Decentralized Stablecoin Fei: "Fattened" Ethereum, "Wasted" Arbitrageurs

This article is from Hive Finance, original title: "Fei (肥) Made Ethereum Fat, Fei (废) Made Arbitrageurs Waste."

The new stablecoin project Fei Protocol faced challenges right from the start. After its launch, it experienced significant market selling pressure, causing the stablecoin FEI to fail to stabilize at $1 and fall "underwater." As a result, most users who received governance token TRIBE airdrops and participated in the genesis mining found themselves trapped, describing it as being "stuck in a water prison."

According to the Fei Protocol white paper, when FEI is "underwater" at $1, selling FEI will devalue it; buying FEI will yield additional FEI rewards. If the market fails to help FEI return to $1, the protocol's unique PCV "vault" will perform a Reweight, forcing FEI back "above water."

On April 6, after a Reweight, FEI was once again hammered down. Returning to $1 has become a challenge for this stablecoin.

Controversy arose, and Fei Protocol founder Joey Santoro proposed five urgent solutions, with the core idea being to change the frequency of Reweight triggers to stabilize the price of FEI. However, some users believe that if FEI cannot enhance stablecoin consensus and increase use cases, relying solely on reserve funds for regulation is not a long-term solution.

Additionally, Shen Yu, co-founder of mining pool F2Pool, believes that since the value of assets in Fei Protocol's PCV is directly linked to ETH, once a bear market arrives, the assets controlled by the protocol may significantly shrink, posing potential risks to price stability.

FEI, which has been continuously underwater, is eroding market confidence. It intended to rely on market profit-seeking to adjust its price but could not withstand the panic in the market. At this point, a question was raised: among all stablecoins, who would use FEI?

1. Fei Sold Off, Whales Trapped in "Water Prison"

The hot new stablecoin project Fei Protocol is being criticized by participants due to the continuous price of FEI being below $1.

On April 7, FEI was quoted at $0.921, below $1, a state described by users as "underwater," just three days after the launch of Fei Protocol.

FEI's price dropped to $0.921

Earlier, Fei Protocol attracted significant attention due to investments from well-known institutions such as a16z, Framework Ventures, Coinbase Ventures, and AngelList. Even before its official launch, this stablecoin project had already gained fame.

According to the genesis launch rules, participants could deposit ETH through the Genesis page on the official website from April 1 to 3. At this time, users had two choices: either do nothing and wait for the protocol to automatically distribute stablecoin FEI equivalent to the value of ETH, along with a total airdrop of 10% of the governance token TRIBE; or users could exchange their deposited ETH for TRIBE on Preswap, effectively participating in an IDO while also receiving additional TRIBE airdrops.

In either case, the protocol ostensibly presented arbitrage opportunities to participants. If they chose the first option, investors could sell both FEI and TRIBE after receiving them, earning early bird profits from the value of TRIBE; the IDO method provided opportunities for TRIBE to profit in the secondary market.

The endorsement from well-known institutions attracted a large amount of funding to Fei Protocol. During the three-day genesis period, approximately 639,000 ETH flowed in, valued at nearly $1.3 billion. During these three days, ETH rose from $1,849 to $2,070, an increase of 12%. At that time, participants in Fei Protocol could not foresee its development, but it did boost the market demand for ETH.

After the genesis launch of Fei Protocol, regardless of the method, participating investors all joined a race against time. Since all the ETH contributed by users was converted into FEI and TRIBE, people had to sell before TRIBE reached its price peak to exchange back into hard currency crypto assets. And on the Ethereum network, racing against time is a technical skill.

Some technically savvy players used bots to quickly sell TRIBE for FEI and then sell FEI for ETH, causing both TRIBE and FEI to plummet, leaving most people trapped "underwater."

Some jokingly said that the whales wanting to arbitrage were trapped in a "water prison," and their current wish is to surface for air, but FEI has yet to "come up."

2. Stability Mechanism Unable to Compete with Users' Desire to Break Even

It is evident that Fei Protocol's new stablecoin experiment encountered issues at some point.

From the white paper, Fei Protocol's goal is to keep the trading price of ETH/FEI closely following the price of ETH/USD while maintaining high market liquidity, thereby ensuring that the price of FEI always corresponds to the price of the dollar.

Its method of maintaining high liquidity is quite unique. Fei Protocol created the concept of Protocol Controlled Value (PCV). Unlike the Total Value Locked (TVL) that DeFi users are more familiar with, PCV is controlled by the protocol, and users cannot withdraw it at will, ensuring that FEI does not become decoupled due to liquidity exhaustion.

FEI-ETH liquidity pool funds rank first on Uniswap

The existence of PCV determines the genesis launch method of this stablecoin project. After raising 639,000 ETH, Fei Protocol minted an equivalent value of FEI and added them to the Uniswap FEI-ETH liquidity pool. After the genesis ended, the FEI-ETH trading pair boasted over $2.5 billion in liquidity, ranking first among all trading pairs on Uniswap.

However, ensuring high liquidity alone is not enough to maintain FEI's price stability at $1. Therefore, Fei Protocol proposed the concept of Direct Incentives. According to the white paper, "Direct Incentives" means that trading activities and the use of stablecoins are incentivized, and "rewards and penalties" will drive the price of FEI toward the pegged direction.

In simple terms, if FEI is below $1, users selling FEI will face penalties, with a portion of FEI being burned, devaluing the FEI in users' hands; the lower the FEI price, the greater the loss when selling FEI. At the current price of $0.921, the "burn rate" for selling is as high as 72.48%; if users buy FEI "underwater," they can receive additional minted FEI as a reward. However, the reward coefficient is lower than the penalty coefficient.

A large amount of capital trapped in the "water prison" is hesitant to sell due to the fear of "penalties." According to the white paper, if FEI does not return above water for a long time, PCV will step in to solve the problem by using the Reweight mechanism to exchange funds from the vault for FEI, bringing FEI back to $1.

The white paper provides an example. In a Uniswap asset pool priced in FEI/USDC, the current liquidity depth is 1100 FEI:1000 USDC. In this example, the price of FEI is less than 1 USDC. Fei Protocol would use PCV to spend some USDC to buy FEI, making the price of FEI equal to 1 USDC.

What seems to be a seamless price stabilization mechanism ultimately failed due to the strong willingness to sell FEI in the market and panic emotions. On April 6, PCV had already performed a Reweight, resetting the price and reward rate of FEI. However, many players waiting to sell FEI immediately hammered it back underwater.

"The feeling of being imprisoned is unpleasant; now everyone wants to exchange FEI for mainstream coins. Although it is positioned as a stablecoin, we don't want to hold it like we do with USDT," a player complained to Hive Finance, expressing panic over FEI's performance and a desire to recover their principal.

Influencer Blue Fox believes that while the PCV model locking ETH is not problematic, the method of attracting users through airdropping TRIBE tokens is flawed, as many users may not understand what is happening and think it's just free tokens, leading to a lack of confidence.

3. Officially Proposing 5 Solutions for Community Discussion

Fei Protocol, which intended to rely on market arbitrage mechanisms to stabilize its price, found itself in an awkward position due to the market's urgent escape sentiment. Compared to over-collateralized DAI and centralized stablecoins like USDT and USDC, the market recognition of FEI seems relatively low.

In the Fei Protocol community, some impatient users expressed that they might as well propose to split the funds in the PCV and part ways. Others believe that as a stablecoin, if FEI is below $1, wanting to use it to buy ETH should not incur penalties, "it's too unreasonable."

In response to external controversies, Fei Protocol founder Joey Santoro stated that the main reason for FEI's price being below $1 is that there is a massive amount of FEI in circulation, and its current use cases are very limited, leading to significant selling pressure. Additionally, since direct incentive measures are also in effect, market buying behavior has delayed the timing of Reweight.

Joey Santoro proposed the following five urgent improvement proposals to help FEI better achieve its goal as a stablecoin.

1. Use a Guardian mechanism to force trigger Reweights, allowing people to sell FEI. This may be a bit clumsy as it will cause FEI's price to fluctuate, but it can be done immediately.

2. Increase the growth rate of rewards, which may ultimately lead to a situation where there is substantial buying support and inflation, keeping the price around $0.90.

3. Set a predefined rhythm for Reweight, such as every few hours or whenever the price falls below a certain percentage. This requires contract changes and DAO voting.

4. Use ETH reserves more directly to stabilize the price of FEI, which requires more substantial contract changes, and the entire process of drafting, reviewing, and voting may take 1 to 2 weeks to complete.

5. Limit the percentage of burning to 2% to 5%, which can accelerate Reweight and simplify integration.

In response to Joey Santoro's proposals, some community users believe that changing the frequency of Reweight triggers is a good solution, as there is a large amount of funds in the PCV that can quickly help FEI return to $1; others feel that relying solely on Reweight does not actually solve the selling pressure issue, and enhancing FEI's use cases and consensus is the long-term solution.

In Shen Yu's view, co-founder of mining pool F2Pool, the PCV of Fei Protocol is not omnipotent, as the funds in the PCV are directly linked to the price of Ethereum. If ETH experiences a sharp decline, it will lead to a decrease in the value of PCV, making it easier for the protocol to exhaust its assets in a bear market.

He believes that the essence of the governance token TRIBE is to control the assets in the PCV. If ETH declines and the PCV assets shrink, the price of TRIBE is also likely to drop. Investors should reasonably assess the risks when buying TRIBE.

Born with a golden spoon, Fei Protocol has gradually faded from its glory within just a week. Looking beyond its PCV mechanism, merely relying on market arbitrage to stabilize the price has proven ineffective. Especially when the price remains below $1, people's confidence will weaken, and buyers seeking rewards may decrease. This has been validated in previous algorithmic stablecoins.

In the past, people have always hoped to create a decentralized stablecoin without over-collateralization through market profit-seeking, yet the so-called new stablecoin Fei Protocol still fails to grasp human nature. Seeing that FEI has yet to "come up," someone left a question on social media: among all stablecoins, what reason do users have to choose FEI?