The crypto space is constantly evolving. New projects are being released that aim to surpass their predecessors and solve pressing issues. The sphere of stablecoins was no exception. There are fiat-backed stablecoins, such as USDT or USDC. There are crypto-collateralized ones whose most famous representative is DAI.
There are also rarer, algorithmic stablecoins, such as AMPL. However, despite the seemingly such diversity, each type of stablecoin has its pros and cons. But what if we take the benefits of these types and create a hybrid stablecoin? This is exactly what the developers of Frax Finance did at the time.
What Is Frax Finance?
Frax Finance is the first of its kind fractional-algorithmic stablecoin, which takes the best of both concepts. In simple words, the stablecoin protocol combines elements of both crypto-collateralized and algorithmic systems. While fully collateralized stablecoins have such an advantage as tight pegging, they also have a huge disadvantage in the form of centralization, which contradicts the original vision of cryptocurrencies. At the same time, algorithmic stablecoins are completely decentralized and reflect the vision of digital assets. However, they tend to be volatile, which makes them useless as stablecoins. Frax developers strive to create a revolutionary model of stablecoins: a decentralized, stable, and scalable monetary system.
Frax has a mechanism that allows you to negate the exchange rate volatility quickly. Frax Finance has a dual token model (similar to Terra) in which the FRAX fractional-algorithmic stablecoin and the FXS governance token are presented. The adjustment of the pegging to the fiat currency is implemented through traders’ motivation to conclude transactions that bring the exchange rate closer to the fiat, that is, arbitration. Frax developers have created something similar to an automated decentralized bank that uses special algorithms to adjust the supply. Frax maintains price stability partly with the help of the FXS governance token and partly with the help of USDC in collateral.
How Does Frax Work?
As already mentioned, FRAX is a fractional-algorithmic stablecoin whose pegging to the USD is provided partly algorithmically due to the FXS governance token and partly with the help of USDC in collateral. The amount of collateral may vary, but there are no specific time frames. According to the developers, in the future, when the adoption of FRAX increases, the price of the stablecoin will be adjusted, for the most part, algorithmically rather than using collateral. In addition, the Frax community can vote to use other on-chain stablecoins besides the USDC. Also, as the ecosystem grows, users can use volatile cryptocurrencies such as ETH or WBTC as collateral.
Upon the launch, FRAX was fully collateralized. Users had to deposit $1 of value in USDC to mint $1 FRAX. Over time, the protocol entered a fractional phase. Thus, to mint FRAX, it is necessary to deposit a pre-specified amount of USDC and burn an appropriate amount of FXS. For example, if the collateral ratio is 80% at the time of minting, the user will need to deposit $.80 USDC and burn $.20 FXS to mint each FRAX.
A tight USD peg is supported by arbitration. For example, if users see FRAX trading below $1, they can buy FRAX at a reduced price and redeem each token for $1 of value from the system. In simple words, you see that FRAX is trading at $.97, you can buy tokens and redeem them for $1, as a result of which you can pocket a $.3 difference. On the other hand, if you find that FRAX is trading above $1, for example, $1.3, you can mint FRAX by depositing $1 worth of value into the system and then sell tokens on the open market, making a profit of $.3 for each token.
Arbitrageurs should also pay attention to what kind of collateral is valid for a certain period of time. For example, if you decide to make a profit while FRAX is un-pegged to the upside and the collateral ratio is 100%, then you will need to deposit $1 of value from USDC for each minted FRAX. If the collateral ratio is 90%, you will need to deposit $.90 USDC and burn $.10 of FXS for each minted FRAX. If you decide to make a profit when FRAX un-pegs to the downside and is in the 100% collateral phase, then as a result of the redemption, you will receive $1 USDC for each FRAX. If FRAX is in the fractional phase, for example, 90% collateral ratio, then as a result of the redemption, you will receive $.90 USDC and $.10 newly minted FXS.
Frax Finance Tokens
As it is already clear, Frax Finance has two tokens: FRAX and FXS.
FRAX is a token that seeks to maintain a tight peg to the USD. FRAX does not have a maximum limited supply, and its supply is elastic. The number of circulating FRAX can change to maintain the tight peg.
FXS is the governance and utility token of the ecosystem. FXS is a deflationary token whose supply constantly decreases when FRAX is in the fractional phase. To mint FRAX in the fractional phase, you need to burn a specific number of FXS. In addition, FXS is needed to achieve decentralization. FXS holders can vote: put forward proposals for the development of the project, support and reject updates, add or adjust collateral pools, update the rate of collateral ratio, and much more.
In addition, following in the footsteps of Curve Finance, the developers of Frax Finance have implemented a vesting and yield system. FXS holders can deposit their tokens into a locked staking pool for up to four years. In return, the stakeholders receive veFXS tokens representing their share in the pool. If you have deposited FXS for the longest possible period, you will be credited with the amount of veFXS four times more than the locked amount of FXS. For example, if you have deposited 100 FXS for four years, you will receive 400 veFXS in return. veFXS holding gives stakeholders special governance rights, increased farming boost, and other benefits.
Investing in FRAX is a good option during periods of bearish trends and general instability. The token will allow you to save savings and not incur losses. FRAX has already shown a tight peg to the value of USD, and the price of the FXS token will only grow as the ecosystem expands.