,000 USD.
This shows that Fei Protocol has taken steps to ensure the protocol is secure. With Fei v2 close to launch, additional audits are underway for the v2 upgrades.
Fei Supply
Total supply of FEI is 705,775,968 with 365,514,237 FEI owned by Fei Protocol and 340,261,731 FEI not held by the protocol.
Fei Protocol Analytics, PCV, and Protocol-owned FEI
You can review Fei Protocol analytics here: Fei Protocol
This page provides a breakdown of the protocol controlled value (PCV), which are assets held by the protocol that are not redeemable by users. Below is a breakdown of Fei’s PCV:
Source: Fei Protocol
There’s also a breakdown of the Protocol-owned FEI, which is included below. Note that 42% of the $365.51mm is allocated to FEI-ETH LP on Uniswap V2. There’s $308,803,847 USD in total liquidity with 154,494,957 FEI paired with 32,626 ETH.
Source: Fei Protocol
Ondo Finance Overview
Disclaimer: sections of this review were included in a previous comment on the LP Partnership with Fei forum post. Certain information has been changed, updated, and included to provide a more in-depth review for this proposal.
We will give a very high-level view of how Ondo operates, potential benefits, and any possible concerns for the PoolTogether community.
Vaults, Subscriptions, and Positions
Anyone can review the Ondo Finance docs for a more in-depth review of the protocol. For simplicity sake, we will cover the essentials using Ondo’s terminology.
If anyone here is familiar with BarnBridge and their SMART Yield product, then you’ll be able to get a handle on Ondo. While BarnBridge uses lending/borrowing protocols as the underlying yield source/money lego, Ondo Finance uses AMMs as the yield source. With AMMs, pairs can benefit from periods of volatility and increased trading, and if there are yield farming incentives (e.g., on SushiSwap), the vault can benefit from subsequent higher yields.
With the LaaS programme, FEI is put into the fixed-yield position, or senior tranche, and for PT, POOL would be put into the variable-rate position, or junior tranche. The pair is then paired and put into a Uniswap V2 pair for a subscription period, or a fixed timeframe where the pair is in an LP until a set maturity date.
The pair then earns trading fees during the subscription period. At maturity, the pair is removed and the interest is split between the fixed-rate and variable-rate positions. The interest rate the fixed-rate position earns is referred to as the “hurdle.” Based on @leighton’s comment on the proposal, Fei Protocol gets back all of the FEI plus a fee equal to 5% annualized APR on the Fei contributed.
Smart Contract/Technical Risk
Ondo Finance has been audited by three separate firms. Everyone can review the Quantstamp Audit (Sept. 2021), Peckshield Audit (May 2021), and Certik Audit (April 2021) in Ondo’s docs, which has already been linked above but it’s included here for reference. To my knowledge, there isn’t an active bug bounty programme for Ondo Finance.
TRIBE Rewards/Fixed-rate hurdle/IL Review
We consulted with @bpm6867 and confirmed that TRIBE incentives will be provided for the first three months, or 13 weeks, of the LaaS programme. The programme started one week ago, so PoolTogether would, at best, be eligible to earn at least 100,000 TRIBE if POOL/FEI were deployed within the next two weeks. Brianna indicated the 10AP per 1mm in liquidity translates to 10,000 TRIBE per week in rewards. Fei Protocol’s Allocation Points are used to determine the weight, or allocation, of where TRIBE rewards are distributed on a per-block basis. If PoolTogether were to deploy $1.5mm in POOL, then the protocol would earn 15 AP.
To be more precise, Fei Protocol has a schedule for TRIBE emissions, which decays over time. The LaaS programme started on 29 November: assuming 13 weeks equals 91 days with the assumption that PoolTogether would deploy POOL/FEI on 20 December, the protocol would earn TRIBE rewards for 69 days total, which would translate to the values included in this Google Sheet or the image below with the current price (at time of writing) of $1.04/TRIBE:
The total return would be 7.33% (105,704.217 TRIBE valued at $109,932.59) over 69 days; annualised, this would be 38.77% APR. While PoolTogether would only earn TRIBE rewards for 69 days of the subscription period, subscription periods are monthly, so we need to assume a three month subscription to project the cost of the hurdle.
With a hurdle at an annual cost of 5% APR, PoolTogether would pay Fei Protocol $18,698.63 assuming a subscription period for 91 days. If PoolTogether experienced impermanent loss (IL) totalling 6.08% ($91,233.96), this would leave the protocol net zero when TRIBE rewards are considered. With a higher TRIBE price, this leaves more room for IL; with a lower TRIBE price, it leaves less room.
Now, consider that PoolTogether is paying 200 POOL per day to Uniswap V2 LPs. Given 91 days at 200 POOL per day, we’d be paying 18,200 POOL for liquidity, which at current prices ($6.95/POOL) is equal to $126,490.
Take the $126,490, add it to the $91,233.96 in TRIBE rewards after the hurdle, and PoolTogether would have to experience $217,723.96, or 14.51%, in IL to equal the current cost of liquidity.
What are TRIBE tokens and what can we do with them?
TRIBE rewards are a safeguard that could cover our losses if significant POOL is lost in the POOL-FEI LP. TRIBE is the governance token of Fei Protocol that is used to manage PCV. How can we best manage the TRIBE rewards we would be receiving?
Selling TRIBE For POOL. If PoolTogether decides to go ahead with this proposal, one option would be to sell the TRIBE we are earning. If our plan is to sell the TRIBE back for POOL, then this may not be seen as building toward a mutually beneficial relationship between our DAOs. PoolTogether should consider how the sale of TRIBE would potentially impact partnerships with other DAOs. PoolTogether’s actions could be approached in a way that can benefit both parties and selling our TRIBE rewards could be seen as a non-ideal scenario for Fei Protocol.
Using our TRIBE As Voting Power and to earn interest. Instead of selling our TRIBE rewards, we could become an active participant in Fei Protocol governance and use our TRIBE tokens to help shape our relationship in a way that could benefit PoolTogether. Fei Protocol is currently in the process of negotiating a merger with Rari Capital, which could be a further reason to build this relationship as PoolTogether could use TRIBE to vote in favour of a whitelisted Fuse pool where POOL and/or tickets could be used as collateral to borrow other crypto assets. Establishing PoolTogether in the Fei Protocol community could be a strong path forward to growing POOL and the PoolTogether community. Getting involved in other protocol’s governance is a way to help grow our ecosystem.
PoolTogether could potentially stake TRIBE or TRIBE/FEI in an LP with the ability to vote via snapshot in TRIBE governance proposals. Currently 31.7% on TRIBE staking and 49% on the LP. Standard liquidity provision risks apply. If TRIBE price were to go on a run, the LP would be selling off our TRIBE tokens to FEI. If TRIBE were to tank, we would be buying more on the way down. If one of our goals is to secure voting power, it would probably be wise to stick with the safer and still very lucrative single-sided option.
Potential Benefits of LaaS
- Creates deeper liquidity for POOL on Uniswap V2
- May result in a financial gain for the treasury
- May allow the protocol to transition away from POOL drip for LPs in the future
- Opens the possibility for further collaboration with Fei Protocol
Potential Drawbacks of LaaS
- Could result in a financial loss for the treasury
- TRIBE rewards could drop in value
- Variable-rate position exposes POOL to more risk
TL;DR | The LaaS programme is beneficial for PoolTogether and complements the Olympus Pro bond sale initiative. PoolTogether would earn TRIBE incentives for participation in the programme, but these rewards only last for the first 3 months of the programme. Assuming PoolTogether and Fei deployed POOL/FEI totalling $3mm in liquidity on 20 December: the total return would be 7.33% (105,704.217 TRIBE valued at $109,932.59) over 69 days; annualised, this would be 38.77% APR.
With a hurdle at an annual cost of 5%, PoolTogether would pay Fei Protocol $18,698.63 assuming a subscription period for 91 days. If PoolTogether experienced impermanent loss (IL) totalling 6.08% ($91,233.96), this would leave the protocol net zero when TRIBE rewards are considered. With a higher TRIBE price, this leaves more room for IL; with a lower TRIBE price, it leaves less room.
Now, consider that PoolTogether is paying 200 POOL per day to Uniswap V2 LPs. Given 91 days at 200 POOL per day, we’d be paying 18,200 POOL for liquidity, which at current prices ($6.95/POOL) is equal to $126,490.
Take the $126,490, add it to the $91,233.96 in TRIBE rewards after the hurdle, and PoolTogether would have to experience $217,723.96, or 14.51%, in IL to equal the current cost of liquidity.