We propose a new token standard for synthetic assets that are only partially redeemable to their underlying asset, but fully backed by other collateral assets.
The standard defines an interface to mint fractional reserve assets, and a standard to reflect economic risk related data to the token holders and lenders.
The Cambrian explosion of new L1s and L2s gave rise to bridged assets which are synthetic by nature. Indeed, ETH on Arbitrum L2, or WETH on Binance Smart Chain are not fully fungible with their mainnet counterpart. However, these assets are fully backed by their mainnet counterpart and guaranteed to be redeemable to their mainnet underlying asset, albeit with certain time delay.
Fractional reserve tokens can allow an ecosystem (chains, L2s, and other networks of economic activity) to increase its supply by allowing users to mint the asset not only by bridging it to the ecosystem, but also by borrowing it (typically against a collateral).
As an example, consider a fractional reserve token, namely, frDAI, that represents a synthetic DAI. Such token will allow users to mint 1 frDAI upon deposit of 1 DAI, or by providing a collateral that worth more than 1 DAI. Quick redemption of frDAI to DAI is available as long as there is still some DAI balance in the frDAI token, and otherwise, the price of frDAI may temporarily fluctuate until borrowers repay their debt.
Fractional reserve tokens may delegate minting capabilities for multiple risk curators and lending markets. Hence, a uniform standard for fractional reserve minting is needed. Fractional reserve banking does not come without risks, such as insolvency or a bank run. This standard does not aim to dictate economic risk management practices, but rather to have a standard on how to reflect the risk to token holders.
The key words "MUST", "MUST NOT", "REQUIRED", "SHALL", "SHALL NOT", "SHOULD", "SHOULD NOT", "RECOMMENDED", "NOT RECOMMENDED", "MAY", and "OPTIONAL" in this document are to be interpreted as described in RFC 2119 and RFC 8174. The standard has the following requirements:
The reserve ratio reflects the ratio between the token that is available as cash, i.e., available for an immediate redemption (or alternatively, a token that was not minted via a fractional reserve minting), and the total supply of the token. Segregated accounts MUST be subtracted from the cash balance.
Formally, the reserve ratio is denoted by $$\frac{totalSupply() - totalBorrowedSupply() - \sum_{a \in \text{Segregated Accounts}} \text{balanceOf}(a)}{totalSupply()}$$.
Additional fractional reserve minting MUST NOT occur when the reserve ratio, multiplied by 1e18 is lower than requiredReserveRatio().
The fractionalReserveMint and fractionalReserveBurn functions SHOULD be called by permissioned addresses, e.g., risk curators or lending markets. These entities SHOULD mint new tokens only to addresses that already locked collateral in a dedicated contract.
The reserve ratio is denoted by $$\frac{totalSupply() - \sum_{a \in \text{Segregated Accounts}} \text{balanceOf}(a)}{totalSupply() + totalBorrowedSupply()}$$.
fractionalReserveMint MUST revert if the reserve ratio, multiplied by e18 exceeds requiredReserveRatio().
A successful call to fractionalReserveMint(_to, _amount) MUST increase the value of totalSupply(), totalBorrowedSupply(), and the token balance of address _to, by _amount units.
A call to fractionalReserveMint MUST emit a MintFractionalReserve event.
A call to fractionalReserveMint MUST revert if after the mint the reserve ratio, multiplied by 1e18 exceeds the value of requiredReserveRatio().
Similarly, a successful call to fractionalReserveBurn(_from, _amount) MUST decrease the value of totalSupply(),totalBorrowedSupply(), and the token balance of address _from by _amount units.
A call to fractionalReserveBurn MUST emit a BurnFractionalReserve event.
At every point in time, it MUST hold that the sum of token balances for segregated addresses equals to totalSegregatedSupply().
The fractionalReserveMint SHOULD be used in conjunction with a lending operation, where the minted token is borrowed. The lending operation SHOULD come with an interest rate, and some of the interest rate proceedings SHOULD be distributed to token holders that are not in segregated accounts.
This standard does not dictate how distribution should occur.
The standard aims to standardise how multiple lending markets and risk providers can interact with a fractional reserve token. The actual lending operation should be done carefully by trusted entities, and it is the token owner's responsibility to make sure the parties who have fractional reserve minting credentials are reliable.
At the core of the coordination relies the need to understand how much additional supply is available for borrow, and at what interest rate. The additional borrowable supply is deduced from the required reserve ratio, and the total, borrowable and segregated supply. Lower reserve ratio gives rise to higher capital efficiency, however it increases the likelihood of depeg or a run on the bank, where token holders cannot immediately redeem their synthetic token. Having the reserve ratio as part of the standard allows risk curators to better price the risk, and, e.g., set the interest rate to be monotonically increasing with the current reserve ratio.
The standard does not dictate how the accrued interest rate is distributed. One possible distribution is by making the token a rebased token. An alternative way is to introduce staking, or just airdropping of proceeds.
While a fractional reserve is most useful when it is backed by a known asset, e.g., frDAI and DAI, it can also be used in isolation. In such a case, a token will have a fixed initial supply, however additional supply can be borrowed. In such cases the supply temporarily increases, but the net holdings (totalSupply() - totalBorrowedSupply()) remains unchanged.
Increasing the total supply could be a concern if a token is used for DAO votes and/or if dividends are distributed to token holders. In order to mitigate such concerns, segregated accounts are introduced, with the premise that money in these accounts is not counted towards the reserve, and therefore, additional token supply cannot be minted against them.
Fractional reserve tokens should be backwards compatible with ERC-20.
Fractional reserve banking comes with many economic risks. This standard does not aim to provide guidelines on how to properly mitigate them.
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