The cryptocurrency market is highly volatile, and projects like Fei Protocol aim to provide users with stability by issuing stablecoins. Crypto prices are known to fluctuate dramatically within a short time span. It's normal for the market leaders Bitcoin (BTC) and Ethereum (ETH) to have a price change of several percent within a day. For less popular altcoins, price swings can be even higher. Cryptocurrency is much more volatile than stocks. On average, company stock prices change a few percent in a year. The high volatility of crypto carries tremendous profit-taking opportunities for investors and traders. However, crypto volatility also brings a lot of risks. An investment can go sideways really fast if the price of a cryptocurrency suddenly starts crashing. Because of this, stablecoins are a precious class of cryptocurrencies, and the Fei USD (FEI) stablecoin introduces exciting innovations to the asset class.
In this article, we'll closely examine Fei Protocol to find out what it is and how it works. We'll focus on the project's key feature, the FEI token, and the operational mechanism behind this stablecoin. We'll look at the situation with the FEI protocol hack in April 2022 and how it works today. Furthermore, we'll find out why it remains a popular crypto even though the project is no longer under development.
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What Is Fei Protocol?
Fei Protocol launched operations in April 2021. However, the project's development started in 2020 when a team of crypto enthusiasts came up with the idea of an innovative algorithmic stablecoin. The company behind the project is Fei Labs, and the key product of the company is the FEI stablecoin. Additionally, there's the Tribe (TRIBE) token, the project's governance token, issued by Tribe DAO. The FEI token is a fully decentralized stablecoin, which makes it considerably different from many competitors. Most stablecoins rely heavily on centralization to preserve their peg to the underlying currency, mainly USD.
Apart from the FEI token and the TRIBE token, the decentralized Fei Protocol app is another crucial element of the project. Users can connect their crypto wallets to the app and use two features. The Mint option allows users to exchange Dai (DAI) tokens for FEI and mint new FEI tokens. The Redeem option enables users to return their FEI in exchange for DAI. The Farm feature used to allow users to engage in yield farming, but it's no longer available.
Although FEI is extremely useful as a stablecoin, the project has had many troubles and was subject to a major hack in April 2022. Fortunately, affected users received reimbursement, but the project is no longer under development. Consequently, the project won't have any future software updates. Additionally, the Tribe DAO community voted to dissolve the DAO. The developer team encourages users to withdraw funds and redeem any FEI or TRIBE tokens. However, the market capitalization of FEI remains above 400 million USD, which ranks the FEI token among the top 100 largest cryptocurrencies. The FEI token is still in circulation, and the mechanism behind this stablecoin is operational thanks to its decentralized nature.
The FEI Token
The FEI token is a unique case of an active stablecoin without a development team behind it. Effectively, the project is dead in terms of governance and future updates, but it still works. Also, it is possible to trade, buy and sell FEI across various crypto exchanges on the market. One of the main reasons that FEI remains relevant despite the lack of a developer team is that it has a solid operational mechanism. FEI uses a decentralized algorithmic architecture. Essentially, this means that a computer algorithm regulates the value of the FEI token. The algorithm ensures that the token stays tied as closely as possible to the value of the US dollar.
However, this mechanism was problematic even during the first days of FEI when the token struggled to maintain its USD peg. The value of FEI is mostly around 0.98 to 0.99 USD per token. Despite having no developer team behind FEI, the token's value remains the same. The algorithm works independently, aiming to maintain a value close to the US dollar.
There's no hard cap on the total amount of FEI that can enter circulation. FEI's algorithm tracks the market demand for the token through a bonding curve. A bonding curve is a mathematical calculation tool to track the supply and demand for an asset, in this case, for the FEI token. The bonding curve tends to fix the FEI price at one USD per token. However, as we can see from the FEI price history, it struggles to achieve this. Nonetheless, it maintains a value very close to the US dollar peg.
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The TRIBE Governance Token
The TRIBE token was the governance token of Tribe DAO, the DAO that governed Fei Protocol. Tribe DAO's community decided to dissolve the DAO in late 2022 after passing a vote to reimburse users affected by the 80 million USD Fei Protocol hack in April that year. During the active period of Tribe DAO, users with TRIBE tokens could vote on Fei Protocol proposals. There were proposals to change the FEI algorithm mechanics or partnerships with other projects, such as Olympus DAO (OHM).
After the dissolution of Tribe DAO, there's no Fei Protocol governing body. The FEI stablecoin is now entirely dependent on its current algorithm version and market circumstances.
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How Did Fei Protocol Work?
The project used a Protocol Controlled Value (PCV) model instead of a standard Total Value Locked (TVL) mechanism. Projects that use a TVL model require users to deposit tokens into the platform's treasury and earn rewards for providing liquidity. Users can withdraw their funds plus the rewards at any time. However, if another project promises higher liquidity providing rewards, users aim to shift their funds to that project. Commonly, this is referred to as incentivized liquidity, and the capital that comes from it is mercenary capital. The name comes from users shifting their assets to the project with the best reward rates. The PCV model utilizes smart contracts to lock assets once users make a deposit. Those assets are the ownership of the platform, and the governance body decides how to manage them. In the case of Fei Protocol, Tribe DAO token holders managed these funds.
The idea was to enable Tribe DAO to invest the PCV funds in projects and initiatives that align with most of the community's views. This model functioned well in practice because it allowed direct user control of Fei Protocol funds. Some investments included partnering with Rari Protocol, investing funds in FEI liquidity pools on SushiSwap, and other projects.
Fei Protocol liquidity came from the algorithm's bonding curve, which stored funds in the ETH/FEI liquidity pool on UniSwap. This pool remains active today, and UniSwap is the largest market for FEI and TRIBE tokens. Users can exchange FEI for DAI and FEI for TRIBE on UniSwap. Data shows that more than 80% of FEI trading volume comes from UniSwap, which indicates that the FEI stablecoin remains popular.
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The Utility of the FEI Stablecoin
Stablecoins are generally great protection from crypto volatility because of their peg to a fiat currency. However, some stablecoins struggle to maintain their value. FEI lost its peg to the US dollar but remains very close to it. One of the reasons why so much FEI remains in circulation is that it uses an automated, decentralized mechanism. There's no central entity controlling the FEI supply, which means no one can manipulate the price of FEI. Traders can use FEI to secure a portion of their crypto from volatility, but the fact that there is no developer team is discouraging for many.
During the active phase of the project, users could benefit from FEI by using the liquidity pools on the platform. Those pools are defunct now, and users can't get any rewards from them.
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The Fei Protocol Hack
The Fei Protocol hack in April of 2022 is one of the key reasons why the community eventually shut down Tribe DAO and the development of Fei. The hack highlighted vital security issues of Fei Protocol which showed that despite its innovations, it isn't very secure. FEI tokens are ERC-20 tokens based on Ethereum. The network uses a smart contract structure from the Compound protocol. However, the smart contract is a fork of Compound that has several vulnerabilities. The community wasn't aware of these vulnerabilities that led to a massive 80 million USD hack of Fei Protocol. The hacker managed to steal 80 million USD of FEI from the protocol through a reentrancy attack.
The Fei Protocol smart contract had a vulnerability in its check-effect-interaction pattern. Smart contracts use such patterns to make sure that crypto transactions are legitimate. The first step of the smart contract is to update its state to ensure that the external input is in line with the operational protocol. However, the Fei Protocol hacker found a loophole in the smart contract and exploited the vulnerability. The result was a successful reentrancy attack, with the hacker avoiding the smart contract's security mechanism.
The smart contract had vulnerabilities before the team used it for Fei Protocol. However, the team didn't see the vulnerabilities of the contract code, which makes them responsible for the hack.
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What Is Happening With Fei Protocol and the Fei Token Now?
After the hack, the situation with Fei Protocol escalated. Tribe DAO voted to reimburse all hack victims from the PCV funds fully. There was a vote where the majority of the community agreed to compensate victims. A huge portion of the victims were, in fact, Tribe DAO community members. That's when Fei Protocol developers held a second vote. The team said that the first vote was a non-binding snapshot and the second vote discarded the initial vote. Fei Protocol decided only to reimburse 10% of stolen funds. Additionally, the community decided to shut down Tribe DAO.
In a turbulent turn of events, Tribe DAO continued to operate, and eventually, the developer team decided to listen to the community. The final vote resolved the stalemate and all Fei hack victims received reimbursement.
As a result of the disagreements between the developers and the community, the developer team withdrew from Fei Protocol, and Tribe DAO ceased to exist. However, the Fei Protocol app is still functioning, except for the liquidity pools. Additionally, more than 400 million USD worth of FEI is in circulation, and users actively use the token.
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What Is Fei Protocol and the FEI Token? - Summary
Fei Protocol is a unique case of a cryptocurrency without a developer team among the top 100 projects by market cap. Despite being an effectively dead project, FEI is still popular and has significant daily trading volumes. Without its decentralized algorithmic mechanism, FEI would have likely lost its value. However, this mechanism and the market demand for FEI keep the token going. Time will show for how long FEI will be able to stay active like this.
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