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AMOs have been democratized by Maker and Frax around April 2021, and are already above $400M and $1B respectively.
They leverage the ability of governance to mint unbacked stablecoins, to use it in new ways to grow or satisfy demand.
In fact, stablecoin protocols could technically inflate their supply indefinitely by minting trillions of tokens, multiple times Aave or Uniswap TVL.
Obviously, this would destroy trust in the stablecoin, and most teams have higher ambitions than that!
AMOs can be a powerful tool to help stablecoins grow and provide new services to users and partners.
For example, Frax relied extensively on this mechanism to expand the FRAX supply through Curve liquidity and other types of AMOs.
In less than a year, they were able to grow supply from $200M up to $2.6B with no significant impact on peg.
FRAX was also able to resist the pushback by aggresively reducing their AMOs due to the recent UST debacle.
Essentially, an AMO is the action of minting unbacked stablecoins and depositing them into another protocol to make more liquidity available.
The unbacked stablecoins are released on the market once users interact with those protocols.
These stablecoins are then backed by the mechanism of the protocols they were deposited on and that ultimately issued them on the market.
Obviously, it’s important that governance teams make sure the unbacked stablecoins don’t get released in the market in ways that increase growth at the cost of threatening their stability.
One way to make sure of that is to use AMOs on lending markets.
For example, Angle minted 1M agEUR that were deposited to Euler and Aave (Polygon), giving more liquidity to borrowers.
Though these agEUR were originally unbacked, borrowers need to deposit collateral to borrow the stablecoins, effectively backing them.
In the end, this is a way to externalize the backing of stablecoins & liquidation mechanisms to the lending market.
A specificity of AMOs on lending market is that they lower the borrowing cost, which is good for borrowers, but takes yield away from suppliers.
Ideally, there should be some way for the DAO to redistribute this profit.
AMOs can also be used to provide liquidity to AMM pools.
For example, it can be used by Angle to sell agEUR liquidity to another DAO token against a fee, a mechanism called liquidity-as-a-service (LaaS) and pioneered by Fei.
This increases liquidity for the paired tokens, and usage of the stablec used, like agEUR.
However, this is riskier as the backing of these agEUR rely entirely on the value of the token they are paired with.
Imagine a Uniswap agEUR/ETH pool with agEUR minted through an AMO.
If the ETH price dropped, users would sell ETH for agEUR in this pool and these agEUR would be released in the wild, unbacked.
Ondo Finance provides a safeguard mechanism against that risk, by transferring it to the paired token. https://docs.ondo.finance/structured-products/example
This is not infaillible and this kind of AMO still bears great risk.
To summarize:
Some protocols mint unbacked stablecoins to be used through AMOs to open new opportunities
The backing of stablecoins (agEUR) minted from AMOs rely exclusively on how they end up in the open market, whether it is through a lending market, a trade from another token on an AMM, or any other mechanism.
This is a very important power that comes with great risk and responsibilities.
The main risk linked to AMOs is that unbacked stablecoins (bad debt) get released on the market, lowering the collateralization of the stablecoin as a whole.
This can come from many sources:
A misjudgement of the risks linked to a specific AMO use case, leading the unbacked stablecoins to be released on the open market.
The protocols with AMO deposits end up failing and cause the unbacked stablecoins to be released freely on the market.
For example, FRAX AMO on Rari ended up creating more than $10M bad FRAX debt after Rari was exploited in November.
Thankfully, this amount is low compared to FRAX total supply and liquidity. However, this is still in the process of being fixed and will likely be costly for Rari DAO (now Tribe).
This can be followed in this governance discussion: https://tribe.fei.money/t/tip-112-fuse-repayment-next-steps-dao-vote/4351/2. AMOs also bring other risks that are more difficult to quantify:
They add risk to the protocols they integrate with if not used responsibly.For example, Mochi tried to exploit Curve and Convex in November by artificially minting USDM and vote for their pools to earn more incentives.
https://gov.curve.fi/t/the-curve-emergency-dao-has-killed-the-usdm-gauge/2307
AMOs artificially increase the stablecoin supply with no regard to the redemption mechanism. In an extreme scenario, there could be a shortage of collateral if all holders try to redeem simultaneously.
This is very hard to quantify, and rather similar to what could happen with traditional banks.
The key to AMOs seem to be the risk/reward of these operations. How much risk starts to be too much? How can stablecoin protocols make sure to limit this risk, while pushing their growth and expansion?
AMOs are yet another powerful tool that stablecoin protocols can experiment with. They bear great risks and responsibilities, but could unlock new features and use cases for protocols.
For now, they are mostly used to expand stablecoin supply quickly into new opportunities when they arise.
The downside is that AMOs mint supply that could be released into the open market without being backed, threatening the stablecoin’s peg.
At Angle we have already deployed 2 lending market AMOs on Euler and Aave, and one as LaaS with PAL.
Research and experimentations in this area is moving quickly, and we could probably imagine AMO-only protocols in the future.
In this scenario, stablecoin protocols could become the de facto DeFi banks thanks to AMOs.
With its decentralized and permissionless aspects, DeFi could end up being a better, user-owned version of banks.
Pushing this further, they could even become the ones powering financial
activities in the real world.
We are already seeing this happen with protocols linking on-chain lenders to real world borrowers, like GoldFinch, Maple, or Atlendis.
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