What is FRAX?

In 2020, the crypto market ushered in an era where a large number of external funds flowed into the market, and a variety of cryptocurrencies were listed during this period. The entire market started to expand exponentially.

In addition to various contract-based altcoins, a myriad of application-based cryptocurrencies also emerge one after another. In the same year, traditional algorithmic stablecoins also witnessed huge breakthroughs. FRAX, for example, is the world’s first fractional-algorithmic stablecoin.

What is FRAX?

Frax Finance is a decentralized stablecoin protocol. The Frax Finance ecosystem includes two different tokens: $FXS, a governance and utility stablecoin, and $Frax, a stablecoin pegged to the US dollar on a 1:1 basis.

Compared with $DAI and $USDC which are over-collateralized, FRAX adopts a partial collateral mechanism. Unlike UST, which mostly relies on algorithms for growth, FRAX adopts a partial algorithm model. Therefore, FRAX is also called a “hybrid algorithm stablecoin.”

$Frax is generated based on algorithms, and the protocol is developing at a fast speed, with risks multiplied with this development. However, as FRAX is backed in part by hard currency USDC, the intrinsic value of FRAX is guaranteed even in extreme market volatility.

The ultimate goal of the FRAX protocol is to provide a highly scalable, decentralized algorithmic currency that will eventually replace fixed-supply, mainstream digital assets like BTC. The governance token Frax Shares (FXS) was launched in 2020 with a total supply of 100 million.

The History of FRAX

Frax Finance was founded by an American software developer Sam Kazemian in 2019, during which he first proposed the idea of creating ​​a fractional-algorithmic stablecoin. Before that, Sam co-founded Everipedia, a for-profit online encyclopedia, with Theodor Forselius in December 2014.

Other members of the founding team of Frax Finance include Travis Moore and Jason Huan. Travis Moore is the CTO of Frax Finance as well as the co-founder and CTO of Everipedia, which makes him a long-time partner of Kazemian. Jason Huan is a graduate of the University of California, Los Angeles (UCLA), who majored in computer science. While studying at UCLA, he co-founded the Blockchain community run by students, which focused on the technical and business aspects of blockchain applications.

Generally, Frax Finance had an experienced team in the early days of its founding. Most of the members have known each other for a long time and are committed to the continued exploration of blockchain technology. Because of this, FRAX itself is strongly backed by this technology when it was designed.

The FRAX Token (FXS)

FXS is the value representation and governance token of the Frax protocol, as all algorithmic procedures are carried out through FXS. The functions of FXS include adding/adjusting collateral pools, adjusting various fees, and refreshing the rate of the collateral ratio. The team believes that if users and the community only complete limited interactions through FXS, then the disagreement within the team on the application of FXS itself will be reduced.

The FXS supply is designed to be 100 million tokens at the beginning. However, given that FRAX is minted at a higher FXS ratio, the amount in circulation is likely to be deflationary. This means that as the demand for FRAX grows, the supply of FXS will gradually decrease.

In addition, FXS adopts a linear and cliff-based releasing mechanism. Among the total supply, 65% is to be distributed to the community, and the remaining 35% is to be distributed to the team and in a private placement. Since FXS and FRAX constitute a two-token system, FXS itself has some functions in order to keep the value stability of FRAX.

Let’s have an in-depth overview of the functions of FXS:

• Governance: Token holders are granted governance rights to add/adjust collateral pools, set minting/redemption fees, and refresh the rate of the collateral ratio.
• Staking: FXS can be staked in various liquidity pools to earn interest at a preferred annualized rate of return.
• Minting and Redeeming: FXS will be destroyed when FRAX is minted, and FXS will be minted when FRAX is redeemed.
• Rewards: Users who deposit UniswapLP tokens into an incentive pool can get FXS rewards.

In the initial stage, FRAX is 100% collateralized, which means minting FRAX only requires placing collateral into the minting contract. In the partial collateral stage, minting FRAX requires providing an appropriate ratio of collateral and destroying the ratio of FXS.

The stability of FRAX is maintained through the support of FXS’s functions, with minting and redeeming at its core.

How FRAX works

FRAX is a hybrid stablecoin. It is considered the world’s first fractional-algorithmic stablecoin, as it is supported by asset collateral and mathematical crypto algorithm.

FRAX is always pegged to $1, and its collateral ratio is adjusted according to market demands to keep the price of FRAX at $1, rather than sticking to a predetermined ratio. When FRAX is above $1, the platform reduces the collateral ratio by 0.25%. When FRAX is below $1, the collateral ratio will increase.

Value stability of FRAX

Minting and redeeming are the two mechanisms to keep the price of FRAX stable. FRAX is minted by inserting an appropriate amount of constituent parts into the system. FRAX is fully collateralized at genesis, meaning that users only need to place collateral into the minting contract to mint FRAX.

During the fractional stage, minting FRAX requires users to place a ratio of collateral and burn the ratio of FXS. That is, the combination of collateral and FXS constitutes one FRAX.

For example, at a collateral ratio of 98%, each FRAX minting requires $0.98 in collateral and $0.02 in FXS. The value of FRAX is guaranteed to be stable through fractional calculation.

Also, FRAX will always be minted and redeemed from the system at a value of $1, allowing it to balance supply and demand on the crypto market. If FRAX is above the target price of $1, arbitrageurs and users can mint $1 worth of FRAX and then sell it for more than $1 on the market.

The same is true when FRAX is below the target price of $1. Arbitrageurs and users can buy FRAX tokens at a cheaper price on the market and redeem them for $1 from the platform. It should be noted that users will receive a combined asset of collateral and minted FXS upon redemption.

(Image: docs.frax.finance)

FRAX uses the above mechanism to ensure its price stability, and the market performance has also proved the excellence of this fractional-algorithmic system.

The team has made huge efforts to expand its ecosystem beyond the FRAX protocol. Fraxswap and Fraxlend are the two most representative applications within its ecosystem and can be regarded as supporting infrastructure of the FRAX protocol.

Fraxswap is specifically designed to be used in key functions of the FRAX protocol via TWAMM (Time-weighted Average Market Maker) purchases. The purpose of Fraxswap was to create a unique AMM with dedicated features for an algorithmic stablecoin monetary policy, forward guidance, and large sustained market orders, with a view to stabilizing the price of an asset by shrinking its supply or acquiring specific collateral over the long term.

Fraxlend is a lending platform that provides lending services between a pair of ERC-20 assets, allowing anyone to participate in lending and borrowing activities. Lenders can deposit ERC-20 assets into the pair and receive yield-generating tokens, a type of token that circulates on the Fraxlend platform.

Conclusion

Since the birth of FRAX, the team has long been committed to achieving healthy growth in the stablecoin track through its two-token system and algorithmic mechanism. The price of FRAX has been stable at around $1 for a long time, but due to the impact of the UST/Terra crash in Q2 2022, the entire stablecoin market has been greatly impacted.

In addition, FXS’s long-term value support for FRAX through minting and burning has also made the circulating supply of FXS decrease over time, which does no good to the development of FRAX in the long run.

In view of this, the Frax Finance team tried to promote its algorithmic stablecoin through other ways and products. The most representative one is the liquid staking token frxETH launched on Ethereum in Q4 2022, which increases users’ yields through a second staking mechanism.

Since its launch, the price of frxETH has been rising all the way. Benefiting from the mass adoption of ETH, as well as the high proportion of CVX held by Frax Finance, the liquidity pool of frxETH and ETH is guaranteed to be stable.

The Frax Ether system is composed of Frax Ether (frxETH), Staked Frax Ether (sfrxETH), and Frax ETH Minter.

frxETH, a liquid ETH staking derivative, acts as a stablecoin loosely pegged to ETH, leveraging Frax’s successful strategy in stablecoins and integrating ETH into the FRAX ecosystem.

sfrxETH is the version of frxETH that generates staking yield. All profits generated from Frax Ether validators are distributed to sfrxETH holders. By exchanging frxETH for sfrxETH, one becomes eligible for staking yield, which is redeemed when converting sfrxETH back to frxETH.

Frax ETH Minter (frxETHMinter) allows the exchange of ETH for frxETH, bringing ETH into the Frax ecosystem, enabling new validator nodes where possible, and minting new frxETH equal to the amount of ETH sent.

It turns out to be much simpler to accrue yields by using a liquid ETH staking derivative. Coupled with the validating feature of frxETHMinter, staking yield can be earned on any amount of ETH, allowing withdrawals at any time and of any size. It gives frxETH much more possibility in DeFi.

After 4pool failed to replace 3pool, the stablecoin field did not develop in the direction Frax Finance had expected. Frax Finance then turned to seek more sophisticated product pegging logic, and also provided an effective method of reducing CVX holdings to acquire necessary funds for future development. It is obvious that Frax Finance enjoys extraordinary insights into the market.

This is also exhibited by what the founder of FRAX shared in an interview in 2023.

In this interview, Jack Corddry shared his insights into the price change of $FXS. During the years of its development, the changes in the crypto market made the market environment even more complicated. Trying to expand its vision and business outside the FRAX ecosystem is indeed a commendable strategy for its growth, which is largely benefiting from efficient collaboration within the team.

All in all, after the FRAX ecosystem tries to expand its business focus, the stablecoin is considered as a benchmark, and appropriate liquidity and supporting lending platforms are also provided. All of these measures have contributed to the FRAX ecosystem in achieving considerable growth throughout DeFi.