The leading algorithmic stablecoin Frax Finance recently launched its v3 plan, gradually opening up various functions. In the future, users will be able to deposit FRAX into protocols like DAI to earn underlying interest through RWA, and also have the option to purchase discounted Frax-issued bond product FXB. This article will provide a detailed introduction to the updates and future strategies of this release.
Frax Finance Introduction
Frax was founded in 2019, with Frax v1 launched in December 2020, using FRAX as a stablecoin token and FXS as a governance and collateral token. Its unique decentralized hybrid algorithmic stablecoin mechanism has attracted market attention and once created a project with a market value of nearly $3 billion.
However, the team did not limit themselves to success in stablecoins or the DeFi field. Over the past three years, they have continuously launched a variety of projects and services, including but not limited to:
- FRAX stablecoin: Decentralized algorithmic stablecoin
- frxETH: Ethereum liquidity staking service LSD
- Fraxlend: Lending protocol
- Fraxswap: TWAMM decentralized exchange
- Fraxferry: Cross-chain bridge
- sFRAX: FRAX active treasury v3 online
- Frax Bond: Frax stablecoin bond program v3 coming soon
- RWA: Earn US Treasury bond returns v3 coming soon
- Frax Chain: In-house Layer2 not online
The true goal of Frax Finance is to build a complete financial ecosystem, where seemingly unrelated services can be interconnected. For example, using RWA to bring income to sFRAX, allowing FRAX to be stored in Fraxlend for earnings, creating diverse value for FRAX stablecoin users, and all these can be automatically interconnected through their own contracts.
FRAX's Three Iterations
Currently, Frax is gearing up for its third version, which is actually closer to a new roadmap and plan, but still related to the services established in the past. Therefore, its past versions cannot be ignored. Unlike other projects that update in the same field and concept each time, each version of Frax has a unique positioning and strategy, representing the development of the previous version in a new dimension or the addition of features, rather than just strengthening a single function. Therefore, to understand the future strategic direction of Frax Finance, one needs to have an understanding of the past versions.
- Frax v1: Started with an algorithmic stablecoin
- Frax v2: Abandoned the strategy of reducing collateralization ratio for algorithmic stablecoins, shifted to increasing collateralization ratio to become an overcollateralized stablecoin, and developed AMO and other services to enhance capital utilization efficiency.
- Frax v3: Introduced RWA to enhance capital utilization efficiency in a larger ecosystem and ultimately become an on-chain bank.
Frax v1 Algorithmic Stablecoin
Frax entered the market with a unique Fractional Algorithmic algorithm. The Frax protocol consists of two tokens, the stablecoin FRAX and the governance token FXS. FRAX is supported by a mix of collateral, USDC, and FXS, with USDC's share called the collateral ratio (CR). The core of the protocol lies in adjusting the collateral ratio to control the price of the stablecoin FRAX as FRAX price fluctuates above or below one US dollar. The collateral refresh function in the protocol allows any user to call it once per hour, adjusting the collateral ratio by 0.25% each time based on whether the FRAX price is above or below one US dollar.
The original design expected the collateral ratio to gradually decrease as users' trust in the protocol increased to maximize capital utilization efficiency. However, in reality, the collateral ratio has remained between 70% to 90%. After the UST collapse event last year, the collateral ratio has remained around ninety percent, not developing as expected.
Although not requiring full collateral can increase capital utilization efficiency for users, the cost of earning a little collateral at 10% far exceeds the benefits it brings. Therefore, the community proposed to fix the collateral ratio adjustment at 100% this year, aiming to transition from algorithmic stablecoin to collateralized stablecoin, marking the end of the FRAX algorithmic stablecoin journey.
However, it has not yet fully reached 100%, so the team retains protocol revenue to provide funding injection into the protocol.
Frax v2 Creating Diverse Protocol Value
Anticipating the above situation, the team started using other methods to increase capital utilization efficiency in version 2. In this version, the updates to the fractional algorithm were stopped, and an automated contract called Algorithmic Market Operations Controller (AMO) was introduced. The AMO can automatically execute various operations to invest idle funds in the Frax protocol, thereby increasing capital utilization efficiency. For example, the Collateral Investor AMO can invest funds in AAVE and Compound for yield farming.
As long as it complies with the rules and does not affect the original collateralization mechanism, community members can freely design various AMOs for diverse market strategies. The main AMOs currently include Curve AMP, Uniswap AMO, Collateral Investor AMO, Fraxlend AMO, and RWA AMO. The profits generated are used to repurchase FXS tokens through FXS-1559 and burn them to return value to token holders. However, the current profits are used to fill the collateralization to 100%.
Frax v3 Building a Complete Ecosystem
Frax v3, the latest version gradually being rolled out, focuses on a series of new designs centered around RWA, combined with existing AMOs from Frax v2, making FRAX a complete and self-sustaining decentralized stablecoin with over 100% collateralization. Frax Finance aims to achieve this through both internal and external protocols, including the internal Fraxlend, Fraxswap, and the recently launched sFRAX, as well as external protocols connected through AMO to acquire value, including Curve and the upcoming RWA purchase.
To achieve and amplify the vision of directly pegging to the dollar with a fully external reserve having a collateralization rate of 100% or more, Frax Finance will use both internal and external protocols. This involves internal services like Fraxlend, Fraxswap, and the recently launched sFRAX, and external protocols through AMO to capture external protocol value, such as Curve and the upcoming RWA purchase.
To realize and increase the fully pegged-to-dollar and independently value-creating vision, several key updates are needed:
1. RWA Purchase Process and Facilities: FRAX's collateralization will be calculated based on the value of external collateral held by FRAX. In v3, a collateralization rate of 100% or more will be achieved, becoming a stablecoin with a fully external reserve, transitioning from an algorithmic stablecoin to a collateralized stablecoin.
2. Anchoring to the Dollar: Once FRAX stablecoin reaches a 100% collateralization rate, Chainlink and other selected oracle combinations will be used to track the dollar price and directly anchor FRAX to the dollar, cutting ties with other stablecoins and ensuring that changes in other stablecoin prices do not affect FRAX's price.
3. IORB Oracle: Frax v3 uses the Interest on Reserve Balances (IORB) as an oracle, known as the "risk-free rate" of the dollar. The IORB oracle is designed to work with the RWA collateral mechanism, automatically converting collateral into US Treasury bonds when IORB is high and reverting the collateral to on-chain assets when IORB is low, earning interest through collateralized Fraxlend.
4. On-chain Governance Process: With the increasing importance of governance in Frax v3, decisions regarding RWA purchases, AMO execution and halting, the dollar oracle, and the sale price of Frax Bonds (FXB) will all be made on-chain automatically through an updated governance module, ensuring the protocol's security and decentralization.
Frax v3 will not allow FRAX to be redeemed for collateral in the future. Instead, various market mechanisms, AMOs, and related protocols will need to be used to achieve dollar parity. The team refers to this as the "ultimate stablecoin" and the feasibility of this approach remains to be proven over time.
Frax vs. Maker Showdown
Wajahat Mughal, a DeFi researcher, compares Maker and Frax, as both are moving towards the path of decentralized crypto banks and have new strategic directions regarding RWA. Frax's future development direction will compete with Maker in the market.
- Collateral: DAI's collateral includes ETH, USDC, other stablecoins, and RWA, mostly US Treasury bonds. FRAX's collateral will change in v3 from the previous combination of USDC and FXS towards complete collateralization, and it is also preparing for RWA.
- Earnings: The current supply of sDAI is approximately 1.73 billion tokens with a 5% interest rate. sFRAX has a supply of 41 million tokens with an interest rate of over 6.5%. While sFRAX has a higher initial rate, it will decrease as the collateral amount increases, and overall, Maker still has the advantage.
- Source of Earnings: sDAI's interest rate comes from various US Treasury bond rates, while sFRAX earns IORB interest through FinresPBC, which then transfers the earnings to sFRAX.
- Project Scale: Maker's annual revenue exceeds $80 million, driven by the increasing supply of DAI. The market value of its governance token MKR is around $1.3 billion. FRAX has multiple revenue sources, including US Treasury bonds, revenue from AMO, and staking fees from frxETH, resulting in an annual revenue of $20 million. The market value of Frax's governance token FXS is around $450 million.
While Frax is currently lagging behind, it is almost competing on the same level, leaving room for significant changes in the future.
Ultimately, both Maker and Frax are excellent protocols. Maker still has substantial cash flow to compete in the market, while Frax continues to add new products to its ecosystem. The key to success for decentralized stablecoins lies not only in collateralization but also in identifying and creating applications beyond interest rates to attract more users to hold and use them.
Frax is still building its foundation, seizing market trends, and gradually improving its ecosystem to attract attention and increase the value of FRAX. Whether its strategy of a diverse service ecosystem can achieve its goals will be determined by the market and time.
