The Frax Finance Stablecoin Protocol, also known as Frax, is a stablecoin protocol that issues decentralized stablecoins and contains subprotocols to support them. Frax currently issues 3 stablecoins. FRAX, a USD pegged asset. The Frax Price Index (FPI) stablecoin, the first stablecoin pegged to a basket of consumer goods creating its own unit of account separate from any nation state denominated money. FraxEther (frxETH), pegged to ETH for use as a replacement for WETH in smart contracts. The Frax Protocol also has 3 subprotocols within it that integrate its stablecoins: Fraxlend, Fraxswap, and Fraxferry. ^[12]

The project began as "the world's first fractional stablecoin with parts of its supply collateralized and parts fractionally stabilized." ^[1][2] On February 23rd, 2023, the Frax Finance community voted to fully collateralize the protocol’s native stablecoin FRAX.^[28]

On November 16, 2020, the testnet was released for early users to experiment with and report bugs. The protocol officially launched on the Ethereum mainnet on Sunday, December 20, 2020, at 4 pm PST (Monday December 21, 2020 at 0:00 UTC).^[5][6][7]

One hour after launch the total value locked (TVL) in Frax Finance was over $43 million. As of Jan 13, 2021, 100 Million FRAX tokens had been minted, with a collateral ratio of around 85%.^[8]

On January 19, 2021, Frax Finance passed Wrapped Bitcoin (WBTC) to become the 5th most liquid token on Uniswap with over $130 million in liquidity.^[9]

On February 17, 2021, Frax Finance became the first fractional stablecoin to be listed on Binance. Binance listed Frax Shares in their Innovation Zone with FXS/BTC and FXS/BUSD trading pairs opening on February 18, 2021, 9:00 AM (UTC) and deposits opening earlier.^[10]

In January 2022, Frax Finance expanded its collaboration with Chainlink to bring the U.S. CPI data on-chain in support of the Frax Price Index. ^[11]

Trivia

The Frax protocol takes inspiration from Robert Sams' 2014 academic paper titled “A Note on Cryptocurrency Stabilisation: Seigniorage Shares.”^[12]

Overview

Frax V1

Before the inception of the Frax Finance protocol, stablecoins were divided into three different categories: fiat collateralized, overcollateralized with cryptocurrency, and algorithmic with no collateral. FRAX is a new type of decentralized stablecoin classifying itself as fractional-algorithmic. ^[13]

The Frax protocol is the first stablecoin designed to transition from fully collateralized to varying levels of fractional backing whereby parts of the supply are not backed by any assets but rather minted and bought back by the protocol itself to keep the price of the FRAX token at $1. ^[14]

The protocol is a two-token system encompassing the stablecoin Frax (FRAX) and the Frax Share token (FXS) which accrues seigniorage revenue, and fees, and provides governance rights. ^[14]

The project has also announced the third token, the Frax Bonds token (FXB) to be released at a future date which is an interest-bearing token representing debt in the system.  ^[14][15]

As FRAX adoption increases, users of the protocol will be more comfortable with a higher percentage of FRAX supply being stabilized algorithmically rather than with collateral. ^[14]

The price of FRAX, FXS, and collateral are all calculated with a time-weighted average price (TWAP) of the Uniswap pair price and the ETH: USD Chainlink oracle. The Chainlink oracle allows the protocol to get the true price of USD instead of an average of stablecoin pools on Uniswap. This allows FRAX to stay stable against the United States dollar itself which would provide greater resiliency instead of using a weighted average of existing stablecoins only.^[14]

Frax V2

Frax v2 expands on the idea of fractional-algorithmic stability by introducing the idea of the "Algorithmic Market Operations Controller" (AMO). An AMO module is an autonomous contract(s) that enacts arbitrary monetary policy so long as it does not change the FRAX price off its peg. This means that AMO controllers can perform open market operations algorithmically (as in the name), but they cannot arbitrarily mint FRAX out of thin air and break the peg. ^[16]

Frax V3

FRAX v3 utilizes AMO smart contracts and permissionless, non-custodial subprotocols as stability mechanisms. The internal subprotocols employed for stability are Fraxlend, a decentralized lending market, and Fraxswap, an automated market maker (AMM) with unique features. As an external stability mechanism, Curve is utilized. Through governance, FRAX v3 has the flexibility to seamlessly incorporate future stability mechanisms as they emerge, including additional subprotocols and AMOs.^[31][32]

Full exogenous collateralization of FRAX:
The protocol strives to maintain a 100% collateralization ratio (CR) at all times. Starting in v3 and after FIP188^[33], the Frax Protocol aims to achieve this by utilizing AMO smart contracts and specific real-world assets held by partner entities approved by the Frax Governance module (frxGov). The CR of FRAX stablecoins is calculated based on the value of external collateral held on the FRAX balance sheet. This segregated balance sheet serves as collateral to stabilize the market price of FRAX stablecoins.^[34]

Sovereign USD peg:
Once the FRAX stablecoin achieves a 100% collateralization ratio (CR), its peg to the USD will be maintained through a combination of Chainlink oracles and governance-approved reference rates. In the event that the FRAX CR decreases, AMOs (Algorithmic Monetary Officers) and governance should make efforts to restore the CR to 100% and ensure that the price of FRAX remains at $1.00, regardless of the prices of other assets like USDC, USDT, or DAI.

IORB oracle:
The FRAX v3 smart contracts utilize the Federal Reserve Interest on Reserve Balances (IORB) rate for specific protocol functions, such as sFRAX staking yield. When the IORB oracle rate rises, the Frax Protocol's AMO strategies respond by heavily collateralizing FRAX with treasury bills, reverse repurchase contracts, and/or USD deposited at Federal Reserve Banks that offer the IORB rate. Conversely, when the IORB oracle reports low or decreasing rates, the AMO strategies initiate the rebalancing of FRAX collateral with on-chain, decentralized assets and overcollateralized loans in Fraxlend.^[35]

Removal of multi-signature trust assumptions: FRAX v3 smart contracts entirely operate onchain using the frxGov module.^[36]

Non-redeemability: FRAX stablecoins, similar to fiat currencies, are non-redeemable and do not grant the holder any rights to assets. Having a FRAX stablecoin does not guarantee the right to redeem it for any specific financial instrument or token at any given time. The primary purpose of the Frax Protocol is to stabilize the FRAX price at $1.00. by utilizing AMO contracts, real-world assets (RWAs), and governance actions through frxGov. This is achieved by referencing USD oracles.

Real-World Assets

FRAX v3 employs a real-world asset (RWA) strategy in response to high rates reported by the IORB oracle. It specifically focuses on RWAs that closely match the IORB rate while minimizing duration risk. As of now, the following assets are being considered, unless modified by the frxGov process:

1.) short-dated United States treasury bills
2.) Federal Reserve Overnight Repurchase Agreements ^[37]
3.) USD deposited at Federal Reserve Bank master accounts
4.) select shares of money market mutual funds

FRAX v3 partner custodians primarily concentrate on only the above assets. RWA partners must report the custody, broker, banking, and trust arrangements employed in the course of holding the assets for FRAX v3 no later than monthly.

Staked FRAX

Staked FRAX (sFRAX) is an ERC4626 staking vault that distributes a portion of the Frax Protocol yield weekly to stakers in FRAX stablecoins. The sFRAX token represents proportional deposits within the vault and can always be exchanged for FRAX stablecoins at the same rate. The sFRAX APY aims to roughly mirror the interest on reserve balances (IORB) rate set by the United States Federal Reserve, as determined by the IORB oracle. This benchmark rate is commonly referred to as the "risk-free rate" of the US Dollar. While the FRAX staking vault strives to target this rate, it does not provide any guarantees. The sFRAX vault APY is determined by a utilization function that can be set by the frxGov governance module. Initially, the utilization curve offers a maximum APY of 10% and theoretically has no minimum APY. However, as more FRAX is staked in the vault, the protocol aims to deploy the staked FRAX to sources that yield as close to the IORB rate as possible, thus maintaining a bottom APY close to the IORB oracle.^[38]

Every Wednesday at 11:59:59 UTC, the Frax Protocol adds newly minted FRAX stablecoins into the sFRAX vault. These newly minted FRAX coins are directly proportional to the earnings of the Frax Protocol during the previous week, ensuring they are fully backed at a 100% collateralization ratio (CR).

Each sFRAX epoch lasts for one week and starts at the same time as the FXS gauge and sfrxETH epoch. It's important to note that there is no guarantee that the deployed capital will come exclusively from a specific type of asset at any given time. The frxGov governance module will determine the deployment path and asset type for sFRAX yield.

The majority of the yield generated by the Staked FRAX vault originates from real-world asset (RWA) strategies employed by partner custodians of the Frax Protocol, including but not limited to FinresPBC.^[39]

Frax Bonds

FXB tokens are trustless and simple tokens that function like zero-coupon bonds. They convert to the FRAX stablecoin upon maturity. It's important to note that FXBs are debt tokens denominated in FRAX, not claims on any other asset or collateral. While FXBs can be converted to FRAX stablecoins, they do not guarantee the FRAX peg, value, or yield in any other asset. They also do not entitle the holder to any offchain or onchain assets, except for FRAX stablecoins.

It is crucial to understand that FXBs are not redeemable for US Treasury Bills or any real-world asset. They are not directly backed or collateralized by them or any specific asset. The primary utility of FXBs lies in their ability to trustlessly convert to FRAX stablecoins at the pre-programmed maturity timestamp generated during minting. Each FXB token is a fungible ERC20 token deployed from an onchain factory contract. At the time of minting, FRAX stablecoins are generated into the FXB redemption contract for conversion upon maturity, ensuring a seamless and trustless process. Multiple FXB series can circulate simultaneously, and there are no limitations on the minimum or maximum maturity timestamp for FXBs deployed from the factory.^[40]

To determine the price of FXB series, a unique gradual Dutch auction (GDA) system is employed. The quantity and price limits are set by frxGov to ensure that FXB tokens are not sold below the

Tokenomics

Frax Share Token (FXS)

Frax Share Tokens eschew DAO-like active management similar to MakerDAO. FXS supply was initially set to 100 million tokens at genesis, but the amount in circulation is deflationary as FRAX is minted at higher algorithmic ratios. The design of the protocol is such that FXS would be largely deflationary in supply as long as FRAX demand grows. ^[14]

FXS has control of the seigniorage and revenue flow of the protocol. FXS is similar to ownership/stake in the protocol, not debt which is a separate financial primitive. ^[14]

Per the FXS yearly halvening schedule, the total FXS emissions halve every 12 months on December 20, 2020. ^[14]

Token Distribution

60% of all FXS tokens are to be distributed through various yield farming, liquidity incentives, and exclusive governance proposals across several years. Thus, a maximum of 60,000,000 FXS will be distributed to the community for liquidity programs and other Defi initiatives as they appear in the space as voted by governance. 5% of all tokens are allocated to Project Treasury, grants, partnerships, and security bug bounties via team and community discretion. The Project Treasury is an entire community and team-governed pool of FXS. It should be used for making grants for the development of the Frax technology, open-source upkeep of the code, future audits of smart contracts, bug bounties through responsible disclosure, possible cross-chain implementations, creation of new protocol-level features and updates, Gitcoin grants for the Ethereum community, Frax Improvement Proposals (FIPs), partnerships with exchanges and DeFi projects, providing liquidity on AMMs at launch. The usage of this fund is dependent on the discretion of the team and community.

20% of all FXS tokens are to be distributed to the team, founders, and early project members. 3% are advisory tokens that are allotted for strategic work done in legal, technical, and business efforts to advance the adoption of the Frax protocol. The tokens are vested evenly over 3 years. 12% are distributed to accredited private investors. The first round in Frax was done in August 2020 with a small allocation that was sold out in under 2 hours. This allocation will have a small number of their tokens, ~2% unlocked at launch. The remainder of the round was done individually through private placements. The remaining 10% is vested evenly over 1 year, half of which has a 6-month cliff. ^[17]

veFXS

In May 2020, the protocol allowed FXS holders to lock up FXS tokens to generate veFXS and earn special boosts, special governance rights, and AMO profits. ^[18]

veFXS is a vesting and yield system based on Curve’s veCRV mechanism. Users may lock up their FXS for up to 4 years for four times the amount of veFXS (e.g. 100 FXS locked for 4 years returns 400 veFXS). veFXS is not a transferable token nor does it trade on liquid markets. It is more akin to an account-based point system that signifies the vesting duration of the wallet's locked FXS tokens within the protocol. ^[18]

The veFXS balance linearly decreases as tokens approach their lock expiry, approaching 1 veFXS per 1 FXS at zero lock time remaining. This encourages long-term staking and an active community. ^[18]

Frax Price Index (FPI)

In January 2022, Frax Finance announced the expansion of their integration with Chainlink to support the launch of the new Frax Price Index (FPI), an algorithmic stablecoin designed to be inflation-resistant and an entirely new unit of account. FPI will be pegged to a decentralized consumer price index (CPI) with crypto native elements added on top of Chainlink’s custom CPI oracle built for FRAX. Frax and Chainlink's initial integration, now live on Ethereum, involves using the Chainlink Any API functionality to create a decentralized, on-chain reference contract that stores the most up-to-date U.S. government Consumer Price Index (CPI) data. ^[19]

Frax Price Index Share (FPIS)

The Frax Price Index Share (FPIS) is the governance token of the Frax Price Index (FPI) stablecoin which launched in April of 2022.

Frax ETH

On October 13, 2022, Frax Ether, the liquid staking system, went live. The system has three components – frax ether (frxETH), staked frax Ether (sfrxETH) and the Frax ETH Minter. Staking refers to locking up coins in a crypto wallet in return for rewards. Liquid staking is the process of locking up funds to earn rewards while still having access to the funds locked via their liquid derivative coins. ^{[25] [26] [27]}

frxETH is an ether-pegged stablecoin meant to be equal to one ether (ETH). Users can deposit ETH into the Frax ETH Minter contract and get an equivalent amount of frxETH, unlocking the liquidity of ether staked. The frxETH tokens can be used to provide liquidity on the decentralized exchange Curve. To earn rewards on the ether staked, however, users need to exchange frxETH with the staked frax ether or sfrxETH tokens.

Frax Finance's two-token model eliminates risks associated with rebasing and simplifies DeFi integrations. The frxETH stablecoin doesn't rebase and is fully backed by algorithmic market operations plus ether. Further, the sfrxETH tokens, which earn staking rewards, increase in price like the Yearn vault token.

Gauges

The FRAX gauge weighted system for controlling FXS emissions & FRAX expansions allows FXS holders to stake for up to 4 years to generate veFXS and vote where future FXS emissions are directed. Users can vote for FRAX gauge weights with their veFXS balance. They can distribute their voting power across multiple gauges or a single gauge. This allows veFXS holders who are the most long-term users of the protocol to have complete control over the future FXS emission rate. Additionally, the gauge system lowers the influence of FRAX pairs where the majority of rewards are sold off since those LPs will not have veFXS to continue voting for their pair. This system strongly favors LP providers who continually stake their rewards for veFXS to increase their pool's gauge weight. Essentially, FRAX gauges align incentives of veFXS holders so that the most long-term oriented FXS holders control where FXS emissions go until the full community FXS allocation is distributed. Gauge weights are updated once every week every Wednesday at 5 pm PST. This means that the FXS emission rate for each pair is constant for 1 week and then updates to the new rate each Wednesday. Any user can change their weight allocation every 10 days. ^[20]

After all, FXS has been distributed, the gauge system will transition to controlling FRAX stablecoin expansions as rewards for LPs. This switch from FXS to FRAX rewards will not occur for a few years until FXS emissions are nearing completion and allow the stablecoin to build trust, confidence, and the Lindy effect first. Additionally, veFXS stakers can feel confident staking the maximum duration of 4 years knowing that the gauge program is not temporary and won't be deprecated when FXS rewards end. The gauge weights will simply transition to distributing FRAX stablecoins as rewards perpetually.^[21]

Fraxswap

Fraxswap is the first constant product automated market maker with an embedded time-weighted average market maker (TWAMM) designed by Frax Finance. Fraxswap is mainly used for conducting large trades over long periods of time trustlessly. On June 2022, the Frax Finance team announced the launch of Fraxswap.

Partnerships

In January 2022, Frax was introduced as a service on Ondo Finance. The partnership will build on Ondo's Liquidity-as-a-Service offering and enable the use of $FRAX (provided by the protocol itself) as liquidity for token issuers. ^[22]

In December 2021, FRAX partnered with Sacred Finance to bring privacy and stability to Defi. The partnership will allow users to lend FRAX privately and earn yield privately through Sacred. The same month, the Decentralized 3 Pool went live on Convex Finance. This is a triple collaboration between Frax, Fei Protocol, and Alchemix (ALCX). The vision is to make the D3 Curve pool the top choice for farming, saving, and holding decentralized dollar stablecoins. In December, NearPad partnered with Frax Finance to bring FRAX and FXS over to the Aurora and Near ecosystem. ^[23]

In September 2021, Pangolin and Frax Finance collaborated to bring the FRAX stablecoin to Avalanche. With the collaboration, Pangolin boosts the availability of stablecoins on the Avalanche network for users of Pangolin and provides sufficient liquidity in innovative stablecoins like Frax. They added reward pools for the AVAX-FRAX pair and the AVAX-FXS pair to support liquidity. ^[24]

Fully Collateralized

The Frax Finance community voted to Fully Collateralize its native stablecoin FRAX on February 23, 2023 as per snaoshot FIP-188. ^[29] The details and motivations are as follows:

Fraxchain

Fraxchain is Frax Finance's Layer-2 blockchain which uses Frax-based stablecoin as gas, such as frxETH and FRAX. Currently aimed for 2024, Fraxchain would be the only protocol with their own stablecoin which has its own blockchain.

There is no whitepaper for Fraxchain, however there have been multiple threads explaining certain mechanics already confirmed by Frax Finance's founder Sam Kazemian. ^[30]

FrxGov

FrxGov will allow everything to be onchain, with allowing veFXS holders to become pseudo msig signers.
FrxGov will have two governor contracts called GovAlpha and GovOmega.

GovAlpha

veFXS holders propose governance votes and choose parameters, with a 5 day voting period which requires a 40% quorum.

GovOmega
GovOmega serves as a signer on Frax Safes with a 2 day voting period which requires a 4% quorum.
Those that want to participate in FrxGov will be required to own veFXS.

Abstract

The time has come for Frax to gradually remove the algorithmic backing of the protocol. The Frax protocol has grown and evolved dramatically since the protocol launched in December 2020. The original protocol included a variable collateral ratio which adjusted based on the market demand of FRAX, effectively letting the market dictate how much collateral was necessary for each FRAX to equal $1.00. This was a highly innovative, elegant approach that Frax pioneered but has now outgrown. The costs of being slightly undercollateralized now far outweigh the benefits – especially because it can undermine the perceived safety of FRAX. Gradually shifting the protocol to 100% CR is the best path forward for the long-term health and growth of the protocol.
This is a significant change to the protocol that over time effectively retires the algorithmic backing of Frax. It has become clear to many active in the community that this is the best path forward. The intention of this proposal is to coordinate the community on increasing the CR to 100% permanently. It is more focused on the destination (100% CR) than how we get there - there is no imminent need to increase the CR and there are many ways of reaching the target CR. Ideally growth, asset appreciation and protocol earnings will increase the CR to 100% over time. To be clear, this proposal does not rely on minting any FXS to achieve the 100% CR.

Motivation

Frax has always approached the algorithmic backing of FRAX conservatively. Even before launch, it was clear that relying on FXS to back the algorithmic portion of FRAX required locked liquidity to ensure smooth functioning of the protocol. Unfortunately, we have now seen many projects that didn’t understand this and failed. The downside of locked liquidity is that the protocol pays for it in the form of FXS rewards.
While this approach made sense to start, the circumstances around Frax have changed. Frax achieved 0 to 1 product market fit and now has a supply exceeding 1,000,000,000 FRAX. The next phase of growth requires increasing the “money” attributes of FRAX, specifically making FRAX an asset that users are comfortable holding, without any incentive, as a long-term store of value. The small algorithmic backing of FRAX creates the perception that FRAX is the less safe option for users to hold, especially after UST’s failure tainted the algorithmic stablecoin concept (whether fairly or unfairly). There is very little benefit in maintaining the current CR of 92%.
@dennett has made the point that FRAX can be fully collateralized by non-FXS assets and still be fractional reserve by deploying protocol owned liquidity via AMOs. Increasing protocol collateral also means that additional collateral can be deployed via AMOs to create liquidity and revenue for the protocol. Frax will continue to be the most capital efficient safe stablecoin while removing the need to constantly fund locked liquidity. At this point, all protocol expansions occur via AMO and effectively are at 100% CR. This means that protocol growth increases the CR.
The gentlest way to increase the CR is to retain protocol earnings as the protocol grows. As part of this proposal, FXS buybacks will be deferred until the CR reaches 100%. This is effectively an investment in the future of Frax that will increase protocol assets and remove the need for FXS emissions towards locked liquidity. There appears to be little impact from FXS buybacks lately and the impact is probably overestimated at this point. This proposal does not impact the current veFXS yield. From the perspective of FXS holders, this proposal should increase the soundness / perception of Frax and accelerate protocol growth.
Finally, this proposal would authorize protocol comptrollers to strategically exchange up to $3m of protocol assets for frxETH each month. frxETH is becoming an important decentralized asset on Frax’s balance sheet, both increasing the CR while also increasing the supply of frxETH and validators. frxETH also offers a strong return potential for the protocol. Up to $3m per month is a small amount given the size of Frax’s protocol assets – it also limits the protocol’s exposure to frxETH price volatility by keeping the value relatively small. The selling of protocol assets authorized by this proposal is not intended to decrease Frax’s holdings of CVX or CRV and will not include either asset.

Investors & Backers

• ParaFi Capital
• Mechanism Capital
• Dragonfly Capital
• Crypto.com Capital
• Electric Capital
• Multicoin Capital
• Galaxy Digital
• Tribe Capital
• Robot Ventures
• Ascensive Asset Management
• Calvin Liu (Div. VC)
• Stani Kulechov (Aave)
• Kain Warwick, Jordan Momtazi (Synthetix)
• Eyal Herzog, Guy Benartzi (Bancor)
• Balaji Srinivasan
• Santiago Roel Santos
• Tetranode