Frax Finance In-Depth Research Report: A New Chapter in the Stablecoin Race

Written by: AlphaXlabs

1. Introduction to Frax Finance

Frax Finance is a DeFi protocol that offers three stablecoins and collateralized derivatives (FRAX, FPI, frxETH) for earning yield, providing liquidity, and staking in DeFi. The protocol utilizes innovative sub-protocols and native governance tokens (FXS, FPI S) to ensure price stability and user governance. It is a major participant in the global cryptocurrency market, with over $800 million in locked value, founded by Sam Kazemian.

Three Stablecoins

FRAX — Core Stablecoin

Anchored to the US dollar (USD), FRAX aims to maintain a 1:1 value ratio, meaning that 1 USD is equivalent to 1 FRAX.

( CR * USDC + (1- CR )* FXS )

The protocol uses a combination of on-chain assets and algorithmic mechanisms to ensure this peg. If the price of FRAX deviates from 1 USD, the system intervenes by adjusting the collateral ratio to rebalance the value. Therefore, FRAX not only provides the advantages of cryptocurrencies such as decentralization and transparency but also plays a role in reducing high price volatility, making it a secure stablecoin for earning yield in DeFi.

On February 23, 2023, the proposal to transition the algorithmic stablecoin FRAX to a fully collateralized mechanism was approved by the community vote, setting the collateralization ratio at 100% to increase the stablecoin reserve and eliminate algorithmic elements. As of now, the market value of FRAX is approximately $1 billion.

FPI — Novel Stablecoin Pegged to CPI

Frax Price Index (FPI) is the second stablecoin in the Frax financial ecosystem. FPI is the first stablecoin pegged to a basket of real-world consumer goods defined by the average value of the US CPI-U. FPI stablecoin aims to maintain its price in line with the prices of all items in the CPI basket, thereby preserving its purchasing power through on-chain stability mechanisms. It functions as a hedge against inflation, as it does not lose purchasing power due to the devaluation of fiat currency.

FPI has its governance token, Frax Price Index Share (FPI S), which entitles holders to protocol earnings. Similar to the FRAX stablecoin, all FPI assets and market operations are on-chain and utilize AMO contracts.

frx ETH — Stablecoin Loosely Pegged to ETH

In the Frax Finance ecosystem, Ethereum (ETH) exists nominally as frxETH and sfrxETH, a liquid staking derivative. frxETH is a stablecoin designed to reflect the value of ETH at a 1:1 ratio, with a target range of 0.9900 to 1.01 ETH exchanging for 1 frxETH. Whenever ETH is contributed to the system, an equivalent amount is minted.

Simultaneously, sfrxETH is a yield-bearing variant of frxETH. Users can exchange their frxETH for sfrxETH to receive staking rewards. As these rewards accumulate, more frxETH is minted and added to the treasury. Therefore, sfrxETH holders have a stake in a growing pool of frxETH, similar to systems like Aave's aUSDC or Compound's cUSDC.

Three Applications

Fraxswap

Fraxswap is the first constant product automated market maker (AMM) with built-in time-weighted average price (TWAP) functionality, allowing for large-volume trades over extended periods without the need for trust. It is fully permissionless, and its core AMM is based on Uniswap V2.

Fraxlend

Fraxlend is a lending platform that allows anyone to create a market between a pair of ERC-20 tokens. Any token with Chainlink data feeds can be borrowed by borrowers or used as collateral. Each lending pair is an independent, permissionless market that anyone can create and participate in. Lenders can deposit ERC-20 assets into this lending pair and receive ftoken with a yield. As interest is earned, the amount of the underlying asset that ftoken can be redeemed for continues to increase.

Lending AMO is similar to mainstream lending markets (e.g., Aave/Compound). However, pool utilization should be noted.

Additionally, Fraxlend supports the ability to create custom term sheets for the over-the-counter debt market. Fraxlend lending pairs can create features such as maturity dates, restricted borrowers and lenders, undercollateralized loans, and limited liquidation.

Fraxferry

Fraxferry is a permissionless, non-custodial, and secure cross-chain bridge for transferring locally issued Frax protocol tokens across many blockchains without the need for bridging or third-party applications. Funds will arrive within 24 to 48 hours.

2. FRAX Trading Market

Frax tokens can be traded on major mainstream exchanges, as shown in the following image.

3. Tokenomics

Frax Finance adopts a dual-token model, utilizing USDC and its governance token Frax Share (FXS) to partially back its stablecoin Frax (FRAX), with a variable collateralization ratio. The token economics of Frax are as follows:

Frax is a crypto-collateralized stablecoin pegged to the US dollar.
The collateralization ratio of Frax is variable, meaning the amount of collateral supporting the stablecoin will change based on market conditions.
Frax Share (FXS) is the governance and value accrual token of the protocol.
The distribution of FXS tokens is as follows:
60% — Liquidity program/farms/community — halving naturally every 12 months through vesting and governance.
3% — Strategic advisors/external early contributors — 36-month vesting for advisory tokens used for legal, technical, and business strategic work to drive adoption of the Frax protocol. Tokens vest evenly over 3 years.
12% — Accredited private investors — 2% unlocked at launch, 5% vested in the first 6 months, 5% vested within 1 year, with a 6-month cliff.
Frax Share (FXS) can be redeemed for Frax (FRAX) and also for partial collateral supporting Frax.
The token economics of Frax Finance aim to incentivize holders to maintain the stability of Frax. Holders can earn rewards by providing their FRAX tokens to liquidity pools.

References:

[1] https://sometimes-interesting.com/frax-frax-and-tokenomics-an-overview-of-the-frax-token/

[2] https://docs.frax.finance/token-distribution/frax-share-fxs-distribution

[3] https://messari.io/report/frax-a-fractional-algorithmic-stablecoin

[4] https://albaronventures.com/frax-finance-analysis/

[5] https://coinmarketcap.com/alexandria/article/what-is-frax-finance-features-tokenomics-and-price-prediction

[6] https://frax.finance

4. Investment Institutions

Prominent investment institutions involved include Dragonfly Capital, Mechanism Capital, Electric Capital, Robot Ventures, and ParaFi Capital, all of which are significant participants in the institutional investment space. Notable individual investors include recognized project founders in the DeFi space, such as Stani Kulechov of Aave, Kain Warwick of Synthetix, and Eyal Herzog of Bancor. Additionally, there are investments from backgrounds in centralized exchanges (CEX), including well-known enterprises like Crypto.com, as well as Balaji Srinivasan, former CTO of Coinbase and partner at A16Z.

5. Team Introduction

One of the co-founders, Sam Hamidi-Kazemian, has a programming background and graduated from the University of California, Los Angeles. In December 2014, he co-founded Everipedia with fellow UCLA alum Theodor Forselius. The result of this entrepreneurial project was a unique online encyclopedia that combined wiki-style collaboration with blockchain technology. Over time, Everipedia evolved into one of the most prominent DApps on the EOS platform, with Sam serving as its president.

6. Trading Data

Regarding Frax Share (FXS Token)

24-hour trading volume: $34,093,794
Current circulating supply: 73,354,242 FXS
Total supply: 99,681,496 FXS

7. Project Highlights

1. Core Team Status:

For further information about the team, please refer to the previous sections. Overall, the team is small but professionally allocated, and the product development and improvement speed is extremely fast. Sam Kazemian is a leading figure in external and community engagement, actively interacting with relevant communities and users in podcasts.

2. Recent Developments

In June 2023, Frax Finance announced plans to launch its own Layer 2 scaling solution, Frax chain, by the end of the year, boosting the price of Frax Share (FXS).
In July 2023, Frax Finance released a monthly report, including various project updates. One of the updates was about Liquid Staking tokens, with Flywheel releasing a comprehensive guide covering these tokens.
In August 2023, Frax Finance released another monthly report, including various updates. One of the updates was about Staked Frax ETH (sfrx ETH), covering all related factors.

The Frax Finance team has been focused on developing its platform and expanding the impact of its product range.

3. Track Outlook

To date, Frax Finance has built a significant user base and business presence. It is no longer just a single currency protocol. Instead, it is shaping a DeFi ecosystem centered around the stablecoin FRAX, supported by key features such as LSD (frxETH), with its reach expanding to elements such as DEX (FRAX Swap) and lending (FRAX Lend).

Frax Finance's initial strength lies in its efficient monetary mechanism and adaptive monetary policy based on AMO modules. Today, its product lineup covers lending, swapping, stablecoins, and LSD. These products are innovative in the DeFi space and may provide the project with lasting competitive advantages.

In summary, Frax is an all-encompassing DeFi platform with a strong ecosystem, unique stablecoin model, innovative features, and a steadfast commitment to security and efficiency. All of these aspects make it a significant player in the DeFi space. Looking ahead to the upcoming LSDFi season, we may witness Frax reaching unprecedented heights.

4. Expected Returns

Stablecoin Perspective: As of now, the market value of FRAX has remained at around $1 billion, less than a quarter of the market value of DAI. Similarly, the total market value of MKR is approximately $1 billion.

LSD Perspective: Lido Finance has approximately $14.3 billion in Ethereum staked, while Frax Finance holds about $445 million. In terms of market value, the current valuation of LDO is approximately $2 billion.

From this perspective, Frax Finance's potential in the LSD competition should catch up with or surpass Lido Finance. Currently, the growth trajectory of frxETH is closely related to the distribution of stETH. Given that the growth of frxETH remains stable and strong, it may gradually erode Lido Finance's market share.

In terms of the stablecoin landscape, Frax Finance's potential ceiling is determined by two key factors. First, the established trading volume of FRAX, which has remained at around $1 billion for nearly a year. Second, it is directly linked to the amount of crvUSD minted through frxETH as collateral. Within just one month of its launch, the trading volume of crvUSD has exceeded $55 million. Additionally, the usage of frxETH as collateral is almost on par with wstETH.

Comparing the potential market value of these pioneering projects, it could reach up to $3 billion. Currently, the market value of FXS is $670 million, which means its potential growth space is approximately 4.5 times its current value.

One point to consider is that the high yield of frxETH may have a chain reaction. Since its inception, the yield of frxETH has consistently outperformed Lido's stETH.

The adoption of the protocol and the increase in yield form a virtuous cycle. If the yield of frxETH exceeds that of stETH, more people may choose to deposit ETH into Frax. Especially after Lido launches withdrawal functionality, the continuously expanding share of frxETH will generate more protocol income. These earnings will flow to ve FXS stakers, thereby increasing ve FXS staking rewards. Due to the potential scarcity of FXS, this could lead to price increases.

Frax Finance's core advantage lies in its comprehensive narrative of LSD and stablecoins. Frax Finance collaborates with Curve to tap into liquidity release opportunities in the multi-billion-dollar LSD market, a strategic move with broad prospects. In addition to leveraging increased LSD profits, there is the potential to shape a new stablecoin landscape by utilizing crvUSD and the native stablecoin FRAX. This strategic approach could pave the way for a new perspective on stable-backed currency protocols.

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