Frax is the first fractional-algorithmic stablecoin protocol.
does that mean?
The name Frax refers to the fractional-algorithmic stability mechanism.
Frax's supply is partially backed by collateralremainder of the supply is algorithmic, meaning that it is floating/unbacked
The ratio of the collateralized and algorithmic components depends on the market price of the FRAX stablecoin, which is pegged to the US dollar
- When FRAX trades above $1, the protocol the collateral ratio.
- When FRAX trades below $1, the protocol the collateral ratio.
Frax shares (FXS)
Frax shares are the governance tokens, which accrue fees, seigniorage revenue and excess collateral value
The community governs the protocol and determines where the collateral is stored, while the algorithm oversees day-to-day management as opposed to a group of individuals, whom as the crypto community is well aware, are usually unnecessary points of failure.
Frax Price Index (FPI) - The other stablecoin
The other stablecoin featured as part of the system is FPI, pegged to the Consumer Price Index
The end goal is to build crypto's own version of the CPI, governed by FXS holders. While currently pegged to the US dollar, FRAX aspires to become the first decentralized, permissionless native unit of account that holds the standard of living stable.
Collateralised vs uncollateralised (a.k.a. algorithmic)
Collateralized stablecoins - every coin is in theory backed by some hard, real-world asset - are seen as characteristically low-risk. In reality, they feature custodial riskrequire on-chain over-collaterilazation
- Being able to maintain a tight peg gives holders confidence in their ability to store value. Tough times never last, only tough tokens last.
Purely algorithmic stablecoins offer a trustless and scalable decentralized model for storage of value. However, they are difficult to get up-and-running, slow-growing, and their significant deviations from peg during times of high volatility can instill doubt in their ability to store value (and in crypto in general). Queue UST acid flashbacks. Historically these 'experiments' have all eventually depegged (Shoutouts to Basis Cash, Empty Set Dollar and Seigniorage Shares).
- The name of the game is capital efficiency, the peg of an algorithmic stablecoin can be held while requiring significantly less fiat or hard assets as collateral.
- Collateralized - safe but not necessarily flexible, custodial risk, over-collateralization often necessary.
- Algorithmic - trustless, scalable, but historically shite
FRAX - fractionally collateralized/algorithmic
This system aims to nestle itself between the two options to be a highly scalable, trustless and stable form of on-chain money.
There is no strict timeframe for changes in the collateralized/algorithmic ratio. The hope is that as FRAX adoption increases, users will be comfortable with a larger portion of the collateral being algorithmic.
- The fractional-algorithmic system also offers capital efficiency, but with a kind of flexibility and security not possible with fully algorithmic systems.
- The fractionally algorithmic system can adapt to the state of the market.
The protocol's collateral ratio refresh function can be called by any user once per hour. When the protocol is over or under $1, the function can change the collateral ratio in steps of 0.25%. The refresh rate and step parameters can be adjusted via governance
The prices of FRAX, FXS and the collateral ratio are calculated with a time-weighted average of the Uniswap pair price and the ETH:USD Chainlink oracle. The latter allows the protocol to obtain the true USD price, as opposed to an average of stablecoin pools on Uniswap.
- The algorithmic fraction should increase with adoption, but there is no timeframe.
- The peg stability mechanism is determined by the refresh ratestep parameters (currently 24 hours and 0.25% respectively), both of which can be adjusted via governance voting.
- FRAX stays stable against the dollar itself through the use of a Chainlink oracle, making it more resilient than the use of the weighted average of existing stablecoins alone.
FRAX minting and FXS burning - sound familiar?
At genesis, FRAX was 100% collateralized (known as the collateral phase). $1 of collateral would be needed to mint $1 of FRAX.
), in the fractional phase, minting $1 of FRAX requires less than $1 collateral, the uncollateralized portion is 'captured' in the form of Frax Shares (FXS), which are burnt from circulation. The value of the FXS increases both as the algorithmic fraction of the protocol increases and as more FRAX is minted (i.e. as the market cap of FRAX increases).
For example, with the current algorithmic fraction of around 10%, minting $1 of FRAX would require $0.90 of collateral and burns $0.10 worth of FXS.
Correspondingly, redeeming your $1 of FRAX at this 10% fraction would give you $0.90 of collateral alongside $0.10 of minted FXS.
If this still hasn't rung any bells, Do Kwon and his now infamous Terra ecosystem borrowed and bastardized this idea for their UST/LUNA mint and burn mechanism, now etched into the crypto history books.
This mechanism in the case of UST/LUNA always gave you $1 worth of these assets upon minting, creating artificial value in the system, which ultimately acted as gasoline to the fire that was the depegging of UST. Ouch.
At all times, $1 of FRAX is redeemable for $1 worth of assets, so unlike the UST/LUNA mechanism, no artificial value is created. As previously mentioned, the value of the algorithmic fraction is 'captured' in the form of FXS.
Assets for FRAX minting mainly take the form of on-chain stablecoins to smoothen volatility in protocol collateral and encourage the push towards more algorithmic ratios.
As the system grows, this stability will enable the usage of volatile blue chips such as BTC and ETH to be used as collateral. But we're not there quite yet.
FXS - Significance of shares
Governance parameters that FXS holders (in the FRAX Dapp) can vote on include adding/adjusting collateral pools, adjusting various fees (e.g. minting/redeeming), and refreshing the rate of the collateral ratio. The protocol aims to be governance-minimized to design trustless money with the same ethos as Bitcoin.
- Utility in both upside (in the abovementioned TLDR) and downside (protocol flexibility and lower entry price for new investors) - but the value stabilises away from the value of FRAX.
- 100 million supply - limited supply and with burning mechanism the shares have the potential to become highly deflationary.
- As the market cap of FXS increases, so does the ability of the protocol to keep the value of FRAX stable.
Quoting from the Frax whitepaper, quoting the whitepaper of Seigniorage Shares by Robert Sam (quoteception):
"Share tokens are like the asset side of a central bank's balance sheet. The market capitalization of shares at any point in time fixes the upper limit on how much the coin supply can be reduced."
To reiterate - Frax is a hybrid (fractional) seigniorage shares model.
2022 FRAX volatility and effects of market cap
Currently (as of 17th June 2022), FRAX has a market cap of $1.462B, while the algorithmic fraction sits at 10.5% (> $153M). Tough times require heavier collateralization ratios. FRAX is currently the 5th biggest stablecoin by market cap (behind giants USDT, USDC, BUSD, DAI).
At present, the collateralized portion is stored as:
- Pool USDC (> $10M)
- Investor AMOs (> $14M)
- Lending AMOs (> $22M)
- Liquidity AMOs (> $282M)
- Curve AMOs (> $953M)
AMO stands for 'Algorithmic Market Operations Controller' - an autonomous contract that enacts arbitrary monetary policy, as long as it does not remove FRAX from its peg.
As the crypto market crashed over the first 7 months of 2022, FRAX held its peg well, experiencing maximum fluctuations of ± 0.003 USD.
Talk about reliability.
Earlier in its history, the price fluctuations were as large as ± 0.02 USD, however, the market cap of FRAX was significantly lower ($100-300M) between December 2020 and August 2021. Even with a drop in market cap from the ATH of $2.90B to $1.462B, FRAX is safely out of shitcoin territory. Fingers crossed for the future.
In times of strong turbulence, knowing that the collateral for your store of value is safu can help you sleep soundly at night.
TLDR - Long story short
If you like what you have read so far, this one might be worth a DCA into various forms (not financial advice):
- The FRAX stablecoin as a store of value
- Hold the deflationary FXS token (market cap $300M), initial supply 100M
- FRAX-FXS LPs
- Long-term FXS staking for veFXS rewards, additional governance rights and AMO profits
Conclusion
We have stroked the tip of the iceberg. All talk of DYOR goes out the window during bull markets, numbers don't go up, they fly up. The inevitable and predictable consequence is FOMO. Take the time now during this period of consolidation to understand how these systems work, so that your hodl or swing trade can be as effective as possible when the bears eventually go back into hibernation.
Please comment below if you think I have missed anything crucial, I will try to add/edit. Also let me know if you think this is too long! I really want this to be a TLDR series.
https://app.frax.finance
https://docs.frax.finance/
Sam Kazemian tweet - title: Why life will soon be ruled by algo stables
Stablecoin rankings coingecko
https://www.coingecko.com/en/categories/stablecoins
