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Frax Finance (FXS): A Stablecoin Protocol in the Bankless DeFi Innovation Index

Frax Finance: A Stablecoin Protocol in the Bankless DeFi Innovation Index

Frax Finance: A Stablecoin Protocol in the Bankless DeFi Innovation Index

The Bankless DeFi Innovation Index (GMI) is designed to capture the performance of the most significant tokens in the Decentralized Finance ecosystem.

The Bankless DeFi Innovation Index (GMI) utilizes an indexing strategy to offer broad, diversified exposure in a single token. GMI allows users to de-risk their exposure to DeFi upstarts–which are often novel and risky, yet contain considerable upside.

FXS is one of 12 tokens currently held in the GMI product. Here’s a basic overview of what you need to know about Frax Finance and the FXS token.

What is FXS?

Frax can be categorized as a ‘partially crypto-backed stablecoin’, with the following properties:

  • Crypto-backed: Backed by crypto assets rather than fiat.
  • Partially Collateralized: The value of the coins being minted is partially backed by a vault of assets. Overcollateralized coins such as DAI or completely uncollateralized coins such as the now defunct Basis.
  • Decentralized- Community governed and not owned by a central entity (e.g. Tether is owned by Tether Holdings, USDC is owned by Circle).
  • Dual-token model: The protocol also issues a secondary token $FXS, which is used for protocol governance and receives a percentage of profit the protocol generates from its activity.
  • Pegged to $1 nominal USD, rather than free-floating (e.g. RAI).

How does Frax Finance work?

how does frax finance work minting and redeeming usdc fxs collateral ratio explanation

From Messari

Collateral Ratio (CR) determines how much collateral is needed in order for users to mint one $FRAX (CR is 85% at the time of writing). $FRAX is the stablecoin that is pegged to $1 USD. On the other hand, $FXS is the governance token of Frax Finance. Together, they form the seigniorage model of stablecoin.

What this means is that in order to mint $1 off $FRAX, $0.85 worth of $USDC needs to be deposited (or other accepted collateral) and $0.15 worth of $FXS. Conversely, if you want to redeem your $FRAX, you receive $0.85 worth of $USDC and $0.15 worth of $FXS.

Frax CR is a dynamic ratio. CR fluctuates according to market forces of demand and supply. It changes according to the $FRAX expansion and retraction. When demand for $FRAX drives up, CR decreases. Less collateral and more $FXS are required to mint $FRAX.

Who created Frax Finance?

Frax Finance was founded in 2019 by Sam Kazemian, Travis Moore, and Jason Huan to create a decentralized stablecoin independent of the price volatility of Bitcoin. Sam & Travis had previously worked together on Everipedia, a blockchain knowledge repository like an on-chain encyclopedia.

What makes Frax Finance stand out?

Strong peg

black line graph of frax price to date

Since its launch, $FRAX has never gone off its peg. This is quite remarkable compared to its peers of algorithmic stablecoins (e.g. Iron Finance and Fei).

High Liquidity from winning the Curve Wars

fxs liquidity distribution from winning curve wars black background bar graph

FRAX also pays the most bribes on Votium each week compared to any other stablecoin protocol. In addition, as the largest holder of $CVX, Frax directs its share of Convex’s pool of $veCRV to direct more $CRV rewards to $FRAX denominated pools.

The largest Frax pool on Curve is the FRAX3CRV pool, which allows users to swap $FRAX against the three major stables USDT, USDC, and DAI. With ~ 1.5 billion of $FRAX deposited, large swaps in the pool have minimal price impact. This affords $FRAX a buffer against tail-risked sell pressure.

Have I mentioned that Frax has just partnered with Terra to create the deepest liquidity pool ever on Curve?

In other words, liquidity begets liquidity.

Why was FXS included in GMI?

Frax is at the forefront of algo-stable innovation, shipping new products day by day. It is a no-brainer for GMI to include Frax.

Frax Price Index (FPI)

Frax has been stacking inflation resistance on top of its dollar-pegged stablecoin. On 1 January 2022, Sam, the co-founder, tweeted that the Frax team is working on the Frax Price Index ($FPI), a new native stablecoin.

$FPI would 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. Token holders see an increase in their token’s dollar-denominated value each month according to the reported CPI increase. This is possible because Frax earns yield on the underlying FPI treasury, created from users minting and redeeming FPI with FRAX.

The peg mechanism is unclear at the moment, but from the preliminary documents, $FPI has properties similar to a money market fund: a deposit balance with a guaranteed quarter yield that is highly liquid. Maintaining this peg on-chain, however, might require some innovative peg mechanisms. Speaking at a Twitter Space event, Sam said that all volatility is smoothed out over a year by taking a trailing 12 months (TTM) CPI. $FPI is also backstopped by deep liquidity provided by Frax and Fei. It aims to be the unit of exchange for DAO contributor pay. Ultimately, the goal is to create a crypto-native CPI that represents the median living cost globally with a set basket of goods.

TWAMM and wider integration with other L1s

Frax is going to launch its own AMM under Paradigm’s TWAMM research. This way, Frax is going to own its swap volume and swap fees.

Frax also has plans to go multi-chain, even owning some L1 native tokens in the treasury.

Frax Finance Tokenomics

Frax has launched two tokens: $FRAX and $FXS

  • $FRAX is the stablecoin pegged to $1 USD
  • Frax Shares (FXS) is the governance token that accrues fees, seigniorage revenue, and excess collateral value

There is $veFXS. It 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).

pie graph chart of FXS distribution to project treasury, private investors, advisors, liquidity programs, and team / founders

Full distribution available on docs

About Index Coop

Index Coop is a decentralized autonomous organization (DAO) that powers structured decentralized finance (DeFi) products and strategy tokens using smart contracts on the blockchain. We offer a suite of sector structured products, leverage and inverse products, and yield-generating products. We aim to create products that are simple to use, accessible to everyone and secure. Our products are built on Set Protocol, a twice-audited, self-custodial DeFi tool that allows for the creation and management of Ethereum-based (or ERC-20) tokens. Among users, partner protocols, and our composable products, Index Coop maintains one of the largest partnership networks in the DeFi ecosystem.

How to buy Index Coop products with fiat currencies:

  • First, you’ll need to create an Ethereum wallet like Argent, Metamask, Gemini, or Rainbow.
  • Next, you’ll set up your new wallet and connect your bank account.

You can also earn or buy GMI tokens directly via your favorite decentralized exchange.

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