While Frax Bull might be a master of the metal barbell, Frax soon might be the master of the investing barbell for Ethereum.
The Barbell Investment Theory is a strategy where investors split their portfolio between two extremes: low-risk, predictable assets like government bonds, and high-risk, high-reward assets like speculative ETH. Deliberately avoiding medium-risk investments, the approach seeks to harness the safety of low-risk assets and the potential significant returns of high-risk assets simultaneously.
The allocation isn't always 50/50; it's adjusted based on an individual's risk tolerance and financial objectives. The strategy posits that while the low-risk end provides stability, the high-risk end offers growth opportunities that can compensate for the modest returns of safer assets. As market dynamics shift, investors can rebalance their portfolios, moving gains from one end to the other.
Up until now, if you wanted to execute this strategy, there was no way to effectively do it fully on-chain. While crypto provides an incredible amount of access to risk assets, finding safe and reliable yield can be a dangerous proposition. Investors lured by Luna/Anchor’s 20% interest rates paid the price when near overnight the price of UST collapsed and went to zero.
Other avenues for finding yield in DeFi can be risky as well, all it takes is one motivated developer to internally rug liquidity or an army of North Korean hackers searching for exploitable code for all of your hard earned cash to instantly disappear. Hackers stole more than $3.8bn in 2022, proving the risky nature of crypto investing.
But even after all of the hacks, many people still want to custody all of their assets on-chain and have zero exposure to centralized third party services where they do not control their assets.
Enter Naly to the Ring
The imputes for this post came over the weekend when Naly made this comment in the chat.
Naly made the point that Frax is creating a “fully vertical, on-chain liquidity stack for investors,” where, depending on their risk appetite, they will be able to seamlessly mix and match yields plus risk with sfrxETH and Fraxbonds (FXB).
Naly writes, “In high-interest rate situations, investors typically lean towards low-risk, high-yielding investments such as US Treasury bonds. FRAX and FRAX BONDS are looking to offer a similar on-chain exposure.”
Fraxbonds will offer discounted FRAX at rates that are similar to off-chain short term treasury yields. By choosing one of 4 annual maturity dates, a FRAX holder could stash their FRAX away and be sure they will earn a fixed yield over the period.
Ok, but why do investors purchase bonds? Well bonds are “cash-like” in some cases and they also pay an interest rate, aka the yield.
As interest rates rise, new bonds provide greater periodic interest, making them lucrative. Additionally, during economic uncertainties, often linked with high interest rates, the perceived low-risk nature of bonds, especially government-issued ones, becomes appealing for capital preservation.
All risk asset prices are judged against bond yields. If you are buying an investment property and it only yields 7% while short term bond yields are 5.5%, it may not be a great choice.
Fraxbonds will mimic the same type of exposure to real bonds, but completely onchain. When markets turn negative, FXB will be a safe haven for degen’s looking for safe and secure yield. FXB doesn’t pay interest, but it does represent purchase of discounted future-issued FRAX.
In contrast, in low interest rate environments, Naly writes “investors move up the risk curve.” As yields decline, less overall return is expected from risk assets, which pushes their asset prices up.
Naly goes on to say that “The belief is that Ethereum (ETH) might become the preferred low-interest rate internet bond.” ETH has both yield and upside. If you know that ETH will accrue rewards, plus it could have wild volatility to the upside, then it makes sense to position for this event.
There is also a possibility of also hedging out the sfrxETH price delta, which is the rate of change of the value of the position for every 1% move up or down, so that when interest rates rise, the effects of price volatility are neutralized.
In this new paradigm, investors could find yield in either low risk FXB and high risk sfrxETH. A true barbell.
When we interviewed Naly for this article, he brought up that the transitions across the barbell could be managed by an AMM based on external interest rate data, acting as an on-chain asset manager.
“Balancer technology allows for weighted pools, but it also allows for Liquidity pools with weights that change over time. There is also a model that could distribute weightings between two tokens dependent on an external data feed. So, for this example, you could have say a weighted pool that is 80/20 FXB/sfrxETH in an environment that US10Y treasury yields are > ...% to then shift to an 20/80 FXB/sfrxETH pool when treasury yields are below ...%.” Naly said to Flyhweel.
Naly's idea here is revolutionary. Imagine a pool that auto-adjusts its strategy based on prevailing market conditions, offering either the safety of bonds or the lucrative staking yields. If executed well, this could redefine how passive investments work in DeFi, bringing a touch of traditional finance's sophistication to the decentralized world.
This AMM could also receive a FXS gauge, further boosting rewards for Barbell Strategists. So not only would yield flow from FXB and sfrxETH, further CVX, AURA, BAL gauge rewards could be added on as well with Balancer integration.
Naly's exploration of the Frax Barbell Investment Theory through on-chain solutions is an intriguing proposition. The idea of blending the safety of bonds with the volatility of ETH, especially with an auto-adjusting pool, is ambitious. It would require new oracles for data input, but in theory it could be built.
It also serves to write a new chapter for the evolution of Frax, as veritcally supporting a dollar + ETH future where the yields are the lifeblood of its growth. We'll see over the next few months as Frax v3, FXB and frxETH v2 are released how this new system ties all these parts together.