Josh

Posted on Dec 27, 2021Read on Mirror.xyz

Fei Protocol: the L2 Playbook

A couple of developments that set up some context for this post:

  • The FeiRari merger was successfully passed by both DAO voting processes — on to the new path of building value and unlocking synergies

  • Polygon, Optimism, Arbitrum, and StarkWare have all been making solid progress in terms of L2 improvements, deployments, and functionality

  • Uniswap’s successful governance proposal to commence Polygon deployment and likely conduct a liquidity mining campaign is the latest vote of L2 confidence

Bottom line is that we are beginning to ramp towards an L2-based DeFi ecosystem and Fei Protocol has a very interesting opportunity to capture growth and create value. While I understand that Fei v2 is currently the main focus amongst the team and core contributors, I believe that their ‘L2 playbook’ should become a close second.

The Stablecoin Product

First and foremost, L2s are a huge market opportunity for $FEI. Assuming that Ethereum becomes the settlement layer, and a multi-layer, hyper scalable ecosystem is stacked on top of it, stablecoin provision will be crucial in the upper layers as transaction frequency (i.e. the money multiplier) will be higher and consumer interaction will be significantly larger. This is not to say that stablecoins won’t be valuable on the settlement layer.

Currently, competitors like $DAI and $MIM are eating up heavy market share on L2s. While L2s themselves are nowhere near Ethereum in terms of market size, the progression to a multi-layered ecosystem will catalyze significant growth for L2s, meaning that these stablecoins could benefit from a first mover advantage in an ecosystem on the brink of exponential adoption.

By getting $FEI up on the L2s (into exchanges, lending pools, option markets, and more), Fei Protocol could strategically position itself to be able to capture the transition to a multi-layered ecosystem and combat the effects of first mover advantage possessed by competitors before it might be too late.

LaaS

Assuming that Fei Protocol deploys contracts onto L2s in a safe and effective manner, the second key strategic opportunity lies in its LaaS product. The first thing I thought of when engaging with the Uniswap proposal to launch on Polygon, in which liquidity mining was suggested, was why liquidity mining? Why is the Uniswap community thinking in a DeFi 1.0 way? And then it hit me — the DeFi 2.0 liquidity methodologies are somewhat missing on L2s.

If this multi-layered world plays out, then we will see numerous projects moving contracts to L2s (we have already seen a glimpse of this). In order for their products to work well and have the same service level / UX as on Ethereum, they will need a good amount of liquidity.

Enter LaaS. If Fei Protocol (as well as Ondo Finance, which makes the coordination of this a bit more difficult) is well positioned on L2s, then it can be the leading partner to several DeFi DAOs in facilitating short-term liquidity boosts as they get their products going on the new layers. Part of the current problem with L2 UX is that liquidity is very low (i.e. try SushiSwap or Balancer, two amazing projects, on some L2s and you will not get the same performance as on Ethereum, gas costs aside).

Projects need liquidity on L2s. Let’s not make the mistake of going down the DeFi 1.0 liquidity mining path. Therefore, DeFi 2.0 methods need to be available on L2. Hence, LaaS opportunity. QED :)

Capital Bridges

In this multi-layered world, capital bridges stand to be one of the most crucial infrastructure components. In order to move between L2 ecosystems and chains, we need efficient, secure, and cost-effective bridges. Connext, Hop Protocol, Synapse and others have emerged to be players in this market. Of course, there are also native bridges like those of Optimism and Arbitrum (but these are costly and slow) and entire blockchains that facilitate capital movement like THORChain and Cosmos. The issue is that a look into platforms like Connext and Hop Protocol reveals stables like $USDC, $USDT, and $DAI (no $FEI).

As L2s grow in use, transaction volume in the bridges will grow at a similar pace, if not even faster. As these bridge volumes grow, the demand for stables used within them grows. Thus, there is value in getting $FEI onto these bridges as it can lead to another source of demand. It also will help combat the first mover advantage (pertaining to competitors) described two sections above as users will come into the L2s starting with $FEI.

Conclusion

Bringing it all together, an L2 strategy would focus on the following: deployment on L2s to rival competition in a market that could soon scale exponentially, strategic positioning of LaaS to facilitate the exponential growth of the L2 market, and demand capture of the chokepoints of capital flow to and from this L2 market, which is also growing exponentially. All these are self-reinforcing as well: owning a part of the bridge flow aids L2 market share capture, LaaS creates L2 liquidity depth for $FEI, and $FEI dominance in L2s strengthens the case for trading into it via a bridge.

This post serves more as a high-level perspective of what the L2 playbook for Fei Protocol could look like. Note, these strategic priorities carry a lot of depth and discussion behind them that was not covered. Once Fei v2 is on solid footing, L2 deployment and related product growth should be the main strategic focus.

Disclosure:* This blog series is strictly personal/ educational and is not investment advice nor a solicitation to buy or sell any assets. It does not represent any views from where the author is working — all views, opinions, and arguments are the author’s. Please always do your own research.*