tl;dr
- The Frax Finance protocol launched FRAX in 2019 as a fractional-algorithmic stablecoin.
- Frax is a decentralized cross-chain protocol that aims to establish a scalable digital currency with a flexible supply, backed algorithmically and by collateral.
- The Frax Price Index or FPI is a unique stablecoin pegged to a basket of real-world consumer items and uses the same type of AMOs as the FRAX stablecoin.
- Frax Ether is a stablecoin system that is soft-pegged to ETH, consisting of frxETH, sfrxETH, and the Frax ETH minter.
- Frax offers multiple DeFi platforms for users to engage with beyond just stablecoins and Ethereum staking.
- FRAX is decentralized and algorithmically pegged to a basket of assets, including US dollars, Ethereum, and Bitcoin, which provides greater stability than reliance on a central issuer and reserves.
- FRAX has several advantages, including its decentralized nature and algorithmic pegging mechanism, but may not be as widely accepted or used as other stablecoins.
An Introduction to Frax
Stablecoins are a type of cryptocurrency that is designed to maintain a stable value. They were created to solve the problem of price volatility, which is a significant issue for traditional cryptocurrencies like Bitcoin. Stablecoins are pegged to a specific asset, such as a fiat currency or a commodity, which ensures that their value remains stable.
The purpose of stablecoins is to provide a stable store of value that can be used for transactions and investments. Stablecoins are particularly useful for traders, who need to be able to move money quickly between different exchanges and wallets. They are also useful for investors who want to hedge against the volatility of traditional cryptocurrencies.
The origins of stablecoins can be traced back to 2014, when BitUSD was launched on the BitShare blockchain. BitUSD was the first stablecoin to be issued as a token on a blockchain, and it was the brainchild of Charles Hoskinson and Dan Larimer, two prominent figures in the blockchain industry. BitUSD was designed to be pegged to the US dollar, which meant that its value remained stable.
A year later, in 2015, Tether or USDT was launched on Bitfinex, a prominent exchange. Tether was the first popular stablecoin, and it quickly gained popularity among traders and investors. Tether is also pegged to the US dollar, which means that its value remains stable. Tether has become one of the most widely used stablecoins, and it is now supported by many exchanges and wallets.
Another stablecoin that has recently gained popularity is FRAX, a fractional-algorithmic stablecoin issued by the Frax Finance protocol. Founded by Sam Kazemian, Travis Moore, and Jason Huan in 2019, Frax Finance's mission is to provide a stable and decentralized currency.
The Frax Ecosystem
Frax is a decentralized cross-chain protocol that aims to establish a scalable, digital currency with a flexible supply, backed algorithmically and by collateral. The protocol is designed to be the first fractional-algorithmic stablecoin protocol that implements the design principles of both collateralized and algorithmic stablecoins.
The Frax protocol is a multi-token system that consists of the stablecoin FRAX and Frax Shares or FXS, which are used to stabilize the system, accrue seigniorage revenue and fees, and provide governance rights.
Frax Infrastructure & Stablecoin Design
The degree to which FRAX is collateralized is determined by market forces, with the collateral ratio determining the proportion of FRAX outstanding to be backed by collateral, with the remainder in FXS. FRAX is optimized to maintain the fiat peg stability and accrue seigniorage fees. Additionally, the governance token provides community members with the necessary tools to participate actively in the protocol's development. This approach is crucial in ensuring the longevity and usefulness of the protocol.
The Frax protocol relies on a pool contract that holds USDC collateral, and the algorithm behind the minting and redemption of FRAX involves interacting with the FXS token. For instance, a collateral ratio of 75% would mean that a newly minted FRAX of $1 value will be backed by $0.75 in a stablecoin asset, and $0.25 of Frax Shares will be burnt. Importantly, the amount of FRAX minted is always equivalent to the amount of value committed to the protocol, either as collateral or by interacting with FXS.
Frax & FPI
The Frax Price Index or FPI is a unique stablecoin that is pegged to a basket of real-world consumer items, as defined by the US CPI-U average. This stablecoin is intended to keep its price constant to the price of all items within the CPI basket and thus hold its purchasing power with on-chain stability mechanisms. The FPI stablecoin is the second stablecoin of the Frax Finance ecosystem, and like the FRAX stablecoin, all FPI assets and market operations are on-chain and use AMO contracts.
The Frax Price Index Share (FPIS) token is the governance token of the system, which is also entitled to seigniorage from the protocol. Excess yield will be directed from the treasury to FPIS holders, similar to the FXS structure. During times when the FPI treasury does not create enough yield to maintain the increased backing per FPI due to inflation, new FPIS may be minted and sold to increase the treasury.
The FPI uses the CPI-U unadjusted 12-month inflation rate reported by the US Federal Government, and a specialized Chainlink oracle commits this data on-chain immediately after it is publicly released. The oracle's reported inflation rate is then applied to the redemption price of FPI stablecoins in the system contract. This redemption price grows per second on-chain (or declines in rare cases of deflation). The peg calculation rate is updated once every 30 days when bls.gov releases its monthly CPI price data.
FPI aims to be the first on-chain stablecoin to have its own unit of account derived from a basket of goods, both crypto and non-crypto. The treasury will first be comprised solely of $FRAX but will expand to include other crypto-native assets such as bridged BTC, ETH, and non-crypto consumer goods and services.
FPI uses the same type of AMOs as the FRAX stablecoin. However, it is modeled to keep a 100% collateral ratio or CR at all times. This means that for the collateral ratio to stay at 100%, the protocol balance sheet must grow at least at the CPI inflation rate. Thus, AMO strategy contracts must earn a yield proportional to CPI; otherwise, the CR will decrease to below 100%. During times that AMO yield is under the CPI rate, a TWAMM AMO will sell FPIS tokens for FRAX stablecoins to keep the CR at 100% at all times. The FPIS TWAMMs will be removed when the CR returns to 100%.
frxETH & sfrxETH
Frax Ether is a stablecoin system that is soft-pegged to ETH, consisting of frxETH, sfrxETH, and the Frax ETH minter. Holding frxETH is similar to holding WETH, and users can deploy their frxETH to third-party strategies like Curve to earn trading fees. The staked version of frxETH, sfrxETH, accrues staking yield, and users can exchange their frxETH for sfrxETH at any time. The Frax ETH minter contract mints frxETH when it receives ETH deposits, and whenever a deposit pushes the minter balance over a certain amount, a new validator is created.
Frax Ether generates revenue through a protocol fee structure that allocates 90% of all staking yield to sfrxETH stakers in the form of frxETH. The remaining 10% is split between the Frax protocol treasury and a slashing insurance fund. The protocol treasury distributes 8% of the fee in the form of frxETH to FXS holders, while the insurance fund covers any potential slashing events to keep frxETH overcollateralized.
How Does the Frax Stablecoin Work?
Frax is a stablecoin system that offers a unique approach to maintaining stability and security. The system consists of multiple stablecoins, including FRAX, frxETH, sfrxETH, and the Frax ETH minter. Each Frax stablecoin has a different architecture and use case.
What Makes Frax Unique?
What makes Frax unique is the fact that it offers multiple DeFi platforms for users to engage with, beyond just stablecoins and Ethereum staking. This allows for a more diverse and comprehensive DeFi experience. Moreover, each of these platforms is designed to be trustless, permissionless, and non-custodial, which means that users have full control over their funds. Frax provides Fraxswap, Fraxlend, and Fraxferry for users.
Fraxswap is the first of its kind, being an AMM with an embedded time-weighted average market maker (TWAMM) that allows for conducting large trades over a long period of time trustlessly. It is fully permissionless and based on the constant product invariant (xy=k).
Fraxlend, on the other hand, is a trustless, permissionless, and non-custodial lending platform that provides lending markets between any two ERC20 tokens. Each pair is an isolated market that allows anyone to participate in lending and borrowing activities.
Finally, Fraxferry is a permissionless, non-custodial, and secure method to transfer natively issued Frax Protocol tokens across many blockchains without requiring bridges or third-party applications.
FRAX Compared to USDT
FRAX and USDT are both stablecoins, but their underlying mechanisms and use cases differ.
USDT is a centralized stablecoin that is pegged to the US dollar and issued by Tether Limited, a company that holds reserves of US dollars to back the token. FRAX, on the other hand, is a decentralized stablecoin that is algorithmically pegged to a basket of assets, including US dollars, Ethereum, and Bitcoin. FRAX is minted and burned based on the market demand for the stablecoin, which is determined by an oracle that monitors the price of the underlying assets.
One advantage of FRAX over USDT is its decentralization, which means that users have full control over their funds and are not subject to the risks associated with centralized platforms. Moreover, FRAX's algorithmic pegging mechanism provides greater stability than USDT's reliance on a central issuer and reserves. However, USDT is more widely used and accepted than FRAX, which may make it a more practical choice for certain use cases.
What are the Pros & Cons of Frax
FRAX has several advantages, including its decentralized nature, which means users have full control over their funds and are not subject to the risks associated with centralized platforms. FRAX's algorithmic pegging mechanism provides greater stability than stablecoins that rely on a central issuer and reserves.
However, FRAX may not be as widely accepted or used as other stablecoins, which may limit its practicality for certain use cases. Also, algorithmic stablecoins may experience de-pegging, as seen with the Terra & Luna collapse.
Conclusion
The future of FRAX looks bright as more and more users become aware of the advantages of decentralized platforms and seek greater control over their funds. With its algorithmic pegging mechanism and focus on stability, FRAX is well-positioned to become a popular alternative to centralized stablecoins.
As the cryptocurrency market continues to evolve and mature, it is likely that more users will recognize the benefits of decentralized platforms like Frax, leading to increased adoption and wider acceptance.
