Partnered With:

Interpreting "解读LSD「后来者」Frax Finance：如何通过产品套件构建增长飞轮？" can be translated as "Decoding Frax Finance, the newcomer in the DeFi space: How to build a growth engine through product suite?"

Read this article in 21 Minutes

Frax Finance was originally a hybrid algorithmic stablecoin protocol that has survived in the competitive stablecoin race after several years of operation.

Original Title: "Interpreting LSD 'Latecomer' Frax Finance: How to Build a Growth Flywheel Through Product Kits?"

Original Source: ZhouYeMen

Original Translation: LlamaC

What is Frax Finance?

Frax Finance was originally a hybrid algorithmic stablecoin protocol, and after several years of operation, it has successfully survived in the competitive stablecoin race.

In early 2023, Frax once again became the focus of attention with its Liquid Staking Derivative (LSD) product frxETH. With the proliferation of LSD narratives, Frax became one of the outstanding winners with its innovative dual-token system.

frxETH will demonstrate how Frax will ultimately become a stablecoin protocol, with the goal of increasing the currency premium of its stablecoin series (FRAX, frxETH, FPI). These stablecoins will adopt Frax's "triple" DeFi primitives (such as Fraxswap and Fraxlend). Recently, Frax voted to fully collateralize its flagship stablecoin, marking the end of its partially collateralized era.

How did Frax build its ecosystem?

FRAX Stablecoin

Frax's support primarily comes from its AMOs, which put its idle USDC collateral to work. Currently, the largest operating AMO is Curve AMO, which has hundreds of millions of dollars in TVL. While the collateral ratio supported by FXS is determined by the market, Frax's AMOs adjust the supply of FRAX to maintain price stability. This is similar to open market operations conducted by central banks for their economies.

AMO: There are several AMOs responsible for different operations. Liquidity and Curve AMOs deploy idle USDC collateral and minted FRAX to different DEXs to create liquidity and anchor pegs. As a result, Frax earns trading fees generated from LP positions and rewards distributed to the pools. Currently, Frax owns 99.9% of the Frax-3CRV pool and 58.5% of the Frax Base Pool (FRAXBP) on Curve. These are the two largest stablecoin pools on DEXs, which gives Frax a strong Protocol Owned Liquidity (POL) reserve and a sustainable source of income. With this model, FRAX is not decoupled from USDC, even during the UST crash.

解读 LSD「后来者」Frax Finance：如何通过产品套件构建增长飞轮？

Source: Llama airforce

Convex AMO and Agricultural Flywheel: Frax's investor AMO holds 3.55 million CVX tokens, accounting for approximately 6.5% of all locked CVX tokens. This enables FRAX to direct CRV incentive measures to Frax's selected fund pool and deepen the liquidity of FRAX and any trading pairs priced in FRAX. As Frax owns most of the Frax-3CRV and FRAXBP mining pools, they receive the CRV and CVX rewards issued. Frax also bribes vlCVX holders, as every $1 of voting rewards brings about $1.11 (as of December 2, 2023) in emissions. Due to its POL and AMO, this is a flywheel that only Frax can achieve.

Net revenue from Curve's liquidity pool farming (excluding Votium bribes).

Frax's net income is highly dependent on the prices of CRV, CVX, and FXS. In January 2021, the prices of these three tokens reached their peak. In recent months, net income has remained in a balanced state, but it is still a net positive for the protocol because they are essentially bribing the mining pool for free liquidity. Therefore, this agricultural flywheel allows Frax to continue bribing and returning rewards.

Frax Base Pool (FRAXBP): Frax is able to protect the Curve metapool, which is composed of FRAX-USDC and can be paired with other assets, similar to 3CRV (USDT/USDC/DAI). Frax incentivizes protocols to work with them by using bribes held in Frax's CVX/CRV to increase incentives to the mining pool based on the proportion of its total TVL with FRAXBP. As more trading pairs are created using FRAXBP, this increases the use cases and demand for FRAX. Therefore, FRAXBP helps Frax establish a moat and establish itself as the central liquidity hub on Curve.

Liquidity Staking Derivatives (LSD)

CurvefrxETH-ETH APR and sfrxETH, frxETH supply breakdown chart for the first 3 months (chart legend: orange line -> CurvefrxETH-ETH APR, blue line -> sfrxETH APR)

Frax uses a dual-token model consisting of frxETH and sfrxETH to provide a unique LSD product. frxETH acts as a stablecoin pegged to ETH, earning no yield, while sfrxETH earns all yield from staking.

Excellent Token Model: Compared with other LSD protocols, the dual-token model adopted by Frax ensures that sfrxETH receives higher staking rewards. This is because frxETH holders give up their staking rewards instead of deploying them to the Curve liquidity pool for rewards. The annual interest rate for Curve LP in the past three months has been 7-10%, while the annual interest rate for sfrxETH is 6-8%. Based on the current supply of frxETH, 1 sfrxETH can obtain a staking APR equivalent to 1.974 ETH, which is why staking ETH with FraETH can provide higher returns. In just four months, the system has helped Frax rank among the top LSD protocols and maintained a growth rate of 15-22% every 30 days. Frax is able to sustain this strategy because its Curve and Convex assets are used to direct incentives directly to the frxETH-ETH pool. Finally, the operating cost of Frax, which operates LSD, is 10%, 8% of which goes to veFXS holders and 2% to the insurance fund.

frxETH Minting Factory: frxETH reserves a certain proportion of ETH to exchange for frxETH (17.617% of the total amount of frxETH held by Frax). These funds are added to the Curve liquidity pool to increase liquidity depth. In addition, Frax receives rewards from the pools it bribes and seeds for liquidity. It is a flywheel similar to Curve and liquidity AMO.

解读 LSD「后来者」Frax Finance：如何通过产品套件构建增长飞轮？

Data Table

Frax uses $549,500 per month to incentivize the Curve liquidity pool and distribute $750,000 in rewards, including $382,300 in FXS. Although Rocketpool's native token issuance efficiency is slightly higher, this is due to the Aura bootstrapping phase. Frax will soon start using Aura bribes to reduce FXS emissions, as bribes for Aura currently generate higher returns. Therefore, as liquidity on Balancer increases (reducing FXS selling pressure), Frax can reduce bribes to Votium.

Token Economics

The governance token of Frax, FXS, uses Curve's ve token locking model, called veFXS. Currently, 41.22% of the supply is locked. Like Curve, FXS gauges can also be bribed. However, the current amount of bribery can be ignored. veFXS holders are entitled to 100% of the AMO income and frxETH income (when not yet allocated). The current yield for veFXS holders is 1.83% APR. Once Frax starts distributing frxETH fees, this should sharply increase the APR of veFXS.

Notice

Low attractiveness to other products: Compared with direct competitors (Aave and Curve), the TVL of Fraxswap and Fraxlend can be ignored. However, this is understandable because these products are mainly built to meet the specific needs of Frax as a stablecoin protocol. Currently, sfrxETH can be used as collateral to borrow FRAX and establish collateral yield leverage. This allows Frax to earn loan fee income, unlike Lido, which outsources it to AAVE. As Frax continues to grow, Fraxswap and Fraxlend will become critical infrastructure. These products will be offered to more public-facing users, and compared with Curve and Uniswap, the liquidity of FRAX on Fraxswap may be deeper.

Incentive Split: As Frax launches more products, it will split incentives across the entire protocol, making liquidity more difficult to attract. However, Frax's Convex holdings may be sufficient to offset any growth.

Regulatory issues: FRAX is currently supported by 92% of USDC, a centralized stablecoin regulated by the US government. If regulatory agencies establish rules for USDC, it may affect FRAX. However, almost all of Frax's USDC is distributed among various DeFi applications and cannot be distinguished from other deposits. Therefore, regulatory agencies find it difficult to take any action through USDC.

Emerging competitors: Curve and Aave have each announced the launch of their own stablecoins, which may challenge FRAX's position as one of the top decentralized stablecoins. However, Frax sees these protocols as potential collaborators and will ultimately pair with FRAXBP and frxETH.

Depeg: After the UST crisis, no stablecoin can completely reduce the depeg risk, even centralized stablecoins like USDT and USDC. The previously mentioned AMO will help Frax maintain its pegged exchange rate, and the worst-case scenario for Frax is that users can only redeem USDC collateral and receive 92 cents back.

Potential Catalysts

The Ethereum Shanghai upgrade will result in more ETH being collateralized by Frax and lead to higher fee revenue for the protocol.

The ETH staking advantage of Lido poses a threat to the security ecosystem of Ethereum and has led users to flock to other LSD protocols.

Frax's core mission is to build stablecoins, and frxBTC will be launched soon.

Frax plans to replace WETH with frxETH as the primary ETH pairing for LPs.

When Frax starts distributing 8% of sfrxETH fees to veFXS holders, it will significantly increase the yield.

LSD Protocol Comparison

Data table (latest data can be viewed at https://defillama.com/lsd)

The above table shows the P/E ratios of the top 4 LSD protocols currently ranked. Frax performs the worst due to its high FDV. However, it should be noted that Frax not only provides LSD services, but also has other products, with a stablecoin issuance of $1.51B. Frax is the only protocol with a profit-sharing model for its native token, where veFXS holders are entitled to 8% of the staking rewards. With the impressive growth of frxETH gaining 1.62% market share in just 4 months, it is clear that as long as frxETH's yield is higher than its competitors, it will continue to grow.

Let's take a look at the predictions for the LSD protocol in the next 2 years.

LSD P/S Protocol's Forecast in ETH

Interpreting LSD's

Data table

The highlighted frxETH P/E ratio is a conservative estimate of what frxETH could achieve. With a market share of 4% by the end of 2023, Frax's P/S ratio is 1/4 of the current P/S ratio, which is closer to its competitors. RocketPool has the best P/S ratio due to its high market share and fees, but its decentralized staking model may become outdated with the addition of Distributed Validator Technology (DVT). Considering potential catalysts, I believe that as more products are built using frxETH, Frax may even exceed its conservative estimates for 2024 and 2025.

思考

The LSD protocol received a lot of attention in January, but due to the rapid spread of AI and ZK narratives, the narrative was shortened. Due to the PvP market environment we are in, the LSD protocol was discarded for the next narrative circulating on Crypto Twitter. LDO, FXS, and RPL performed poorly during this period. Therefore, this may be a good opportunity to accumulate FXS before the LSD narrative fully unfolds.

As Shanghai's upgrade approaches, all eyes will be on ETH and all of its LSD protocols as the direct test version of the event. Currently, many users have not staked ETH due to locking and pegging deviations. Only 15% of ETH has been staked, while the staking volume of other L1s exceeds 30%. As Lido occupies about 30% of the collateral ETH supply, this will pose potential risks marked by many Ethereum observers. Therefore, although frxETH is the highest-yielding LSD, it may be an attractive choice for many people who dump after the Shanghai upgrade. The frxETH-ETH LP will be able to handle any outflows immediately after the upgrade and should expand with future inflows (frxETH Minter). This, in turn, will generate more fees for Frax through staking and LPing.

Frax is the main stablecoin issuer for ETH and BTC, which is why it is the biggest bullish factor for outperforming ETH. In order to replace WETH, Frax must create a trading pair with frxETH and incentivize the protocol to pair with frxETH. Frax has assets (CVX) and a strong reserve of Frax stablecoins that they can rely on. Using FRAXBP as a TVL of about $700 million or Frax liquidity AMO, Frax can mint Frax based on the protocol's collateral ratio to create a flywheel, as shown below:

解读 LSD「后来者」Frax Finance：如何通过产品套件构建增长飞轮？

Once frxETH is paired with tokens, the above flywheel will come into play, thereby generating a net positive impact on the Frax ecosystem.

The most important thing is that Frax regards other LSD protocols as collaborators and has announced the WETHR plan for other LSDs on Curve. There is no information about frxBTC, but the potential impact on Frax is an increase in demand for FRAX or FRAXBP and the possibility of integrating it into Frax's flywheel.

Replacing WETH and WBTC is an extremely challenging task, but the Frax team has remained steadfast, as evidenced by their full suite of products. Betting on FXS is equivalent to betting on the entire DeFi ecosystem (FRAX, frxETH, Fraxswap, Fraxlend, Fraxferry (Bridge), FPI). All of these products and primitives are part of the Frax ecosystem and will help expand its foothold to other networks.

In summary, the main factors that allow FXS to outperform ETH are the attention from Shanghai upgrades and a broader LSD narrative. As frxETH gains more market share, Frax will have a healthy source of revenue, solidifying FXS's position as a revenue-generating token.

Disclaimer: This is a guest article and does not represent the views or opinions of Flywheel DeFi. It is not financial or tax advice. This article is for educational purposes only and is not an inducement to invest or make any financial decisions to buy or sell any assets. This article is not tax advice. Please consult with your accountant. Do your own research.