Most stablecoins are either backed by collateral or algorithmic. But there is a distinctive stablecoin that combines two backing mechanisms. This is Frax. Additionally, Frax operates with the vision to create highly scalable, decentralized money in place of fixed-supply digital assets like BTC.
Let us take a look at the peculiarities of FRAX and the innovations it is introducing to DeFi.
What is Frax Finance?
FRAX is the first stablecoin with a dual collateral-backed and algorithmic peg mechanism. In simpler terms, Frax Finance (FRAX) is an algorithmic stablecoin partially backed by collateral. FRAX combines collateralization with an algorithm to establish a collateral ratio, which varies with time.
This collateral ratio defines what ratio of collateral backs 1 FRAX to $1. FRAX is backed in part by USDC, the second-largest stablecoin by market capitalization, and in part by its FXS governance token.
FRAX functions in a similar way to how TerraUSD (UST) is backed by Terra (LUNA). FXS benefits from seigniorage when minting FRAX.
Frax’s Unique Features
1. Price Stability
The Frax protocol achieves price stability using a two-token mechanism made up of FRAX and its governance token, Frax Shares (FXS). As a fractionally-collateralized stablecoin, its collateralization ratio depends on the market’s pricing of the FRAX stablecoin.
The protocol will decrease the collateral ratio if FRAX trades above the peg ratio. If FRAX trades below peg (<$1), the protocol will increase its collateral ratio.
2. Algorithmic Market Operations
The Frax Finance Algorithmic Market Operations (AMO) controller is a framework for “composable, autonomous central banking legos.” An AMO module is a series of smart contracts that enact “arbitrary monetary policy.”
This enables AMO controllers to carry out algorithmic market operations without affecting the fractional-algorithmic stability of the FRAX token.
Frax Tokenomics
Frax Finance uses FXS as its utility and governance token. The tokenomics are as follows: total supply of 100 million FXS and token distribution of FXS allocated to:
Farming rewards at 60%: Distribution halving every 12 months.
Treasury at 5%.
Team and investors (35%): 20% to the team, 3% to advisors and early contributors, and 12% to private investors.
FXS Risks
As for the risks, FXS suffers from potential volatility, which can arrive if the FRAX stablecoin changes its distance from the focused $1 price point. As previously explained, arbitrageurs profit by keeping FRAX in line, and at both ends of the spectrum (buying and selling), FXS is either sold or bought.
Such an environment creates massive fluctuations for FXS, which can occur if FRAX moves too far. For investors, this can turn into a nightmare if FXS constantly ranges at a certain price level.
However, we are reasonably sure that active traders will have a good time buying the lows and selling the highs.
Governance
Frax Finance uses a minimal governance model, a fork of the Compound Finance governance structure. Holders must stake the FXS token to vote on proposals to make changes to the protocol.
By locking FXS tokens, users receive veFXS tokens, which are essential for casting votes.
Bottomline
Most stablecoin projects tend to favor either collateral or algorithmic backing. However, Frax Finance takes a novel hybrid approach that enables market confidence to determine the type of backing that takes precedence.
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