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Last updated: Aug 15, 2023
Frax Finance is a fractional-algorithmic stablecoin protocol, which means that the digital asset is partially backed by collateral and partially stabilized algorithmically. The company aims to provide highly scalable, decentralized, algorithmic money which would replace fixed-supply digital assets like BTC.
The name of the Frax Finance stablecoin FRAX is derived from the fractional-algorithmic stability mechanism, whose ratio of collateralization and algorithmic strategy depends on the market’s pricing of the stablecoin. Generally, if the token is trading above $1 the protocol automatically decreases the collateral’s amount, while if it gets under $1 the protocol increases it.
The protocol uses Uniswap and Chainlink’s price oracles. Currently, the stablecoin is pegged to USD, however, the main aspiration of the team is to build a crypto native version of the Consumer Price Index (CPI) which would be governed by FXS and other protocol’s token holders and would be called Frax Finance Price Index (FPI). The team believes that in this way FPI will become “the first decentralized, permissionless native unit of account which holds the standard of living stable”.
Frax Finance is community-governed, however at the base of the protocol is the principle of autonomy achieved by the algorithmic approach, so there is no need for active management. The governance of the project is enforced through the Frax Finance Shares, FXS token which also accrues fees, revenue, and rewards holders with a percentage of the excess collateral value when there is such.
FRAX’s collateralization is in the form of USDC tokens and is kept in a liquidity pool smart contract; such pools can be removed or added through the project’s governance. The protocol’s price is calculated through a time-weighted average of the Uniswap pair price and the ETH:USD Chainlink oracle, which allows the protocol to get a “true” price of USD instead of an average of stablecoin pools on Uniswap.
FRAX stablecoins can be minted by transferring the required amount of collateralization, at the moment of minting, to the minting contract. Although the design of the protocol allows it to accept any type of cryptocurrency as collateral, v1 of the project only accepted on-chain stablecoins.
The system of minting FRAX allows for arbitrage opportunities where, if the price of the token is above $1 on the market, the arbitrageur can pay and mint the coin for $1 and sell it for profit on the market, thus keeping the price at the target level of $1.
Since only part of the collateral of the asset is kept in the form of a cryptocurrency, to account for the rest, the system requires the user to burn FXS worth the required amount. For example, if the stablecoin reaches a level of 50% collateral and 50% algorithm action, to mint a FRAX coin the user would be required to deposit $0.5 worth of a supported asset and burn $0.5 worth of FXS tokens.
As the system allows redeeming FRAX tokens for a value of $1 at all times, again in the form of percentages depending on the project’s collateral-algorithm values, there are also arbitrage opportunities when the price of the token falls under $1. In such cases, users can buy FRAX on the market, and redeem it from the protocol’s dApp for assets worth $1 per Frax Finance token.
In the current v2 of FRAX, the idea of an “Algorithmic Market Operations Controller” (AMO) was introduced. This is an autonomous contract enabling arbitrary monetary policy with the condition of not interfering with the FRAX price’s peg. What that means is that AMO controllers can perform open market operations algorithmically but they aren’t allowed to arbitrarily mint FRAX and break the peg. The use of AMO modules doesn’t interfere with the base layer stability mechanism.
The Frax Finance app can be used in cases when there is an excess collateral value or adding collateral is required to reach the collateral ratio. To provide for this, the Frax Finance protocol has two built-in swap functions.
The recollateralization function can be called by anyone and checks if the total value in USD over the system is below the collateral ratio. In such cases the Frax Finance app allows the caller to add up to the amount needed to reach the target collateral ratio. This is incentivized with newly minted FXS at a bonus rate, initially set to 0.2%. The Frax Finance fee paid to arbitrageurs helping in the recollateralization of the protocol is subject to governance voting and can also be set to a dynamic PID controller-adjusted variable.
In cases where there is excess collateral in the system, any FXS holder can call the buyback function and exchange the amount of excess collateral for FXS tokens, which the protocol then burns. This mechanism redistributes excess value so holders don’t need to actively participate in buybacks to gain value.
Before connecting a wallet, Frax Finance warns to make sure it is up to date and supports EIP-1559. Currently, the way to connect to the dApp is through MetaMask or by WalletConnect.
The Frax Finance Share token FXS is the protocol’s utility token and is meant to be volatile and hold governance rights. Although the project is meant to be highly autonomous due to the various algorithms and arbitrage opportunities available, there still are parameters available for adjustment. Such are adding and adjusting collateral pools and various fees such as the minting and redeeming fees, another mechanism whose parameters are up for a vote is the refreshing rate of the collateral ratio.
The initial supply of FXS was initially set to 100M tokens at the genesis block, however since the protocol employs deflationary mechanics such as burning, the amount in circulation is also meant to be deflationary.
Frax Finance allows its users to lock FXS tokens for various periods in exchange for veFXS tokens which bring special governance rights and AMO profits. The vested tokens are not transferable and cannot be utilized on liquidity markets. To participate in this program, there is a whitelisting program available on the governance panel of the dApp.
In the future, allocating voting power to long-term holders of vested FXS tokens might be implemented to incentivize farmers for staking FXS. There are also plans for the creation of a bond-like utility for FXS and the creation of a benchmark APR rate for staked FXS.
The Frax Finance team was created by Sam Kazemian, who previously co-founded Everipedia, after graduating from the University of California, Los Angeles (UCLA) in 2015 where he also started other small projects while studying.
Another of the co-founders of the company is Travis Moore who also serves as a CTO and was also the co-founder and CTO of Everipedia and graduated from the same university as Sam Kazemian.
The other co-founder of the project is Jason Huan, who has experience as a lecturer in the first blockchain course within UCLA’s School of Engineering. He is also the founder of a formal student-run blockchain community at UCLA, centered around the technological and business aspects of blockchain applications, as described by Jason Huan himself.
Frax Finance audits can be found in the protocol dashboard on this webpage.
Recently, Zigzag Exchange added 2 million Liquidity of FRAX in their fast withdrawal bridge, allowing users to withdraw up to that amount of tokens directly from Zigzag Exchange to L1 in less than a minute. FXS was one of the collaterals eligible for rewards on QiDao’s vault incentives gauge. There was a partnership announced in March 2022 with Planet Finance, which became Frax Finance’s lending partner on Binance Smart Chain, providing for users to supply their FRAX and earn FRAX paid by borrowers, as well as rewards denominated in GAMMA tokens from the protocol.
Frax Finance also partnered with Zenlink to launch a FRAX liquidity incentive program on the Moonbeam Network. Ola Finance also collaborates with Frax Finance in the launch of a lending network on Moonbeam.
Frax Finance is currently distributing its latest stablecoin via an airdrop. The Frax Finance Price Index FPI token will be airdropped to holders and stakers of any of the other tokens on the Frax Finance ecosystem. FPI is claimed to be an inflation-resistant algorithmic stablecoin, designed to mirror the U.S. government-published consumer price index CPI. To gather the various data Frax Finance uses Chainlink as an oracle solution providing sourcing of data from the Bureau of Labor Statistics’ monthly inflation report. The FPI is denominated in USD so if for example, the inflation level reaches 10%, the value of the digital asset would be equal to $1.10.
In the future, holders of the governance token will be able to vote on the data sourcing mechanism of FPI as well as other changes in the mechanics of the algorithm.
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Last updated: Aug 15, 2023
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