Frax: Using Algorithms to Control the Price of Stablecoins｜Project Introduction
Written by: 0x26
The information source of this article is Frax on July 29, 2020 A white paper.
Stablecoins have become the backbone of the cryptocurrency space
Since their debut in 2014, stablecoins have become a mainstay of the cryptocurrency space, and as of now, more USDT transfers are worth more value across the Ethereum network than any other ERC-20 token, including native Coin ETH. The average daily transaction volume of USDT on the global chain exceeds 50 billion US dollars, which is much higher than Bitcoin itself. The gap between the market value of stablecoins on Ethereum and Ethereum itself is gradually narrowing. Some people predict that the total market value of stablecoins will be higher than that of Ethereum in the future. If this happens, it will be the first time in blockchain history that tokens in a mainstream L1 blockchain network are more valuable than the protocol’s native assets. (Rhythm note, as of now, the market value of Serum tokens has briefly surpassed Solana, its construction platform)
As of July 2020 In March, the activity of Ethereum stablecoins has risen from 10% to nearly 40%. As more and more new Ethereum addresses hold stablecoins, it is clear that the massive growth of Ethereum today is guided and driven by the ecological needs of stablecoins.
While there are many ways to classify stable code, over time two distinct designs Concepts have come to the fore: collateralized stablecoins and algorithmic stablecoins. Variations of each type have been tested with some degree of success (or not yet) - staking stablecoins are usually subdivided into crypto token staking (MakerDAO's Dai) or fiat staking (Tether, BUSD, USDC ), both tokens are widely used. Despite various high-profile attempts, algorithmic stablecoins have had little apparent traction. Algorithmic stablecoins attempt to alter the supply cycle of a token so that changes in demand for the stablecoin affect its price minimally. A major reason for the current lack of appeal of algorithmic stablecoins is not their economic infeasibility, but rather their design and execution flaws.
Frax proposed its own algorithmic stablecoin design model, by using a dynamically adjusted model, the algorithmic stablecoin Keep prices stable and release stablecoin dividends to participating users.
How does FRAX model the algorithmic stablecoin?
Analyze Frax according to the logic of putting the elephant in the refrigerator. In the initial stage, FRAX is a 1:1 USD pegged stablecoin, whose collateral is 100% other stablecoins, and other tokens will be gradually introduced. In the algorithm stage, the pledge native token FXS is introduced, and according to the market demand, the pledge ratio of stablecoins (and other pledgeable tokens) and FXS is automatically adjusted according to the algorithm, so that the market value rivet is 1 USD.
Implementation principle
Frax The protocol is fully mortgaged at the initial stage and goes through three stages: 100% mortgage stage, partial mortgage stage, and algorithm adjustment stage.
The minting of the stablecoin FRAX can be achieved by putting its constituent parts proportionally into smart contracts. In the initial stage, FRAX is 100% collateralized, which means that minting FRAX only requires placing collateral in the minting contract. During the partial staking phase, minting FRAX requires placing collateral and FRAX(FXS) into the system in an appropriate ratio. While the protocol is designed to accept any type of cryptocurrency as collateral, the implementation of the FRAX protocol will primarily accept on-chain stablecoins as collateral to smooth the volatility of underlying assets, allowing FRAX to transition smoothly and smoothly to its algorithmic phase.
Three FRAX tokens pass through 3 different mortgage pools (respectively USDT , DAI and USDC) minted with a 72% collateralization ratio. Each FRAX consists of 2 parts, represented by icons in the above picture: Stablecoin and FXS
FRAX is always available from $1 worth of stablecoins minted and redeemed in the system. This allows arbitrageurs to balance supply and demand for FRAX in the open market. If the market price of FRAX is higher than the target price of $1, then there is an arbitrage opportunity by putting $1 worth of collateral into the system to obtain FRAX and selling the minted FRAX on the open market for more than $1 Token. At any time, in order to create new FRAX, users must stake $1 worth of collateral to enter the system. The difference is simply the collateral and FXS as a percentage of the $1 value. When FRAX is in the 100% collateral stage, 100% of the value put into the system for minting FRAX is collateral. When the protocol enters the fractional collateralization phase, a portion of the value that enters the system during the minting process becomes FXS (which is then burned from the total supply). For example, at a collateralization ratio of 98%, each issuance of FRAX requires $0.98 in collateral and $0.02 in FXS. At a 97% collateral ratio, each FRAX issuance requires $0.97 in collateral and $0.03 in FXS, and so on.
Frax pool can be any cryptocurrency, but stablecoins are the easiest to implement due to low price fluctuations . Frax is designed to accept any type of cryptocurrency as collateral, but low-volatility pools are preferred in the beginning because they don't change the collateral ratio at will. There are some promising new projects, such as Reflex Bonds, that dampen the volatility of their underlying crypto assets. Reflex Bonds, may become ideal FRAX collateral in the future. New Frax pools can be added through FXS governance votes.
Each pool contract has a pool cap (the maximum allowed collateral that can be stored into FRAX) and a price for the asset feedback. The initial Frax pool will be USDT due to its large market cap, stability, availability on Ethereum. The protocol plans to support BUSD, sUSD, USDC, Dai, and more in the future.
The protocol adjusts mortgage rates during periods of inflation and deflation. During inflation, the protocol lowers the collateralization ratio to the system (the FXS ratio goes up), so minting FRAX requires depositing less collateral and more FXS. This reduces the amount of collateral required for FRAX. During deflationary periods, the protocol increases the collateralization ratio so that FRAX redeemers get more stablecoins and less FXS from the system. This increases the ratio of stablecoin pledges to FRAX supply in the system. As the proportion of stablecoins in FRAX increases, the market's confidence in FRAX is enhanced.
Fully decentralized and no oracle
In the initial phase, the protocol will adjust the mortgage ratio using the specified price feed oracle. Given the price of FRAX on the open market, the oracle periodically adjusts the collateralization ratio up or down.
In a future protocol update, collateral price feeds could be obsolete and the minting process could move to an auction-based system to limit reliance on price data and further decentralize the protocol. In a later update, the protocol will operate without requiring price data for any asset, including FRAX and FXS. Minting and redemption will take place via an open auction block, with bidders posting the FXS max/min collateral rates at which they are willing to mint/redee FRAX. This auction arrangement will enable price discovery of collateral from within the system and does not require any price information to be provided through oracles.
Alternatively, the collateral ratio controller can be automated so that if certain conditions are met, the collateral ratio can Call from Frax smart contract to increase/decrease ratio. For example, a predefined, deterministic rule set could be devised (i.e. "if the price of FRAX exceeds $1 for X blocks, adjust the collateral ratio by y%"). Anyone can call this function and the system will check the price history for X blocks and modify the scale if necessary.
Initial stage, CD0 price P0 . Demand increases, the curve shifts to the right, at this time the price is P1, and then FRAX will be gradually minted until the price reaches P0. The total market value of the CD0 stage is blue, and the total market value of the CD1 stage is blue + green. (Note: The shading of the green square represents the total value of FXS that would be destroyed if the amount of FRAX was at 66%, which is important for visualization because the market value of FXS is intrinsically linked to the demand for FRAX.)
Finally, it is important to note that Frax is protocol agnostic. It does not make any assumptions about the collateralization rate that the market will maintain in the long run, but instead continuously maintains the collateralization rate at the market's requirement for FRAX to be priced at $1. The protocol only adjusts the collateralization ratio based on the demand for more FRAX and the increase in the price of FRAX. When the price of FRAX drops below $1, the protocol will stake and increase the ratio until confidence is restored and the price recovers. It will not collateralize this ratio unless demand for FRAX increases again. It is even possible that FRAX becomes fully algorithmic, but the collateralization ratio is adjusted to a considerable proportion if market conditions require it. This deterministic and reflexive protocol is the most elegant way to gauge market confidence in something like a stablecoin.
Redeemability
Seamless redemption of FRAX collateral and FXS is critical; otherwise, if redemption is lengthy or costly, the price of FRAX may be lower than the price of the actual collateral in the reserve. Redemption simply requires sending FRAX to a smart contract and paying a negligible redemption fee (currently set at 0.04% of transactions), the collateral and FXS are sent back to the user immediately. Redemption fees are accumulated in the system, and future FXS governance votes can allocate funds for use. In the initial phase, each FRAX can be redeemed at any time for $1 worth of collateral (no FXS).
In the partial pledge phase, each FRAX is only backed by a portion of the collateral. However, since FRAX may trade at $1, it must be redeemable for $1's value from the system's smart contracts. Therefore, in the fractional phase, FRAX is redeemable at a rate that secures it and the remaining value is minted in FXS from the system. For example, at a 90% collateralization ratio, each FRAX is backed by only $0.90 of collateral. However, users can still redeem $1 in value per FRAX by accepting $0.90 in collateral and $0.10 in FXS. This allows redemptions to not affect the collateral ratio of the banking system. It is worth noting that FRAX is always redeemable for 1 USD value from the system, not just 1 unit of collateral or FXS. For example, if the collateral ratio is 90%, then each FRAX can be redeemed for $0.90 of collateral value instead of 0.9 units of collateral. This is important because although the Frax protocol uses stablecoins as collateral to prevent large swings in the collateral ratio, the value of each collateral unit can still be slightly off (i.e. $1.01 or $0.99 per USDT). If FRAX can be redeemed for 1 unit of collateral instead of $1 value, then there is an arbitrage opportunity when the price of FRAX is at or above $1 and the price of collateral is below $1/unit Pool evacuated. This type of arbitrage is not what the protocol wants.
When the protocol reaches the complete algorithm stage, if each FRAX is generated without stablecoin pledge (0% pledge ratio), Then $1 worth of FXS can always be redeemed from the system. Instead, each FRAX can only be realized by placing $1 worth of FXS in the system. This redemption process is smooth, easy to understand, and economically sound. In the latter two stages, FRAX is minted, FXS is burned; when FRAX is redeemed, FXS is minted. Therefore, the value of the FXS token is determined by the demand for FRAX. The total increased FXS market capitalization is the sum of the non-stablecoin collateral value in the FRAX market capitalization, as shown in the FRAX supply and demand diagram above.
Frax Share Token(FXS)
FXS is a non-stable, value-accumulating token in the protocol. It is meant to be unstable and an investment asset, unlike the $1 stable price of FRAX rivets. The total FXS amount has the potential to rise and fall. The supply of FXS is initially set at 100 million, but the number in circulation may be unstable due to FRAX minting and redemption. FXS will be largely deflationary and grow in value due to demand from FRAX. The Frax protocol is a hybrid minting ecosystem.
Use Frax pool assets to obtain agreement income
Since Frax Pool holds encrypted assets, these encrypted assets can be used to earn interest, collect liquidity fees, and participate in Farming, so future updates to the Frax Pool contract can automatically deposit collateral in the whitelisted DeFi protocol products, thereby earning income for the Frax protocol. The original Frax pool design did not utilize any revenue-generating services due to the unique risk profile each activity presented. An upgraded Frax pool could be deployed at a future date, depositing its underlying collateral into these services and adding revenue to the system. It depends on the votes of FXS users for the new Frax pool using DeFi protocols such as Curve.fi, Uniswap, Aave, Compound, etc. These modified pool contracts must also guarantee that their related ctokens, LP tokens, etc. can be redeemed against FRAX in accordance with the same collateral ratio of the FRAX protocol.
Finally, there may be a more complex setup where the underlying collateral for each pool is used for insurance and hedging, Such as Nexus Mutual, Opyn, and other emerging DeFi hedging platforms. This allows one type of collateral to hedge against the failure/depreciation of another type of collateral, creating a stronger and more resilient overall collateral pool for FRAX.
Governance
FXS Support Some also participate in governance, including (but not limited to): system upgrades, forks, setting system parameters, such as voting for price oracles, and how to utilize collateral assets in reserve funds. Governance operations require proposals, which need to reach a quorum (minimum number of approvals) within a given time frame.
The protocol requires the price of FRAX, FXS and collateral to run the basic process. In the initial version of the protocol, similar to other stablecoin designs, FXS users voted for a stablecoin oracle. In future system upgrades, the prices of FRAX and FXS can be obtained through on-chain data such as Uniswap pools and decentralized platforms. Additionally, a future protocol upgrade will completely remove the requirement for collateral price data, making the FRAX minting process an auction. In such a system, only the USD prices of FRAX and FXS are needed, which can be easily retrieved from on-chain stablecoins.
Finally, if the protocol develops enough, FXS holders can create a "Frax Standard" and Contact in the rivet, FXS holders will have the right to decide when and what reference price to rivet.
FXS distribution and incentives
FXS must be sufficiently decentralized to have a diverse initial distribution when future governance actions are determined by FXS holders. In addition, in the initial stage, FARX is not attractive enough compared to other stablecoins due to low liquidity and stability. For these two reasons, FXS tokens will initially be distributed to the creators of FRAX, and since there is no initial token offering or fundraising, this staking process (mimicking "liquidity mining") is the way to get FXS tokens The main way.
In addition, the staking reward program will motivate users who provide liquidity for FRAX on Uniswap. Users can contribute to FRAX : ETH Uniswap pools provide liquidity and stake their LP tokens to staking contracts to earn FXS rewards allocated to FRAX Uniswap LPs. As usage increases, FXS rewards can be channeled to other DeFi platforms such as Aave or Compound.
team background
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Sam Kazemian｜CEO
Sam is the co-founder of Everipedia (IQ) People, graduated from the University of California, Los Angeles.
Stephen Moore｜Chief Economic Officer
Stephen is a White House economic adviser and was nominated for the Federal Reserve Board in 2019.
Fortune magazine report
Ralph Benko｜Senior Counselor
Ralph is a former Reagan Deputy General Counsel.
Project Significance
Team members have strong academic ability and rich experience in the political field. At the same time, if the token model design can be fully realized, there is great value, which not only adds a new possibility to the stablecoin market, but also allows the dividends of stablecoin pledges to be released to ordinary users.
However, the author found some problems while reading the white paper, docs files and official website, and pointed them out here. First of all, the white paper provided by the official website actually has large-scale repetitions, and the paragraphs with the subtitle "Utilizing Frax Pool Assets for Protocol Revenue" are repeated on a large scale. According to observations, this white paper was published on July 29, 2020.
Frax is not designed to flood the market with a stable currency containing the Rebase property, but to find A more reasonable design path has been established. However, the design goals of the project are relatively ambitious, and some goals are difficult to achieve. The details of the economic model are still open to discussion, and the project is complicated with too many functions and possibilities. Whether the goals can be fully achieved is worth further observation.
Furthermore, from the docs document, we can see that the V2 version of Frax will release the second algorithmic token, Frax Bond Token (FXB), according to reports, it represents pure debt with interest rates attached. This undoubtedly adds another layer of instability to the complex stablecoin system.
Reference materials:
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