Target Rate Feedback Mechanism (TRFM)

A purely algorithmic TRFM where the supply of tokens in every holder's wallet is programmatically adjusted to move the price toward a target. Key features:

• Rebase Function: The protocol's smart contract periodically calculates a new supply based on the price deviation from the target.
• Example: If the price is 20% above target, all wallets see a 20% increase in token balance, diluting the per-token value.
• Goal: To create a stable unit of account without collateral, relying solely on expansion and contraction of supply.

A TRFM that uses discounted bonds to absorb excess supply and build protocol reserves. When price is below target:

• Users can sell tokens to the protocol at a discount for a bond, redeemable for more tokens later when price recovers.
• The protocol uses the bought tokens to build Protocol-Owned Liquidity (POL), securing its own trading pairs.
• This reduces circulating supply and creates a price floor. Real-world example: The Olympus DAO (OHM) model popularized this mechanism.

A governance-mediated TRFM used in collateralized debt positions (CDPs). To maintain a collateral-backed stablecoin's peg (e.g., DAI):

• The Stability Fee (interest rate on loans) is adjusted by MKR token holders.
• If DAI trades above $1, the fee is lowered, encouraging more borrowing (minting) to increase supply.
• If DAI trades below $1, the fee is raised, discouraging borrowing and encouraging repayment (burning) to reduce supply.
• This is a manual, vote-based feedback loop rather than a fully automated algorithm.

A TRFM that uses liquidity provider (LP) rewards to correct peg deviations for stablecoin pools. Core mechanism:

• When a stablecoin in a pool (e.g., USDC, USDT) deviates from its peg, the protocol algorithmically increases LP rewards (CRV emissions) for that specific asset.
• This incentivizes arbitrageurs to deposit the undervalued asset or withdraw the overvalued one, restoring equilibrium.
• It's a market-driven correction powered by incentive alignment, not direct supply changes.

A conceptual TRFM where a central authority (e.g., a central bank) directly controls monetary policy levers. This is the traditional finance counterpart to on-chain mechanisms.

• Interest Rates: The primary tool. Raising rates contracts money supply; lowering rates expands it.
• Open Market Operations: Buying/selling government bonds to inject or remove liquidity from the system.
• Reserve Requirements: Mandating how much banks must hold, influencing lending capacity.
• Contrasts with decentralized TRFMs by relying on a trusted central actor rather than code or distributed governance.

A TRFM implementation that separates the volatile rebase token from a stable value token. Key components:

• Rebase Token (AMPL): Undergoes elastic supply adjustments daily based on price deviation from a target.
• Spot Price Oracle: A decentralized oracle provides the price feed that triggers the rebase calculation.
• Stable Value Token (e.g., SPOT): A derivative token that represents a claim on a basket of AMPL, designed to maintain a stable value despite rebases.
• This model isolates volatility to the rebase asset while offering a stable derivative for users.

The Target Variable is the specific metric the system aims to stabilize, such as a target price (e.g., $1 for a stablecoin) or a target exchange rate (e.g., ETH/stETH). An Oracle is the secure, decentralized data feed (like Chainlink or Pyth) that provides the real-time market price of this variable to the smart contract, serving as the system's "eyes." Without reliable oracle data, the TRFM cannot make accurate adjustments.

This is the algorithmic "brain" of the TRFM. Typically implemented as a Proportional-Integral-Derivative (PID) controller, it calculates the necessary corrective action based on the deviation (error) between the oracle-reported market price and the target price.

• Proportional (P): Reacts to the current size of the error.
• Integral (I): Accounts for accumulated past errors.
• Derivative (D): Anticipates future error based on its rate of change. The output is a rebase rate or expansion/contraction signal.

These are the executable actions the protocol can take to correct price deviations. The primary levers are:

• Supply Expansion: Minting and distributing new tokens (e.g., as staking rewards or protocol revenue) to decrease the unit price.
• Supply Contraction: Burning tokens or requiring users to lock/burn tokens (e.g., via seigniorage shares or bond sales) to increase the unit price.
• Incentive Reallocation: Adjusting yield rates or liquidity mining rewards to influence supply/demand dynamics indirectly.

The rebasing mechanism is the on-chain function that applies the calculated policy change to user token balances. In a positive rebase, all holder balances increase proportionally (expansion). In a negative rebase, balances decrease (contraction). The key property is that each user's percentage share of the total supply remains constant, while the nominal number of tokens they hold changes. This mechanism directly alters the token's supply elasticity.

This component manages the economic surplus or deficit created by the TRFM. A stability fee may be charged during contraction phases (e.g., for redeeming bonds). Seigniorage is the profit generated from creating new tokens during expansion phases. This value is often directed to a treasury, distributed to stakers, or used to build protocol-owned liquidity. Its distribution is critical for aligning stakeholder incentives and ensuring long-term protocol solvency.

While the TRFM operates autonomously, its parameters (e.g., target rate, controller gains, reaction speed) are initially set and can be updated via decentralized governance. Token holders typically vote on proposals to adjust these parameters, allowing the system to adapt to new market regimes. This creates a hybrid system: algorithmic execution with human-supervised parameter policy. Examples include adjusting the rebase lag or the oracle security margin.

The TRFM relies on external price oracles (e.g., Chainlink) to determine the market price of FRAX relative to its $1 peg. An attacker could:

• Manipulate the oracle price feed through flash loan attacks on the underlying DEX pools.
• Exploit latency or downtime in oracle updates to trigger incorrect minting or redemption actions.
• Cause the protocol to incorrectly calculate the required collateral ratio (CR) adjustment, leading to unsustainable minting or a broken peg.

The TRFM's sensitivity and reaction speed are controlled by governance-set parameters, such as the adjustment step size and reaction delay. Malicious or poorly calibrated governance proposals can introduce instability:

• Overly aggressive parameters can cause the CR to oscillate wildly, creating arbitrage opportunities that drain protocol reserves.
• Setting the target rate incorrectly can permanently de-peg FRAX by signaling an unsustainable monetary policy.
• This creates a centralization risk, as control over these parameters is concentrated among governance token holders.

The mechanism's feedback loop can create reflexive market conditions that exacerbate volatility:

• A falling FRAX price triggers the TRFM to lower the CR, requiring less collateral per minted FRAX. This can be perceived as a loss of backing quality, potentially accelerating selling pressure in a death spiral.
• The system assumes rational arbitrageurs will correct deviations. During extreme market stress or liquidity crises, arbitrage may fail, leaving the TRFM ineffective.
• The mechanism interacts with Frax Shares (FXS) valuation; a collapsing FXS price can impair the protocol's ability to use it as a recapitalization tool.

The TRFM logic is encoded in smart contracts, introducing execution layer vulnerabilities:

• Bugs in the Controller or Pool contracts could allow unauthorized minting, burning, or parameter changes.
• Integration risks with minting venues (AMM pools) and collateral types (e.g., volatile crypto assets, yield-bearing tokens) can create unexpected interactions or insolvencies.
• Upgradeability mechanisms for the TRFM contracts, if any, present an additional attack surface if compromised.

The TRFM's effectiveness depends on deep liquidity for both FRAX and its underlying collateral assets to facilitate arbitrage.

• If the primary AMM pools (e.g., FRAX/USDC) lack sufficient depth, large redemptions or minting arbitrage can cause significant slippage, hindering peg restoration.
• A bank run scenario, where many users redeem FRAX for collateral simultaneously, could drain the most liquid collateral reserves, leaving less-liquid assets and threatening solvency.
• The protocol's health is tied to the liquidity profile of its entire collateral portfolio.

The Frax protocol incorporates several design choices to mitigate TRFM risks:

• Time-weighted average prices (TWAP) from oracles reduce susceptibility to instantaneous price manipulation.
• Gradual parameter adjustments (e.g., a maximum daily CR change) prevent sudden, destabilizing shifts.
• Multi-collateral backing diversifies risk away from any single asset.
• Transparent, on-chain logic allows for continuous public auditing of the mechanism's state and actions.
• The dual-token model (FRAX/FXS) provides a recapitalization pathway through FXS minting and burning.

A supply adjustment method where token balances in all wallets are programmatically increased or decreased to move the market price toward a target. This is the primary action of a TRFM. Key characteristics:

• Non-dilutive: All holders' proportional ownership remains constant.
• On-chain oracle dependent: Requires a reliable price feed to trigger.
• Examples: Ampleforth (AMPL), Olympus DAO's initial OHM design.

The profit made by the protocol when it creates new tokens. In a TRFM system, seigniorage occurs during expansionary phases when the market price is above the target. The newly minted tokens are often distributed to specific stakeholders (e.g., stakers, treasury) to incentivize ecosystem participation and fund protocol operations.

A treasury model where the protocol itself owns and manages a pool of assets (e.g., liquidity provider tokens, stablecoins, crypto reserves). A TRFM often uses PCV to:

• Back the stablecoin and provide intrinsic value.
• Execute monetary policy, such as buying tokens during a contraction or providing liquidity.
• Generate yield to fund protocol operations.

A critical data feed that provides the external market price of the asset to the smart contract. The TRFM's rebase logic is entirely dependent on this oracle's accuracy and security. Vulnerabilities include:

• Manipulation attacks on the price source (e.g., DEX pools).
• Oracle latency causing delayed or incorrect rebases.
• Solutions often involve time-weighted average prices (TWAPs) from multiple sources.

The algorithmic rules that define how the TRFM responds to price deviations.

• Contraction Policy: Triggers when price < target. The protocol reduces supply, often by offering bonds or burning tokens.
• Expansion Policy: Triggers when price > target. The protocol increases supply, minting new tokens as seigniorage. The specific thresholds, lag times, and magnitudes of these adjustments define the mechanism's stability and responsiveness.

A cryptocurrency designed to maintain a stable value (e.g., pegged to $1) primarily through algorithmic, on-chain mechanisms rather than direct collateral backing. The TRFM is a foundational model for this asset class. Key differentiators from collateralized stablecoins:

• Endogenous collateral: Relies on its own economic policy and token dynamics.
• Reflexivity: Price, demand, and supply are highly interdependent, leading to potential volatility cycles.