Steering an Algo-Stable flywheel
Minting and AMOs are powerful engines. Learning how to harness them generates wealth and stability
Abstract
All fractionalized Algo-Stable coins can be understood as a blend of two key components: a fully backed stable coin and an unfunded Stable coin, each with its native engine:
1. The fully backed stable coin generates profits by investing or farming backing assets, particularly through Algorithmic Market Operations (AMOs). This approach is most effective when the market is bullish, with high farming returns.
2. The unfunded stable coin is backed by the protocol token. The Minter function burns the protocol token whenever new stable coins are minted. Burning the protocol token is most effective during bearish market conditions when the protocol token price is low. The minter operations are profitable if tokens are bought and burned at a lower price than they are issued and sold.
The essence of Algo-Stable tokenomics lies in the optimal combination and switching of the Minter and AMO functionalities to accrue, redistribute wealth, and create a persistent Algo-Stable flywheel.
This article delves into the risks, benefits, and best practices for utilizing Minter and AMO to illustrate how to generate a sustainable Algo-Stable ecosystem.
Summary
Algo-Stable tokenomics aims at defining the optimal use of value generating tools so as to accrue value in the protocol token.
Accruing value of the protocol token is crucial for DEFI’s incentives-driven expansion to last. Most protocols lack robust tokenomics and exhaust their resources renting mercenary liquidity, then falter.
Value accrual is the Grail and energy the flywheel needs. lack robust tokenomics that embrace the principles of value accrual.
This paper demonstrates the utilization of Minter and AMO, the two intrinsic value-creating tools of the Frax Algo-Stable protocol, within the framework of value accrual as outlined in the Value creation and destruction theorem.
A value-accruing use of the Minter and AMO tools can be simplified as follows:
- The Minter function is related to the equity (unfunded) part of the Algo-Stable. Minting the increased demand for the stable coin involves biuying and burning the protocol token. Burning is powerful when the protocol token price is low, this tool can kick-start protocols. Tokens burned must be reissued at a higher price.
- Farming reserves is most profitable when the market is “on” and the protocol token price is high. Then bribing consumes a minimal amount of protocol tokens. Increased demand for the stable coin is AMOed and fully collateralised.
:--------------::--------------::----------------:
: :: High Price :: Low Price :
:--------------::--------------::----------------:
: Circ. supply :: AMO :: Mint :
: UP ::(fully backed):: (burn token) :
:--------------::--------------::----------------:
: Circ. supply :: Minter :: de-AMO :
: DOWN :: (issue token)::(give usdc back):
:--------------::--------------::----------------:Simple accounting rules ensure that overall the protocol token supply shrinks and that value accrues.
Minter — a powerful tool to be used with caution
The Minter tool must be used with caution. To accrue value, the protocol must ensure that over time, DEUS is bought-back and burned (during DEI expansions) at a lower price than minted for DEI redemptions.
Figure 1: the Minter associated burn function is a very effective pump that can blowup if actioned at the wrong time
The Minter tool is quite powerful.
It can jumpstart an Algo-Stable protocol by burning a significant portion of the protocol token (e.g., DEUS) when its price is still low.
Over time, wealth accumulates in DEUS only if, on average, DEI is redeemed with DEUS re-issued at a higher price, so, an untimely use of the minter can lead to wealth dissipation. In fact, a decline in the DEUS price can lead to a situation where DEI is not fully backed.
Correlation between DEUS price and changes in DEI supply imply that an uncontrolled usage of the Minter function depletes the protocol wealth. The tipping point occurs when the DEUS realizable market cap falls below 10% of the DEI supply. Instant redeemability of DEI is then over.
The Minter tool is not sufficient either to accumulate value or to ensure stability. AMO as an alternative tool to meet changes in DEI circulating supply
A curve AMO to farm the backing reserves
When the demand for the stable coin increases, any new DEI can be fully backed, that is, created by a pure AMO function rather than by a Minter function.
The AMO first acts as a comprehensive wrapper for secure and fungible underlying assets like USDC. This makes it part of the stability tools.
The AMO also is part of the wealth generation tools. The USDC backing can be paired with free-minted DEI and farmed. AMO profits can be recycled as bribes incentives, protocol treasury, and to permanently burn DEUS.
Vocabulary:
- user-owned DEI is fully backed, redeemable, and called “outstanding DEI” (in the Frax vocabulary)
- free-minted DEI has no backing, is not redeemable but only “burnable”. It is called “protocol-owned DEI” in the Frax vocabulary.
Free-minted, protocol-owned DEI used in AMO is not redeemable for USDC
It can only be burned when demand for DEI falls. Free-minted DEI needs no backing — thus has no backing.
Protocol-owned, unbacked DEI entail no risk if they can be withdrawn whenever there is excess money supply. Therefore, it is possible to lend or farm protocol-owned DEI as long as these activities occur within a secure environment. By contrast, creating unbacked but fully redeemable money would create redemption risk, both onchain as in real world pegged economies.
Optimal AMOing is easy as a lego
Executing optimal AMO operations is straightforward. Value creation, value accumulation and stability goals can be aligned.
Consider the case of a booming market, where protocol prices and farming rewards are both high. Should an increased demand for the stable coin be met with the Minter or the AMO function?
- Buybacks and burns are not advised when protocol prices are very high. The use of the minter is not recommended
- By contrast, since farming rewards are also high in a booming market, AMO is recommended.
Friction contribute to both value and stability (Dei can be created at $1.01 and redeemed or withdrawn at $0.995 as soon as Dei demand falters and liquidity pools unbalance).
Minter and AMO used in this framework also contributes to stability: fully backed DEI AMOed allows for the eventual redemption of DEI without the necessity of minting and selling DEUS, particularly when market conditions deteriorate.
Implementation preview
Finally, since the optimal use of the Minter and AMO tools is time dependent,
- the protocol, not the trader, decides how to allocate the USDC backing.
- the public minter function can be killed altogether and replaced by a backing ratio management function
- backing ratio is managed in a counter-cyclical way.
(1) Financial Stability = Counter-cyclical capital ratio
(1) is my one-liner on 2k years of banking + 200k pages of financial stability research — see eg FSB, IMF, and Basel Committee@BIS )
Follow-up article will show how easy the implementation is for crypto.
The transparent management of reserves on-chain eliminates the need for banking-like regulation. This incentivises a meticulous implementation of well-established financial stability concepts.
Conclusion: optimal use of the Frax toolkit
Most Defi protocols have devised tools to attract value and kick-start a flywheel. Using value-creation tools within a wealth-accrual framework is a necessary condition for the long-term growth of an Algo-Stable protocol.
