Frax Finance v3: The Multi-dimensional Upgrade of the FRAX Stablecoin

深入解析Frax Finance v3：美元稳定币FRAX的综合升级

全面分析Frax Finance v3：美元稳定币FRAX的多维升级

By Jiang Haibo, LianGuaiNews

Frax Finance boasts one of the most comprehensive DeFi product suites, including the FRAX stablecoin, Frax Price Index (FPI), FraxEther for ETH liquidity staking derivatives, native AMM Fraxswap, lending market Fraxlend, and cross-chain bridge Fraxferry.

Frax v3 has been rolling out its features since October, introducing sFRAX, which is comparable to sDAI in MakerDAO. But the updates of Frax v3 go beyond that, with some features still under development. Below, LianGuaiNews will provide a detailed overview.

Frax v3 Overview

Frax v3 is described by the official team as the “ultimate stablecoin.” At its core, FRAX remains a stablecoin, still governed by the Algorithmic Market Operations (AMO) and internal and external sub-protocols such as Fraxlend, Fraxswap, and Curve to maintain stability. However, Frax v3 introduces several new mechanisms.

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• Complete external collateralization: The protocol aims to achieve a collateralization ratio (CR) of >=100%, which means every FRAX stablecoin will have an equivalent collateral without the need for additional minting of FXS. This measure is expected to boost confidence among FRAX holders, enhance stability, and potentially be more regulatory-friendly after the Terra crash.

• Tethered to the U.S. dollar: FRAX’s price will be maintained at $1, instead of being pegged to assets like USDC, USDT, or DAI. Once CR reaches 100%, a combination of Chainlink oracles and governance-approved reference rates will be used to track the U.S. dollar.

• Introduction of the IOBR oracle: The Interest on Reserve Balances (IORB) implemented by the Federal Reserve since 2021 will be utilized for certain functions, such as the staking yield on sFRAX. IORB represents the upper limit of the interest rate corridor set by the Federal Reserve for financial institutions, replacing the previous statutory reserve and excess reserve rates.

• Elimination of the multisig trust assumption: The smart contracts will run entirely on-chain, decided by governance, eliminating the previous centralized factors.

• No longer redeemable: FRAX does not guarantee redemption for specific financial assets or tokens like USDC. However, stability will still be maintained through the AMO contract. For example, when the FRAX price falls, the AMO will remove and burn a portion of FRAX held by the protocol in the FRAX/USDC pool on Curve. This reduces the proportion of FRAX in liquidity and increases the proportion of USDC, driving up the FRAX price.

These features will ensure alignment of the FRAX price with the U.S. dollar, enhance the protocol’s resilience, and mark improvements in decentralization, stability, and efficiency for Frax.

Real-World Assets in the Balance Sheet

Frax now allows holding certain real-world assets (RWA) held by partner entities approved by the governance module in its balance sheet. Frax has introduced the IOBR oracle, and when the IOBR rate is high, Frax will deploy some of its funds into RWAs.

The RWAs permitted for holding include low-risk types close to the IOBR rate, such as short-term U.S. Treasury bills, overnight repurchase agreements of the Federal Reserve, U.S. dollars held in Federal Reserve main accounts, and shares of selected money market mutual funds.

The first RWA partner approved via proposal FIP-277 is FinresPBC, focusing on low-risk RWAs referred to as “cash equivalents.” FinresPBC is a non-profit Delaware-registered company whose main purpose is to provide access to traditional financial assets for the Frax protocol and offer secure cash equivalents and income approximating Federal Reserve rates, with all profits distributed to Frax. Its banking partner is Lead Bank, and feasible operations include:

• Holding USD deposits in FDIC-insured savings accounts and earning returns.
• Minting/redemption of USDC and USDP stablecoins.
• Holding, purchasing, and selling U.S. Treasury bills in an independent brokerage account for generating returns.

As of October 30, the Frax balance sheet already includes “OFFCHAIN_USD” tokens, which represent FDIC-insured bank deposits and short-term US Treasury bills, with a value of approximately $2.98 million.

sFRAX: The Equivalent of sDAI

sFRAX stands for Staked FRAX, which is a special staking treasury that distributes a portion of the Frax protocol’s earnings to stakers on a weekly basis. The annualized yield of sFRAX will aim to approximately track the IORB rate of the Federal Reserve. The graph below shows the IORB rate ranging from 5.4% from the end of July until now.

The yield rate of the sFRAX treasury is determined by a utilization function, initially set at 10% and gradually decreases as the staked capital increases. The protocol deploys the staked FRAX to revenue sources as close to the IORB rate as possible. Every Thursday at 7:59:59 am Beijing time, the protocol mints new FRAX stablecoins into the sFRAX treasury based on the profits earned. sFRAX represents a certain proportion of FRAX deposits in the treasury, which means more FRAX can be redeemed over time.

The protocol strives to achieve a yield rate close to the IORB rate but does not guarantee it. The majority of the yield comes from partner RWA strategies. Frax also holds $56.28 million worth of sDAI, which generates returns through MakerDAO’s RWA strategy.

Zero-Interest Bond Tokens: FXBs

Frax also plans to introduce a bond-like token called FXBs, which can be converted into FRAX stablecoins upon maturity. Specifically, FXBs are debt tokens denominated in FRAX, guaranteeing conversion to FRAX stablecoins at the time of maturity.

FXBs are auctioned through a progressive Dutch auction system, with quantity and price limits set by governance to ensure that the auction price of FXBs does not fall below a certain threshold. According to the characteristics of zero-interest bonds, they are usually issued at a discount. For example, an FXB maturing in one year may trade at $0.95, and each FXB can be exchanged for 1 FRAX upon maturity, resulting in a yield rate of 0.05/0.95, approximately 5.26%. This helps establish a yield curve for FXBs and price the time value of lending FRAX to the protocol itself.

The introduction of FXBs bridges traditional finance and decentralized cryptocurrencies, providing users with an innovative way to balance risk and return.

Limitations of Frax RWA Strategy Compared to MakerDAO

Although sFRAX in Frax offers a higher yield rate compared to MakerDAO’s sDAI (6.5% vs. 5%), there are still several limitations to Frax’s RWA strategy.

• Collateralization ratio (CR): FRAX’s CR is still below 100%, which may raise concerns among some users. As of October 30, CR = (Total assets in the balance sheet – Locked liquidity) / Total debt = (806,442,146 – 120,069,640) / 742,061,132 = 92.5%.

• Issuance scale: According to data from Makerburn and the Frax official website, DAI has a circulation of 5.565 billion, with the emission reaching 4.44 billion before the Enhanced DAI Savings Rate implementation, after which the growth stopped about two weeks ago. FRAX’s circulation is approximately 672 million, which has been decreasing for the past year and a half, with no increase after the launch of sFRAX this month.

• Asset composition: In MakerDAO, a significant portion of the collateral for minting DAI consists of stablecoins, which can be used for purchasing RWAs after keeping a small amount of stablecoins for liquidity withdrawal. So far, RWAs account for 3.378 billion. In Frax, many FRAX tokens are controlled by the protocol itself, such as when AMO mints FRAX into the Curve USDC/FRAX pool for liquidity. These collateral assets are recorded in the balance sheet as FRAX owned by the protocol or liquidity owned by the protocol. However, there is not enough liquidity in the market for all of these FRAX tokens to be redeemed and exchanged for other stablecoins and then used to purchase U.S. treasuries. According to blockchain explorer data, Frax Finance: Comptroller contract controls 262 million FRAX, accounting for 39.1% of FRAX issuance.

• Exchange mechanism: MakerDAO’s PSM provides zero-cost 1:1 USDC/DAI swaps, while purchasing FRAX for investment in sFRAX requires trading on Curve, which incurs transaction fees and slippage, making it less friendly for large investors.

• Network effect: RWA projects require significant costs for off-chain compliance work, and a sufficient pool of assets is needed to generate profits for sustained operations and gain trust.

Conclusion

Frax v3 will make Frax more decentralized, stable, and efficient. sFRAX, comparable to MakerDAO sDAI, has already launched this month, and additional products such as bond-like tokens FXBs will be introduced.

However, there is still a substantial gap between Frax and the well-established MakerDAO. The issuance of FRAX has not increased after the launch of sFRAX, with only around 672 million in circulation. Moreover, it is likely that half of this amount is held by Frax itself and cannot be sold for purchasing RWAs.

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