How Frax Finance Breaks Barriers With Its Fractional-Algorithmic Stablecoin
Frax Finance is the first hybrid stablecoin protocol backed by both collateral and algorithms. Think of it as the first on-chain central bank that controls the monetary policy of a fractional-algorithmic stablecoin called FRAX.
Because of its partially collateralized and algorithmic-pegged model, it has created a niche within the stablecoin space, breaking away from most other stablecoins that are either overcollateralized or entirely algorithmic.
What Is Frax Finance?
FRAX is the first fractional stablecoin that aims to be scalable, decentralized and algorithmic money. It was founded by Sam Kazemian, Travis Moore and Jason Huan, who have created other Frax products such as the Frax Price Index.
What Is a Fractional-Algorithmic Stablecoin?
A fractional-algorithmic stablecoin has parts of its supply backed by collateral, such as USDC, and parts algorithmically stabilized.
The fractional model works to provide peg stability for the stablecoin, and can be used to defend the peg during black swan events, unlike fully algorithmic stablecoins with no backing. This makes users feel more confident due to the blockchain’s transparent nature of showing how much collateral is behind the stablecoin.
How Do FRAX and FXS Work?
The Frax protocol is able to maintain price stability using two main mechanisms: The FRAX stablecoin and its governance token, Frax Share (FXS).
As a fractionally collateralized stablecoin, FRAX is minted using both FXS and USDC. It is currently collateralized by USDC, and its collateralization ratio depends on the market price of FRAX. If FRAX is trading above the $1 peg, the protocol will decrease the collateral ratio to mint FRAX so less USDC is needed. Likewise, if FRAX is trading below the $1 peg, the protocol will then increase its collateral ratio to prevent a Terra UST death spiral scenario.
The protocol collects minting and redemption fees between 0.2 and 0.45 percent in FRAX, which allows the treasury to earn more during an increase in minting and redeeming FRAX.
How Does Collateral Ratio Work?
The collateral ratio (CR) is managed by Algorithmic Market Operations (AMO).
The Frax protocol reinforces existing arbitrage and algorithmic mechanisms by implementing a new concept known as AMO, an autonomous contract that performs open market operations algorithmically to maintain FRAX’s peg. This basically enables the protocol to automatically capture arbitrage opportunities within its liquidity pools on the open market to stabilize its peg.
If the protocol has reached its current collateralization ratio after accumulating excess collateral, anyone can interact with it to redistribute value back to FXS holders, or increase the system collateral through its buyback and recollateralization functions.
Key Features of Frax Finance
Fraxswap
Their native decentralized exchange, Fraxswap is the first automated market maker with time-weighted average market maker orders. It assembles orders over a period of time instead of all at once, allowing for a better average price with less slippage. This is used by the Frax protocol for rebalancing collateral and mints/redemptions, and for expanding/contracting FRAX supply and deploying protocol-owned liquidity on-chain.
Fraxlend
Fraxlend is the stablecoin-lending facility that allows for permissionless lending, debt origination, customized noncustodial loans and onboarding of collateral assets to the Frax Finance economy. FRAX can then be minted into money markets, such as Aave, to allow anyone to borrow FRAX and pay interest. The FRAX treasury earns from the interest paid by the borrowers. The platform allows anyone to create a market between a pair of ERC-20 tokens. Tokens provided by the Chainlink oracle can be lent to borrowers or used as collateral. When lenders deposit ERC-20 assets into the pair, they receive yield-bearing fTokens. Due to the interest that accrues over time, the fTokens can then be redeemed for increasing amounts of the underlying asset.
Algorithmic Market Operations (AMOs)
AMOs were launched in Frax v2 to create an automated process around the movement of FRAX and its collateral across DeFi ecosystems. The AMOs automatically leverage on Frax’s assets in a capital-efficient way by moving collateral, or FRAX, to different locations depending on the collateral ratio.
Frax has implemented 5 AMOs: Collateral Investor AMO, Curve AMO, Uniswap v3 AMO, Frax Lending AMO and FXS1559 AMO. They will loan or reclaim collateral automatically as the collateral ratio changes, and give 100 percent of all AMO profits back to veFXS holders.
Collateral Investor AMO: Deposits idle collateral from the Frax treasury across several DeFi protocols such as Aave, Compound and Yearn.
Curve AMO: Moves idle collateral and new FRAX to the FRAX3CRV pool to create more liquidity and tighten the FRAX peg. The FRAX3CRV pool will earn Curve trading fees, CRV and other LP rewards (by loaning out the CRV LPs to Yearn, StakeDAO and Convex).
Uniswap v3 AMO: Provides liquidity for other stablecoins to be traded for FRAX, and collects trading fees generated from that liquidity.
Frax Lending AMO: Allows FRAX to be minted into money markets, such as Aave, to allow anyone to borrow FRAX by paying interest instead of the base minting mechanism. The collateral provided in these protocols’ treasuries would back the FRAX minted.
FXS1559 AMO: Acts as a balance sheet that calculates all excess value in the Frax system above the collateral ratio, and uses this value to buy FXS for burning.
FRAX3CRV Pool
With a whopping $1 billion in TVL, FRAX3CRV is the largest stablecoin pool on Curve. It recently overtook the fabled 3Pool — composed of DAI, USDC and USDT — that had previously held over $3 billion worth of liquidity.
As mentioned above, Curve AMO moves idle USDC collateral and new FRAX minted to the FRAX3CRV pool on Curve. The pool will earn trading fees, CRV and other LP rewards. Trading fees and LP rewards will be given to veFXS holders, while the CRV rewards will be used to boost the FRAX3CRV pool rewards.
Frax Price Index (FPI)
The FPI is the second stablecoin of the ecosystem. It’s pegged to a basket of real-world consumer items to track inflation, keeping its price constant within the Consumer Price Index basket. Like FRAX, all FPI assets and market operations are on-chain and use AMO contracts.
It has a governance token that works like FXS does to FRAX, called Frax Price Index Share (FPIS). It’s also entitled to seigniorage from the protocol, directing extra yield from the treasury to FPIS holders. Since the protocol is launched from within the Frax ecosystem, the FPIS token will also direct a variable part of its revenue to FXS holders.
What Is FRAX Token?
FRAX is the stablecoin of Frax Finance. It’s partially backed by FXS and USDC and can be minted by providing both to mint FRAX.
The supply of FRAX is not fixed, and scales according to the supply and demand for the stablecoin. It has a current supply of 1.44 billion, which dropped from a previous high of 2.9 billion.
Source: CoinGecko
However, FXS also suffered soon after Terra collapsed, crashing over 75 percent to trade below $10. This was still well above the all-time low price of $1.50 in June 2021. FXS is currently trading between $5 to $7.
While FXS may not be doing well given the current market conditions, we could see FXS grow exponentially if FRAX were to start taking market share from USDC and USDT. Looking at the current state of crypto, here are some of the predictions:
According to Price Prediction, FXS will surpass current highs in 2026 at a maximum price of $43.95, and possibly surge to $196.40 by 2030.
WalletInvestor is less optimistic with a projection for FXS at $8.80 by the end of 2022 and a five-year-high target of $47.46.
DigitalCoinPrice's conservative prediction for FXS tells us the coin will average $7.68 in 2022. Then, it will slowly follow a year-on-year uptrend to reach $11.45 by 2025 and $27.71 by 2030.
Do keep in mind that FXS is heavily reliant on the performance of FRAX, and predictions serve only as a guide, and not advice.
Where to Buy and Trade FXS
FXS can be bought and traded on different crypto exchanges. Here’s how you can trade FXS as a derivative spot on Bybit:
Step 1: Open an account on Bybit and verify it to complete the registration process.
Step 2: Purchase USDT by visiting the Buy Crypto page. You’ll see several options to buy USDT: Express, Fiat Deposit, Crypto Deposit and P2P Trading. Choose the option that’s right for you.
Step 3: After you’ve purchased USDT, click the Derivatives tab, then choose USDT Perpetual from the drop-down menu. You’ll be directed to the Perpetual trading terminal.
Step 4: Search for the FXS/USDT trading pair on the left side of the trading platform, which usually displays BTC/USDT by default.
Step 5: Enter your long or short position and leverage size by filling in the values on the right side of the trading terminal.
If you’re looking to buy FXS on-chain, you can buy the cryptocurrency of your choice on Bybit and send it to a wallet such as MetaMask before swapping it for FXS on Fraxswap or Uniswap. For larger amounts, you can try the TWAMM feature on Fraxswap that allows you to swap between FXS, FPI and FPIS with low slippage over a selected period.
The Bottom Line
Frax Finance is an innovative stablecoin project with its algorithmic price stability mechanism. The FRAX stablecoin is one of the top decentralized stablecoins in terms of on-chain liquidity and peg stability. The protocol has a bright future with plenty of room to grow as they launch new products, such as the Frax Price Index, which solves the real-world need for an inflation-resistant stablecoin, and their upcoming money market that will increase the adoption of FRAX.