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Whitepaper

The Fractional Reserve Stablecoin: The Natural Evolution of Modern Banking Introducing InfiniFi, the first fractional reserve stablecoin to secure greater returns without increased risk by better addressing banking’s duration gap problem.

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Abstract

For the vast majority of history, the world’s financial capital has rested on a flawed foundation. Today, nearly all modern government treasuries and private financial institutions rely on fractional reserve banking. Banks use past behavior to predict how much of their customers’ deposits to keep on hand while lending out the rest to secure greater returns. This can lead to greater capital efficiency and economic expansion in the regions they serve. However, fractional reserve banking also creates duration gaps — a mismatch between the average maturity of a bank’s liquid liabilities and illiquid assets — which can lead to insolvency if enough depositors attempt to withdraw their money at once. To account for those duration gaps, banks must efficiently manage their balance sheets, effectively model cash outflows, and appropriately handle coordination failures that could lead to bank runs. However, they have imperfect solutions for doing so, relying on reactive lookback models and centralized planning models that misalign incentives between them and their depositors. This leads to increasing threats to the integrity of the global financial system, as witnessed in 2023, the biggest year ever for bank failures, with five banks managing a record $548.7 billion collapsing (led by First Republic Bank, Silicon Valley Bank, and Signature Bank, which represented the second, third, and fourth-largest bank collapses ever). We propose InfiniFi, a fractional-reserve stablecoin powered by a self-coordinated, duration-matching autonomous balance sheet to directly measure market sentiment and address the problems posed by duration gaps. This depositor-directed system decentralizes how assets are allocated, giving individual depositors choices based on their specific risk, duration, and liquidity preferences. This allows InfiniFi to create more proactive models that better forecast depositor behavior and reduce the risk of coordination failures and bank runs. By better addressing the duration gap, InfiniFi more efficiently deploys capital, allowing it to generate higher returns for any existing asset without increased risk. As such, InfiniFi represents a generational opportunity to move our shaky financial system to steadier ground, while also providing the first major incentive to tokenize all assets on blockchain technology.

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1.0 The fracturing of the fractional reserve system

Fractional reserve banking has existed for centuries. It relies on the fact that depositors do not generally ask for all of their money back at once. That means shrewd bankers can lend out a significant portion of those deposits and generate high returns, so long as they keep enough cash on hand to cover expected withdrawals. Rather than deploying all of their cash deposits into liquid assets that can immediately be redeemed for cash, such as treasury bills, banks that use fractional reserve deploy a portion of deposits (typically the majority) into illiquid assets, such as loans, that cannot immediately redeemed but pay higher returns to compensate for the increased risk they represent. This allows banks to increase their returns above what would otherwise be achievable in fully liquid assets. This increase in capital efficiency comes at a cost. The vast majority of depositor obligations held by banks (their liabilities) are fully liquid (90%) and may be redeemed at any point in time. However, the illiquid assets held by banks have a duration associated with them that must pass before they reach maturity. The mismatch between these zero-duration liabilities and these positive-duration assets is termed the “duration-gap” and serves as the core problem that most banking infrastructure has been built to address. Since banks do not have cash on-hand to cover depositor obligations, they must design and operate systems that manage this shortcoming. Any entity utilizing a fractional-reserve system must determine how to select assets to ensure that daily cash inflows are sufficient to match projected outflows, how to model and predict what those projected outflows will be, and how to respond when outflows far exceed inflows and a bank run begins. For traditional banks, these problems are addressed with hierarchical balance-sheet management, look-back models trained on past data, and a government-sponsored insurance framework. This traditional approach is as good as the tools of the time have allowed but is neither efficient nor sufficient.

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1.1 The misaligned incentives of centralized balance sheets

To ensure that the existence of the duration gap does not result in the insolvency of the bank, institutions utilizing fractional reserve systems must determine which assets to select such that daily cash inflows from those assets reaching maturity are roughly equivalent to daily cash outflows. This process of selecting illiquid assets to reach maturity at a certain rate over a given period of time is known as “laddering,” and serves as an important and labor intensive task for any bank.This task of balance-sheet management necessitates an organized approach to address it, and to this end, banks use a top-down hierarchy. Upper management breaks the task of laddering into sub-tasks, then hires employees to perform these sub-tasks, rewarding and promoting the employees whose decisions result in better outcomes for the bank. This is an efficient and time-tested approach to solving complex problems such as laddering, but unfortunately, the top-down approach that banks utilize to address laddering results in the creation of perverse incentives. As employees are rewarded for producing the best outcomes for their employers, they are encouraged to pursue goals that will provide the best outcomes for the bank, rather than the depositors. This incentive misalignment encourages bankers to pursue balance-sheet management strategies optimized purely for high returns, which directly make the bank more money, rather than optimizing for a balance of risk and reward. With high return strategies comes higher risk, but if the strategies which bankers are incentivized to pursue result in loss of depositor capital and bank failure, the penalty to any individual banker is negligible, as the Global Financial Crisis highlighted (2008). While many individual bankers doubtlessly find the incentives their system creates concerning, those who might otherwise pursue more conservative strategies are put in a situation where they must choose between pursuing higher risk strategies, or hamstringing their own careers. Banks are not fundamentally evil, they simply are the victims of a system design which rewards it.

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1.2 The limitations of lookback models when predicting the future

To ensure that assets match liabilities on a day-to-day basis, banks rely on control systems to measure past depositor behavior and establish margins within which the bank can continue to operate. Initially, this began as simply keeping a sufficient amount of cash-on-hand, or reserves, to buffer bank runs that might occur. As time has progressed, banks have evolved their balance sheet management to measure average inflows and outflows of deposits, laddering illiquid assets to match their projected capital outflows. The process of projecting these cash outflows began with simple averages, but as statistics and finance have evolved, has become an advanced process. In the present-day, banks utilize algorithms to measure holistic depositor behavior over time, with the most advanced systems utilizing AI, data science, and Machine Learning models to augment the bank’s risk management operations. However, all of these models suffer from a common flaw: they largely rely on look-back models. Look-back models use historic knowledge to predict what future events will occur. The assumptions that go into these models are that if something has happened, it will likely happen again, and if something has not happened, then it is unlikely to happen. They look to the past to predict the future, but the black-swan events that often precipitate a bank failure are by their nature unpredictable, and fundamentally break the assumptions that go into models of this design. While it is possible for banks to measure what the market is likely to do, current banking models do not permit depositors to tell banks exactly what they will do. As such, banks relying on lookback models are forced to be reactive rather than proactive, limiting their ability to predict cash flows effectively and respond to changing events in real-time.

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1.3 The socialized cost of coordination failure and bank runs

As a consequence of the duration gap existing, and bank balance-sheet assets not being immediately redeemable 1:1 for cash, depositors cannot all immediately retrieve their money from a fractional reserve system. It is this duration gap that allows for bank runs to occur and that gives rise to the coordination problem of fractional reserve banking. In the current financial reserve system, even banks that are fundamentally solvent may fall victim to a bank run when depositors are uncertain about the health of their investments and lack the ability to communicate effectively between them. A potential liquidity crisis, or even the perception for the potential of a liquidity crisis, leaves depositors with a prisoner’s dilemma: while it may benefit everyone involved to keep their funds in the bank and avoid triggering an insolvency crisis, there is a strong first-mover incentive for depositors to recover their funds early to avoid being left without access. Nobody wants to be the person who holds tight and loses everything. At their core, all bank runs are caused by this coordination problem - if depositors could perfectly coordinate their withdrawals to avoid over-stressing the bank’s reserves, bank runs would not occur and no insolvency would result. However, as that is not the case, bank runs and their resulting insolvencies have become an accepted part of the banking system. The most famous example of this coordination failure is Black Tuesday, in which many Americans flocked to banks to demand their cash after hearing about banks going under from bad debt created by margin trading, a mass rush of withdrawal requests led to somewhere between a third and one half of US banks collapsing, thrusting the United States into the Great Depression. In an attempt to stem these widespread financial losses, governments have spent decades trying to address the coordination problem. Mostly, they have attempted to limit depositor losses in the event of a bank failure by socializing losses across their native currencies. In the United States, this has resulted in all American banks being placed under the regulatory umbrella of the Federal Deposit Insurance Corporation, an entity designed to both oversee banks and offer bank depositors insurance. The FDIC enacts policies meant to ensure banks hold sufficient reserves while also composing their balance-sheets of high-quality assets. In the event of a bank failure, the FDIC takes over the bank, sells its balance sheet assets at a reduced price to other banks through private deals, and compensates for any remaining losses by printing money. This solution is inherently market-inefficient and will ultimately prove to be unsustainable. Placing government-appointed individuals in charge of determining the secondary price of balance-sheet assets results in poorly priced deals, while socializing losses through inflation simply transfers the losses of bankers to the American public. Making depositors whole at the cost of taxpayers serves as a band-aid rather than a preventive cure, and dissolving banks entirely throws out the proverbial baby with the bathwater, reducing competition for larger banks and encouraging monopolistic stagnation.

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1.4 Summarizing banking’s duration gap problem

Fractional reserve systems, by their very nature, result in the creation of duration gaps that demand an organized approach to banking, a model to predict what depositor outflows will be, and a methodology to address the coordination problem of fractional reserve banking. The current banking system has addressed these problems as best it can with a top-down organizational approach, algorithmic look-back models, and a government-administered insurance framework. Yet these solutions are lacking, as they result in perverse incentives for bankers, in models that are purely reactive rather than proactive, and in government-sponsored insurance frameworks that serve only to socialize the cost of coordination failures rather than disperse them entirely. The existing banking system, with its centralized and hierarchical nature, is not good at measuring social consensus, nor at responding to it. Even innovations designed to side-step some of these issues, such as credit unions (better incentive alignment), still fall prey to the others. A new system is needed to address these three core issues with better solutions than have thus far been offered: InfiniFi offers that solution.

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2.0 Introducing InfiniFi

InfiniFi is a self-coordinated, depositor-driven fractional reserve system built to better address the challenges created by duration gaps in traditional banking, aligning incentives while securing greater returns without increased risk regardless of asset class. InfiniFi corrects the misalignment that has consistently destabilized banks by giving the platform’s key decision makers the most to gain or lose based on their decisions, while also offering depositors full transparency into the health and risk profiles of their investments. InfiniFi is also able to better measure market sentiment in real time by incentivizing depositors to become illiquid along a continuum of unbonding periods, creating a self-laddering system from which duration-matching can then be executed. This incentivization is driven by the distribution of returns from all balance sheet assets towards illiquid depositors, according to a multiplier assigned to them relative to their unbonding period. InfiniFi uses this market-sourced information to extrapolate current depositor preferences across liquid depositors as well, applying the self-similarity principle to discern their time preferences. Co-deployment of illiquid and liquid deposits into illiquid assets, according to fractional reserve principles, is utilized to increase rates of return for both liquid and illiquid participants above those available in respective traditional liquid and illiquid vehicles. To better handle coordination breakdowns, we introduce two features: an automated insurance backstop that grows more effective with every depeg and a liquidity pool to facilitate depositors directly exiting their positions, eliminating the need to sell balance sheet assets directly. We further delegate first-loss to the most illiquid depositors, those who have the most control over investment decisions in our system, which further aligns their incentives. Blockchain is chosen as the medium for InfiniFi because of its censorship resistance, its ability to improve social coordination through transparency, and the efficiency with which liquidity can be sourced through DeFi-based infrastructure.

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2.1 How InfiniFi Works: A technical case study

Any cryptocurrency asset can be deployed into InfiniFi. In this example, we will consider a dollar-pegged stablecoin like USDC. When someone deposits USDC into InfiniFi, they mint iUSD, and that deposit asset is immediately deployed to a trusted set of liquid vehicles. To achieve higher returns than depositing their assets on another platform — for example, a 5% return for depositing USDC to Aave — they must then bond their iUSD, with depositors self-selecting an unbonding period based on their time preferences (note: this is not how long their asset will be locked up for, but rather, how long it will be locked-up once they decide to begin unbonding). Depositors receive an ERC20 token to represent their bonded iUSD. To incentivize staking iUSD, InfiniFi awards depositors who stake for a longer period of time with a higher weighted-average time-multiplier. This is based on our weighting function — for example, if you agreed to a one-year unbonding period, you might receive a time-multiplier of two. We utilize that time-multiplier to calculate your weighted product. With that number calculated, we sum all weighted products together, and our weighted-average engine redistributes returns across depositors according to their fractional proportionality of the weighted product sum. For example, if you had $10 in a$100 pool earning $5 per year, you would normally get$10/$100*$5=$0.50 of interest. In this case, we treat your$10 as $20 in a$110 pool, meaning you get $20/$110*$5=$0.91 of interest. At this point, depositors who have chosen to become illiquid depositors are making more than liquid depositors (9.1% in this example); this might be an acceptable return, except now liquid depositors are making lower rates than they could receive from simply depositing into AAVE (4.45% here). To address this, we take advantage of the fact that many illiquid depositors have just shared their liquidity preferences with us by bonding their iUSD. Armed with this knowledge, the system is able to self-ladder. This process is depicted in Figure 1, where known illiquid liabilities of varying durations inform the acquisition of illiquid assets. Knowing how much capital is willing to bond for a given duration allows depositors to direct the acquisition of illiquid assets (for example, Pendle) that duration-match known illiquid deposits. USDC is withdrawn from AAVE and redeployed into these illiquid assets. To implement a fractional reserve system, improve returns for all participants, and increase capital efficiency, a proportion of the capital deployed to these illiquid assets is sourced from liquid depositors. What proportion of the capital deployed may be sourced from liquid sources is determined both by depositors themselves and by limitations imposed by the need to keep a certain amount of liquid capital on-hand at all times to satisfy a reserve-rate. Figure 1: Based on known illiquid liabilities, illiquid assets may be selected with matched durations This co-investment of liquid deposits into illiquid vehicles moves InfiniFi’s liquid depositors slightly further out the risk-return curve, resulting in higher returns than would be possible for either liquid or illiquid depositors in the respective liquid and illiquid assets. Liquid depositors receive a return profile at an average between the liquid and illiquid assets, meaning that they are earning rates that are higher than their liquid deposit could otherwise make. Meanwhile, returns for illiquid depositors include distributed returns from the liquid deposits deployed fractionally to illiquid assets, resulting in returns for illiquid depositors that are above those achievable by depositing into the raw illiquid asset. Both of these statements may be verified in Figure 2, where a liquid asset returning 5% and an illiquid asset returning 8.5% are utilized in a fractional reserve system composed of two $100 depositors, one liquid and the other illiquid. Applying fractional reserve principles to this system results in a liquid return of 6.5% and an illiquid return of 10.15% for depositors. With these added returns, the financial benefits of InfiniFi over both existing stablecoin and fractional reserve system designs are apparent. Figure 2: An example of an InfiniFi system with two depositors and two assets. Returns for both depositors exceed what they could otherwise access outside of InfiniFi. To withdraw capital from InfiniFi, liquid depositors must redeem their iUSD for the backing asset(s). Typically, InfiniFi will have reserves on hand, and redemptions will be immediate. In the unusual case that InfiniFi is temporarily locked-up, a redemption request will be created instead of a full redemption, with the request being placed into a withdrawal queue and redemptions being processed on a first-come, first-serve basis as illiquid assets reach maturity and re-collateralize liquid depositors. This FIFO (first in first out) queue ensures that redemptions are a level playing field during lock-up events and that automated MEV systems are not given undue advantage over human participants. Should participants desire liquidity on their iUSD during periods of lock-up, it may be sourced from secondary exchanges, such as Curve. For illiquid depositors, representing illiquid positions with a series of ERC20 tokens opens a variety of possibilities. Illiquid depositors will have their illiquid positions represented by any one of a series of ERC20 tokens, with each successive series corresponding to a different period of weeks to exit the position. This position will remain locked indefinitely until the unbonding process is triggered by the position holder; this exit process takes as long as the unbonding period chosen when the illiquid depositor in question locked iUSD. During the unbonding process, the time-multiplier allocated to any given position will begin to decay, starting at the value given by the weighting function and reaching unity once the unbonding process has concluded. While this is happening, the depositor holding the position may cancel unbonding at any time and return to their full-strength time-multiplier, but at the cost of having to go through the entire unbonding process again if they want to unbond later. Unbonding periods may be increased at any time, capped only by the global maximum lockup, and the time-multiplier associated with the corresponding position will increase to match. Additional deposits of iUSD will be permitted, but this functionality won’t go live until several months after launch. To ensure this mechanic is not abused, additional deposits will be capped at the same proportion of TVL as the initial deposit represented (or at the point that additional deposits are turned on). Should participants desire early liquidity on their position, they may source it through external AMMs or lending systems. Further details surrounding InfiniFi’s individual components and workings will be provided in future docs.

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2.2 Deploying depositor assets

To address the need for laddering balance-sheet assets created by the duration gap, InfiniFi places depositors fully in charge of asset selection and allocation. By utilizing a bottom-up organization method over the more traditional top-down approach, InfiniFi corrects the incentive misalignment of traditional financial reserve banking by handing depositors complete transparency and control over the risk profiles of their investments. Illiquid depositors are given voting privileges proportional to the weighted product of their time-multiplier and their deposit size. These votes are then utilized to determine how much depositor capital is deployed to any given asset, liquid or illiquid. Amongst liquid assets, these votes determine what weighting any given liquid vehicle may have. With illiquid assets, these allocation votes determine how much capital will be allocated to a given illiquid asset (evergreen assets), or if any capital at all will be allocated in the case of assets that require a threshold to trigger the investment. Those locking the largest amounts of money for the longest periods of time have the most voting power in InfiniFi but also stand to lose the most from bad investment decisions, fully aligning their incentives to strike a balance between taking on risk and seeking higher returns.

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2.3 Matching assets to liabilities

InfiniFi also offers a better way to match assets with liabilities than the lookback models deployed by the traditional financial reserve system. InfiniFi incentivizes depositors to become illiquid by offering them greater returns, even attracting illiquid depositors on other projects to migrate their assets into InfiniFi and earn more as well (for instance, Pendle could be used as an illiquid asset, with the Pendle token holder serving as a new illiquid depositor, routing his existing deposit to Pendle through InfiniFi without changing his risk profile). This improves InfiniFi’s ability to close the duration gap by increasing the average duration of InfiniFi’s liabilities. Having more illiquid deposits means that InfiniFi can have higher reserve rates than traditional banks, improving stability, without sacrificing capital efficiency. In addition, InfiniFi’s self-laddering system allows for direct measurement of market sentiment. Rather than having to rely solely on predictive control systems to guess at cash inflow and outflow rates, InfiniFi incentivizes depositors to tell InfiniFi their direct future intentions. While predictive control systems will likely bring even higher capital efficiency and functionality to InfiniFi, the fact remains that direct knowledge of the future is always more efficient than guesswork. InfiniFi is further able to achieve stability through the self-similarity principle. In alignment with this principle, InfiniFi operates under the assumption that the holistic liquidity preferences of both the illiquid and liquid depositors will be roughly equivalent (in most cases, whether a depositor is liquid or illiquid will have more to do with how active they want to be on InfiniFi rather than a difference in liquidity preferences). Based on this assumption, InfiniFi can get better insights into the capital availability needs of its liquid depositors, using the information it has already gathered from its illiquid ones. This knowledge further reduces the likelihood of a depeg event, in which depositors are temporarily unable to redeem iUSD (such events, while rare, are to be expected, and InfiniFi has a number of ways to address them).

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2.3 Managing Bank Runs and Bad Debt

In finance, as in all business, things eventually go wrong. It is how systems respond that dictates their resilience. When coordination failures do occur, when illiquid assets default, InfiniFi must not be placed in a permanent failure mode. To address the question of what to do when things go wrong, InfiniFi establishes first-loss principles and automates the process of finding buyers-of-last resort through a Curve stableswap pool. In the unlikely event that an illiquid vehicle that InfiniFi depositors have directed capital into defaults, InfiniFi may first attempt the sale of the bad debt on the secondary market to recover some capital. Whether capital is recovered or not, the remaining losses are then socialized to InfiniFi illiquid depositors proportional to their voting power —- those with the highest voting power are socialized a larger proportion of the loss than those with lower voting power. As long as illiquid deposits exist to absorb losses, liquid depositors remain fully insulated from losses. This model strongly aligns incentives for those with the most voting power to refrain from excessive risk taking — while they receive the highest returns as a result of their high voting power, they also receive the highest losses in the event of default. Through additional safeguards, such as caps on concentration of capital across a single protocol or investment vehicle, InfiniFi offers a mechanism design that incentivizes depositors to acquire a lower-risk and diversified basket of assets on InfiniFi’s balance sheet, over ones that risk permanent insolvency. Still, for all of InfiniFi’s advances in direct measurement of market will, increased illiquidity of depositors, and duration matching of public sentiment, coordination failures can occur. In the event that liquid depositors begin to cash in, this leads to a reduction of capital in the liquid pool, resulting in yields for liquid depositors increasing. Under typical circumstances, this is itself enough to encourage additional depositors to deposit their capital into InfiniFi and replace those leaving (particularly if lending markets and leverage loops exist). However, during certain events, this will be insufficient, and all liquid reserves in InfiniFi will be exhausted. To tackle this eventuality, InfiniFi will incentivize liquidity onto Curve stableswap pools, using deliberately segregated streams of its emissions to attract LPs (eventually acquiring its own protocol-owned liquidity). A further discussion of this incentivization may be found in the Governance section. The existence of an automated secondary market for iUSD liquidity will facilitate automated provisioning of buyers-of-last resort for depositors during a temporary insolvency. Rather than the closed-door methodology employed by conventional deposit insurance frameworks — which operate by seizing and selling illiquid assets held on a balance sheet at an artificially determined price — InfiniFi uses AMM technology to facilitate a fair-market price for InfiniFi’s liquid liabilities. Multiple case-studies in DeFi have shown that when fully-backed assets become temporarily insolvent, the result is never total collapse, but rather, temporary trading below peg. One classic example of this is USDC, which was temporarily insolvent over a weekend in March of 2023. The well-reputed stablecoin depegged to $0.74 amidst concerns over insolvency, giving many arbitrageurs the opportunity of a lifetime to purchase a dollar at less than a dollar. Once redemptions resumed Monday morning, the token quickly re-pegged, and all who bought below peg made significant profit. Another well-known example, for a far-longer period, of temporary insolvency, is Lido’s well-known liquid staking token, Staked Ether (stETH). While stETH was known to have a 1:1 backing for much of its existence, it was not possible to redeem this backing until after the Ethereum Merge in early 2023. Prior to this, stETH frequently traded below its 1 ETH peg, trading in 2022 at as low as 0.9 ETH. Despite this, people continued to use stETH, and when the Merge occurred, those who had purchased below-peg reaped the benefits. When protocols that are fully backed become temporarily insolvent, the result is not collapse, but opportunity, and that is precisely the mechanic that InfiniFi takes advantage of during depeg events. Not wanting to let all profit from depegs go solely into the hands of arbitrageurs, InfiniFi implements an active mechanism designed to guard the peg, growing larger with every depeg.

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2.4 Summarizing InfiniFi’s innovations

InfiniFi offers a novel approach to solving the problems of the financial reserve system. Its depositor-driven system better aligns incentives, closes the duration gap beyond what traditional banking is capable of through direct market knowledge, and facilitates the efficient handling of both bad debt and temporary insolvency events through DeFi-native architecture. All this is accomplished while providing depositors with higher returns than they would be able to access for any given liquid or illiquid yield source, passing along the improvements in capital efficiency that would typically be absorbed as profit in the traditional banking world would be absorbed entirely as profit. InfiniFi offers a vision for the future of banking in which risks are properly weighed with returns, in which depositors can begin to conceive of fractional reserve practices as a beneficial practice rather than an odious insider’s game, and in which banking benefits primarily those who trust it with their hard-earned money. To realize this vision, InfiniFi introduces a series of mechanisms that have their own second and third order implications. To manage these implications, and preserve the benefits of InfiniFi for years to come, InfiniFi introduces further systems to provide for its decentralized, on-chain governance.

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Governance

To fully address governance is a whitepaper unto itself. This whitepaper is currently being written, and prior to it being merged into this paper, the outline describing governance functionality shall suffice.

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Why is Governance Needed?

How will capital be deployed? Who decides where capital can be deployed? Tragedy of the Commons problem Hijacking of funds must be avoided How to incentivize early adopters? How to incentivize liquidity providers?

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Non-Governing Roles

Protocols - propose a new parent adapter for different product offerings May take a cut of proceeds from adapter Subject to audit requirements May be subject to bond requirements Must pay a fee in utility token to submit Proposers - propose new product offerings from a parent adapter May take a cut of proceeds from product Keep offerings on InfiniFi up-to-date with protocol offerings MEV expected to dominate Put up bond if required for parent adapter Must pay a fee in utility token to submit

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Allocators

Allocators direct funds to illiquid vehicles, reserves deployed according to a set proportion Also vote on liquid vehicle composition Capital delegated according to voting power Depositors being in-charge produces better incentive alignment Voting system of individuals and delegates One-layer deep Agents will eventually be automated (AI) Delegated votes must arrive one day before individual ones and can be erased during a 24 hour grace period, during which individuals can un-delegate if they do not like outcome To receive their emissions, Allocators must: If solo voters, vote weekly If delegated voters, their delegates must vote on their behalf. Delegates get a cut of emissions from their delegators.

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Verifiers

Introduce token Concept of Verifiers Approve protocols Approve specific products created from Protocol adapters by Proposers May include max size (non-evergreen) May include maturity (illiquid fixed-maturity) May include duration (illiquid fixed-duration) Economic difficulty of acquiring 51% of the tokens Voting rights gained by Staking tokens with one-week unbonding period Burning tokens to permanently bind them to an illiquid position (more later) Voting incentivized by desire to not lose value in token or money in deposits Voting system of individuals and delegates One-layer deep Delegated votes must arrive seven days before individual ones and can be erased during a seven day grace period, during which individuals can un-delegate if they do not like outcome Delegates receive additional bonus to Loyalty Multiplier on a single position, dependent on how much power has been delegated to them Diminishing returns to discourage centralization Increase to bias (up/down)

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Token Gamification and Emissions

Emissions on a long-tail decay curve Loyalty Multiplier concept Linearly increases while you are bonding Increase to voting power, earnings, and emissions Can be permanently increased in step-function by burning utility token Game theory - Financialization of “being early” Sell Burn Stake Hold Bias can be additionally increased/decreased by delegated Verifier power

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Vetoers and Election System

Vetoers can kill any adapter or product proposal Only one out of five (⅕) needed to kill a proposed offering Can ban addresses from being Proposers or Protocols, contracts from being adapters, bytecodes from being accepted One member up for reelection every year Challenger must reach 75% of the vote to win, otherwise incumbent remains If multiple parties in election, worst 75% eliminated, vote re-held ⅘ Vetoers may remove a single Vetoer and trigger an election Special period, new adapters not accepted until 5/5 present Voted on by Verifiers and Allocators with each side equally weighted Makes attacking Vetoer system to steal deposits extremely difficult

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Treasury, Design Parameters, and Incentive Management

Treasury Pool financed by small fee on interest Management of both reserved for Allocators Deployment of Treasury managed by Allocators Incentive Management Allocators incentivized to use Treasury for POL acquisition Certain amount of emissions set-aside for: Liquidity on stablecoin Liquidity on utility token Design Parameters Require a high margin to pass changes (66%+)

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3.0 Virtuous cycles for modern finance

InfiniFi’s novel structure creates a series of flywheel effects for depositors and the network that helps them earn more for investing their hard-earned assets on it as more participants join in. For a financial enterprise, flywheel-effects, where positive-feedback cycles play-off their own success, are critical to long-term success and growth. InfiniFi possesses two such flywheels: one dealing with the positive-feedback loop between rates and TVL and the other describing InfiniFi’s network effect.

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3.1 The positive rate-TVL feedback loop

Figure 3: The positive feedback loop that powers InfiniFi’s growth. The growth loop is depicted on the left, while the balancing loop is depicted on the right. When liquid capital depositors begin to dilute the above-underlying returns that InfiniFi is capable of offering liquid depositors, these rates will begin to approach the underlying liquid vehicles in an asymptotic manner. As liquid return rates decrease from dilution, liquid depositors are incentivized to become illiquid to gain access to higher rates. When liquid depositors become illiquid, more capital becomes available for acquiring duration-matched illiquid assets, and this increases the total returns of the entire system, resulting in higher yields for both liquid and illiquid depositors. These higher yields, particularly in the presence of leverage-loopers who trade between margins of InfiniFi and whatever the cost to borrow any given fiat asset is, incentivizes the minting of additional amounts of iUSD, increasing InfiniFi TVL and continuing the positive-feedback effect. This growth loop will run until all illiquid vehicles available are exhausted, or until too many people have become illiquid, in which case a negative feedback cycle kicks on to rebalance the system automatically. This self-balancing loop occurs when there is not enough liquid capital to make additional fractional deployments - in this case, any deployments made must be done so with only illiquid capital, resulting in yield compression for illiquid depositors. Under these circumstances, liquid capital being scarce will automatically attract additional liquid depositors (as liquid returns will be higher). Should additional external capital not enter the system, illiquid depositors at the shorter end of the unbonding spectrum are incentivized to fully unbond and return to liquid iUSD, capturing both the convenience of being liquid and the higher rates currently available for liquid participants. These participants who choose to unbond result in two positive outcomes: with fewer participants, yield compression for illiquid depositors is alleviated, and with more liquid capital now available to deploy to illiquid vehicles, the growth loop can resume. Through this clever design, InfiniFi is able to remain stable even in periods of low growth, resuming growth once additional liquidity arrives from either external or internal sources. The full cycle described is depicted in Figure 3. And in addition to helping InfiniFi grow, this flywheel has another critical benefit: it brings with it more valuable information that is valuable to the network, as seen in the next section.

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3.2 The information network effect

Figure 4: The positive feedback loop that improves InfiniFi’s stability through additional information. This loop further serves as a moat to would-be competitors. As more liquid depositors deposit to InfiniFi, liquid returns are once again diluted, and liquid depositors are similarly incentivized to stake their iUSD, just as is the case with the previous flywheel. When liquid depositors stake their iUSD, they provide an additional data point of what their liquidity preferences are. This improves the accuracy of InfiniFi’s laddering schedule, with each data point growing the platform’s ability to accurately measure depositor intent. That added knowledge helps InfiniFi better match assets with liabilities, assessing the will of illiquid depositors and then applying the self-similarity principle to more accurately predict the will of liquid depositors. Accordingly, every additional illiquid staker joining InfiniFi increases its stability. A more stable system is more attractive to additional liquid depositors, and the cycle repeats, with each positive feedback cycle looping to create compounding improvements to InfiniFi. This network effect further serves as a moat to any would-be competitors, as anyone considering switching from InfiniFi to an alternative would have to contend with a fundamentally less stable offering. This positive feedback loop is depicted in Figure 4.

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3.3 Higher yields for all

An attractive second-order implication of InfiniFi’s fractional reserve arrangement is that yields on both liquid and illiquid assets are increased above levels achievable with the raw liquid and illiquid assets alone. As previously mentioned, this is possible because the extra information that InfiniFi gathers from depositors allows it to securely move a portion of depositors further out onto the risk-return curve to earn higher returns for the entire system. For example: Consider a system with $100 of liquid deposits and$100 of illiquid deposits. This system may allocate to both a liquid asset returning 5% and an illiquid asset returning 20%. If we choose to allocate $100 of liquid deposits to the liquid asset and$100 of illiquid deposits to the illiquid asset, our total return will be: ($100) * 5$100) * 20% = $25 This gives us a total ROI of $25/$200 = 12.5% ROI This is the outcome of full-reserve systems, and reflects the design that many existing stablecoins in DeFi have chosen to utilize. InfiniFi utilizes a fractional reserve system, wherein some liquid deposits may be allocated to the illiquid asset. Let us suppose , for the sake of argument, that our reserve rate (how much we must hold in liquid assets) is 50%, a number five times higher than that required by the US Federal Reserve for member banks. We will be deploying “D” dollars from our liquid deposits to illiquid assets and “$100-D” to our liquid assets. Our return is then: D = R * $100 ($100-D)*5$100+D)*20% = Return 505%+15020% = $32.50 This gives us a total ROI of $32.50/$200 = 16.25% ROI A rigorous derivation exemplifying this is included in Appendix A. By pulling liquid depositors further out the risk-return curve, InfiniFi is able to increase returns over what is possible in a full-reserve system — and by then further shuffling yield an even distribution for all participants to a concentration favoring illiquid depositors, InfiniFi is then further able to increase returns for illiquid depositors above those achievable in raw illiquid instruments. The remaining returns are given to liquid depositors, who receive a combination of both liquid and illiquid returns, necessitating that the return they receive will always be above purely liquid vehicles (asymptotically approaching the liquid returns as size grows to infinity). The result is a system that is capable of achieving greater returns regardless of asset class, allowing depositors to receive significantly more of the rewards from their investments compared to traditional banks that typically take the spread as profit — making InfiniFi an attractive option for all forms of capital.

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3.4 A symbiotic system

InfiniFi will begin in DeFi, where liquid assets are readily available: systems such as AAVE, LIDO, MakerDAO, Spark, Frax, Euler, and many others offer liquid yield-bearing assets on a variety of well-known backings. More recently, illiquid assets have gained great prominence with their higher returns: systems such as Pendle, EtherFi, and Ethena all offer a variety of durations and correspondingly higher returns. InfiniFi will symbiotically exist with these systems: rather than needing to compete with them for dominance, InfiniFi can instead offer an opportunity for participant migration. For instance, instead of directly depositing USDC to AAVE and earning 5%, AAVE liquidity providers could move to InfiniFi, continue to provide liquidity to AAVE, and earn 8%. Rather than earn 30% APR on Pendle, PT-token holders could migrate their fixed-income assets to InfiniFi, receiving a duration identical to their original, with their assets still deployed through Pendle, but with the added bonus of returns jumping to 40%+ from liquid co-deployments to the same asset. These greater returns are all possible without any of the symbiotic partner-protocols losing a cent of TVL in the process. (in nearly all cases, they should actually see TVL increase from liquid co-deployments). InfiniFi can absorb existing DeFi liquidity, coexist with established DeFi systems, and produce elevated returns for their users. This symbiotic relationship will additionally incentivize existing protocols to scramble for compatibility with InfiniFi, taking the burden of integration away from the InfiniFi team and democratizing the process through InfiniFi’s governance apparatus. Once DeFi has been absorbed, the next frontier is an obvious one: TradFi assets.

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4.0 Driving the Tokenization Revolution

Despite ongoing optimism throughout the history of blockchain technology, tokenization of real-world assets has been slow. In the past, this could be attributed to a lack of regulatory clarity surrounding digital assets. Yet even as many governments have made meaningful progress in clarifying those questions, tokenization has still failed to materialize at scale. Niche and interesting activity may be found in the worlds of international dollar settlement and neobank access to American investment vehicles, yet the spark needed to overcome the “so-what” problem remains absent. Until now, there hasn’t been a real financial incentive to take on the cost of moving traditional financial assets into DeFi, which requires additional technological costs and intermediary costs to move on-chain. InfiniFi provides that incentive, creating a synthesis of the TradFi thesis and the DeFi antithesis, dubbed “InFi”. By offering those either already holding or looking to acquire TradFi fixed-income assets a fundamental increase in returns, InfiniFi will overcome the “so-what” problem and drive the tokenization revolution. InfiniFi will be to tokenization what the internet was to personal computers.

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4.1 Tokenizers

As InfiniFi makes the jump from onboarding DeFi assets to TradFi ones, existing tokenizers will serve as the bridge between worlds. Tokenizers will benefit greatly from InfiniFi, taking a cut from the cash flows that cross through their system and seeing significant increases in demand for throughput across the world. For tokenizers dealing primarily with liquid assets, the process of onboarding with InfiniFi will certainly involve more legal agreements, KYC, and diligence than typical liquid assets, but will be straightforward compared to illiquid asset tokenizers. Within InfiniFi, illiquid asset tokenizers are expected to play roles in three distinct types of transactions: resale of existing assets to InfiniFi, origination of new TradFi assets for InfiniFi, and refinancing of existing assets through InfiniFi. Including extensive legal agreements to provide InfiniFi with recourse in the event of fraud or default, illiquid asset tokenizers will be expected to engage in a combination of refinancing and either of the other two practices. This is desired to ensure that tokenizers are responsible to both InfiniFi and their own clients should their diligence process fail, as refinancing creates new depositors with InfiniFi from the tokenizer’s own clients (explained in more detail below), facilitating the establishment of an escrow for such clients, which can be seized in the event of default. This means that defrauding InfiniFi will result in the tokenizer’s clients having their deposits seized by InfiniFi, applying pressure to the tokenizer from both within and without, heavily disincentivizing fraud. The nuances of these arrangements will likely become more defined as InfiniFi develops further, but suffice to say, incentivizing tokenizers to perform aggressive diligence on any deals brought to InfiniFi is a prerequisite for success.

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4.2 Origination

For this operation, tokenizers facilitate the creation of new debt and the sale of this debt to InfiniFi as a fixed-income illiquid asset. Tokenizers source borrowers from their networks, construct a packaged deal, propose it to InfiniFi, and, should it pass muster, receive funding from InfiniFi. The repayment of this loan is then transferred to InfiniFi as it is made.

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4.3 Resale

Resale operations are simple transactions for existing TradFi asset holders, wherein a tokenizer is used as a bridge to facilitate the sale of a fixed-income asset from a TradFi holder to the InfiniFi protocol. This operation is roughly analogous to origination, though in this case, the tokenizer only serves as a middleman for tokenizing the already existing asset.

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4.4 Refinancing

Refinancing is an operation which may be carried out in one of two ways: either the holder of a discrete fixed-income asset may receive an immediate cash refund from fractional-liquid deployments and a higher rate (but lower total return) on the remaining capital or the holder of an evergreen debt asset may receive a higher return on his existing debt instrument with the co-deployment of InfiniFi liquid deposits to the same vehicle (for the remainder of this description, we will reference the second form, as it is more intuitive). Refinancing represents a migration of sorts: the existing fixed-income asset holder becomes a depositor at InfiniFi with the same term and capital outlay as he has already, while InfiniFi deploys liquid deposits along fractional-return principles to the same vehicle. The asset reaching maturity and the refinanceer’s position fully-unbonding will occur commensurate with one another; none of this, of course, will be visible to the refinance, as it will be run in partnership with the tokenizer. It is this asset which will be held in escrow to ensure tokenizer incentives are aligned with InfiniFi’s success.

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4.5 Siloed Illiquid Positions

As InfiniFi moves from the decentralized world to the world of fixed-income, it will likely be necessary to silo illiquid positions from one-another, particularly in cases where the depositor is themselves an existing asset holder (refinancing). This will assure the asset holder that the boost to returns provided by InfiniFi’s co-deployment of liquid capital is a truly fixed-rate one — the asset holder will neither benefit nor suffer from the external capital environment of InfiniFi, nor have exposure to default beyond their own asset. This siloing of risk will make InfiniFi more accessible to traditional asset managers, who are used to siloed and segregated risk profiles. While not likely active for DeFi systems at launch, hooks to facilitate this siloing of risk will be built into InfiniFi’s base architecture, making utilization as straightforward as appending new modules to the system.

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4.6 A comprehensive, but evolving, position

The details in this paper are meant to provide a holistic understanding of InfiniFi as it stands today. Design parameters have been deliberately not assigned numerical values, as the development thereof is a complex optimization problem that will be guessed at, improved, and iterated upon post-launch. The path to creating InfiniFi as it drives tokenization of the global financial system will be complex, but the game theory underpinning InfiniFi, the technology facilitating it, and the improvements offered for all fixed-income assets provide a clear roadmap.

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5.0 Conclusion

InfiniFi proposes significant innovations to address the problems created by the duration gap in fractional reserve banking through better incentive alignment, direct measurement of market sentiment, and a more efficient system for dealing with liquidity crises. InfiniFi addresses the tragedy of the commons inherent to management of public resources through a decentralized governance system, ensuring longevity, censorship resistance, and stability. In addressing these problems through the lens of creating a mutually beneficial, positive-sum game, InfiniFi also offers the second order impact of increased returns on all liquid and illiquid assets, serving as the catalyst needed to kickstart universal asset tokenization. Whitepaper [Working Copy]