Is it stable or unstable? Star institutions succumb to death spiral, Fei Protocol suspends incentive mechanism to stabilize price

Fei Protocol, an algorithmic stablecoin project backed by notable institutions such as Andreessen Horowitz (a16z), Framework Ventures, and Coinbase Ventures, successfully raised 639,000 ETH. However, it quickly found itself in the dreaded "death spiral" common to algorithmic stablecoins. Amid continuous criticism and vulnerabilities, Fei Protocol has decided to implement some "emergency measures."

What is "Algorithmic Stablecoin"

"Algorithmic stablecoins" are different from asset-backed stablecoins like USDT and USDC, as their price is determined by the market and approaches the target stable price through various currency inflation/contraction measures. For example, when an algorithmic stablecoin is priced higher than the target price, holders of the stablecoin will receive additional tokens on the platform, motivating holders to sell the stablecoin at a premium price, thereby stabilizing the price.

However, the most challenging issue is how to incentivize the market to invest funds when the price falls below the target price, in order to bring the coin price back to the target anchor price. Various algorithmic stablecoin projects have introduced different mechanisms to incentivize actions, but it is currently difficult to determine if anyone has truly succeeded.

The main reason for the need for algorithmic stablecoins is mostly to have a decentralized stablecoin that is not subject to audits, not tied to other assets, and has high capital efficiency.

Fei Protocol's Basic Defense Failure and Remediation

Fei Protocol's approach to dealing with being "below the anchor price" is primarily through a "reward and punishment mechanism," where those selling the stablecoin FEI are required to pay additional penalties, while buyers receive additional rewards.

This mechanism faced strong selling pressure on the platform's launch day: "Fei Protocol's Performance is Poor, What's Next? How Are People Evaluating?" FEI quickly fell below the anchor price, and the governance token TRIBE also significantly dropped in value.

On April 7th, Fei Protocol announced the discovery of a protocol vulnerability and suspended the distribution of rewards for buying FEI:

The team was made aware of a vulnerability this morning through our bug bounty program.

We evaluated its viability, then used the protocol's safeguards to suspend mint rewards on $FEI buys to ensure the protocol and PCV are secured.

— Fei Protocol (@feiprotocol) April 7, 2021

There were even situations where selling FEI would result in a Sell Burn Rate where the penalty exceeded the principal, while the buying reward was 0.

On the morning of the 8th, Fei Protocol stated:

"We hear you. We are working on stabilizing and focusing on development." Fei Protocol implemented two measures: closing the token burn reward and punishment mechanism and allowing the community to decide to use the Protocol Controlled Value (PCV) of $1 billion, which currently has a value lower than $1 billion, to support FEI and TRIBE.

We’ve heard your comments. We’re focused on getting to stability and building from there:

➡️We have turned off the burn incentive as a step to address the vulnerability disclosed yesterday.

➡️The community can wield the $1B+ in PCV to support FEI and TRIBE.

— Fei Protocol (@feiprotocol) April 7, 2021

The so-called PCV is composed of the funds raised by the project initially. According to Fei Protocol, it will be used as follows: to support FEI in a straightforward manner.

This high-wire act of an algorithmic stablecoin drama is far from over, and we will continue to follow and report on it.