Here is what we are going to cover:

• The basic framework of an AMO
• Collateral Investor AMO
• Liquidity AMO
• Curve AMO
• Lending AMO

This article goes in-depth in explaining the AMO structure and how FRAX v1 is broken into sub-structures of the same AMO structure.

Implications and operation of different AMOs.

If this simple reading layout doesn’t excite you, you could scroll down to consume the same content as if it were a magazine.

⚠ Disclaimer: All information presented here is my perspective and should be considered educational content. I won’t be responsible for any kind of financial profits or losses derived from your decisions. Financial and investment advice

Algorithmic Market Operations Controller (AMO): The concept

While Frax v1 introduced the concept of a fractional algorithmic stablecoin, Frax v2 introduces the building blocks, simple mechanisms that are used as value accrual vehicles for $FXS.

AMO controller is intended not to lower the collateral ratio and change the $FRAX price by altering the supply.

If and when the $FRAX price is above $ 1, the CR is lowered, the $FRAX supply expands like usual, and AMO controllers keep running. If the CR is lowered to the point that the peg slips, the AMOs pause all market operations, and the system re-collateralizes just like before as $FRAX is redeemed and the CR goes up to return the peg.

Every AMO has 4 aspects (an example of Frax v1 as an ideal AMO controller is provided in each aspect):

Decollateralize:

The portion of the strategy which lowers the CR can be considered as an investment of collateral assets to accrue value to the protocol.

FRAX v1: When the price of $FRAX is greater than $ 1, the protocol lowers the collateral ratio.

Market operations:

The portion of the strategy where market operations
are carried out to generate yield without altering the CR.

FRAX v1: The CR is not altered until the price deviation occurs.

Recollateralize:

The portion of the strategy which increases the CR. Basically squaring off the investment positions to serve as backing or for redemption.

FRAX v1: When the price of $FRAX is lower than $ 1, the protocol increases the collateral ratio.

FXS1559:

A mechanic that accounts for the excess collateral and thus the quantity of $FXS to be burned.

FXS1559 calculates all excess accumulated profits that are above the collateral ratio and it is used to mint $FRAX in proportion to the collateral ratio against the value. It then uses the newly minted $FRAX to buy $FXS off of the market to burn it.

As per governance voting (Oct 2021), FXS1559 moves 100% of AMO profits to veFXS yield.

The idea behind the proposal was that burning gives sellers a chance to exit while increasing the $veFXS yield incentivizes users to hold their $veFXS positions for multiple years.

FRAX v1: Excess collateral value is used to generate value towards $FXS.

AMO Controller: Collateral Investor

The Collateral Investor AMO uses the idle USDC collateral to invest in the selected DeFi protocols that provide reliable yield.

As of July 2022, the integrated protocols include:

The ability of AMO to instantly withdraw the invested position in order to facilitate the FRAX redemption does not allow the CR to drop lower. Thus this satisfies the AMO requirements/aspects discussed earlier.

Investments that cannot be immediately withdrawn lower the CR calculation.
AMO can operate as intended unless CR is forced to lower and in a case where CR is forced to drop, the AMO halts and squares up the positions.

Decollateralize - The AMO invests idle collateral in various yield-generating protocols

Market operations - The AMO earns rewards on the investments made in other protocols

Recollateralize - The AMO withdraws investments from vaults to free up collateral for redemptions.

FXS1559 - Revenue earned that places the protocol above the CR is distributed to $veFXS holders.

AMO Controller Liquidity

Similar to collateral investor AMO controller, the $FRAX is minted to pair it with other stable assets and is made available for liquidity pools across different AMMs. The operations are carried out without altering the CR.

$FRAX is paired with collateral and supplied to liquidity pools. The collateral ratio would not drop due to the AMO operation as the $FRAX that will go into the market will be swapped with an asset and this swapped asset will act as a backing for that $FRAX.

Decollateralize -The AMO deposits idle collateral and newly minted FRAX in the liquidity pool.

Market operations - The AMO accrues transaction fees and swaps between collateral types.

Recollateralize - The AMO withdraws the liquidity, burns the $FRAX, and returns $USDC to increase the collateral ratio.

FXS1559 - Revenue earned that places the protocol above the CR is distributed to $veFXS holders.

AMO Controller: Curve

Frax finance owns the FRAX3CRV metapool and it allows the Curve AMO controller to set and collect admin fees.

The AMO controller can move idle $USDC collateral or newly minted $FRAX to its own Curve pool to deepen the liquidity and tighten the peg while earning revenue.

The Curve AMO can put $FRAX + $USDC into its own Curve pool and control TVL. The CR re-collateralize when the $FRAX price drops by more than 1%, meaning, there is some value of FRAX that can be sold directly into the Curve pool before the FRAX price slips by 1%.

When FRAX’s price drops beyond 1%, the protocol would increase the collateral backing of the outstanding $FRAX. A scenario could be created where the price of $FRAX is deliberately pushed down by less than 1% by supplying an extra $FRAX (minted $FRAX).

The price drop here would not trigger a CR alteration but at the same time, the liquidity depth is increased.

The Curve AMO can generate more fees through the liquidity created with that extra $FRAX.

TVL is actively managed by the AMO through minting and burning $FRAX.

When the $FRAX price is rising in the pool, the AMO can mint more $FRAX and deploys in the pool to balance out the demands and this won’t alter the CR.

However, when the price drops, the AMO can suck out the supply of $FRAX from the pool and burn it, but the AMO cannot pull out more $FRAX than it initially supplied by minting it.

The quantity of $FRAX that can be added to the pool (by minting more $FRAX) can be calculated by using the current TVL of the pool and some variables from a trade order and pool-specific variables.

For calculating the required $FRAX supply Y such that selling all of Y at once into a Curve pool with Z TVL and A amplification factor will impact the price of $FRAX by less than X%, where X is the CR’s band sensitivity (X was 1% in the case discussed above).

As of writing this report, the fees generated from the Curve AMO are used to buy $CRV and $CVX to build a more robust incentive mechanism to boost the $FRAX utility.

Decollateralize - The AMO places idle collateral and newly minted $FRAX into the FRAX3CRV pool.

Market operations - The AMO accrues transaction fees, $CRV rewards, and periodically rebalances the pool. The FRAX3CRV LP tokens are deposited into yield-bearing vaults, Stake DAO, and Convex finance for extra yield.

Recollateralize - The AMO withdraws excess $FRAX from the pool first, then withdraws $USDC to increase CR.

FXS1559 - Revenue earned that places the protocol above the CR is distributed to $veFXS holders.

AMO Controller: Lending

This controller mints $FRAX directly into lending money market protocols to allow anyone to borrow $FRAX by paying interest instead of the base minting mechanism.

This AMO does not lower the collateral ratio (CR) as $FRAX is minted into money markets and will not enter circulation unless they are overcollateralized by a borrower through the money market.

It is similar to minting $FRAX by using collateral but this is done through lending protocols where users can reap rewards of price appreciation of their long-term holding that they have placed as collateral to get into a debt position.

The Lending AMO creates a new avenue to get FRAX into circulation by paying an interest rate set by the money market.

This AMO can be considered as MakerDAO’s entire protocol in a single market operations contract. This controller allows the protocol to directly lend $FRAX and earn interest from borrowers through existing money markets.

The AMO can increase or decrease the interest rate on borrowing FRAX by minting more $FRAX and depositing in the lending protocols (lower rates) or withdrawing/removing $FRAX and burning it (increase rates).

When an ample supply of capital is available, interest rates are lowered on lending platforms to encourage borrowing.

When the supply of capital is scarce, interest rates are increased on lending platforms to encourage repayments of debt and additional supply.

Since the AMO can mint and remove $FRAX to target a specific rate, the cost of leverage can be more or less expensive depending on the discretion of the protocol.

Decollateralize - Mints $FRAX into lending money markets. The $FRAX that enters circulation is overcollateralized (collateralized debt position).

Market operations - Accrues interest revenue from borrowers.

Recollateralize - The AMO works a bit differently as other AMO mentioned invests the collateral that acts as a backing for $FRAX outstanding in the market. The lending AMO can control the interest rates, ultimately the CR by varying the supply of $FRAX in lending protocols.

Withdrawing the excess $FRAX from the lending market can facilitate the needed re-collateralization

When excess $FRAX is supplied, the interest rates would decrease and there might arise the case where $FRAX demand goes down due to excess supply.

In the above case, the AMO withdraws $FRAX from lending protocols to hike the interest rates higher and encourage users to repay their debts thus sucking the supply from the market. This can be considered as re-collateralization as CR can be stabilized through it.

FXS1559 - Revenue earned that places the protocol above the CR is distributed to $veFXS holders.

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