What is FRAX: an overview

The number of stablecoin users continues to grow, followed by the capitalization of such assets. According to the forecasts of well-known funds such as VanEck, in 2024, the capitalization of stablecoins will exceed $200. The forecast is more than realistic, as this figure already exceeds $154 billion as of April 2024.

What is Frax?

FRAX is another stablecoin tied to the US dollar exchange rate. However, this stablecoin is peculiar in that it is both secured and algorithmic.

On the one hand, the FRAX stablecoin is 100% asset-backed, but not with US dollars, treasury bonds, and other traditional financial instruments, such as Tether (USDT) or USD Coin (USDC) tokens, but with digital assets, including USDC, Gemini USD (GUSD) and DAI stablecoins.

On the other hand, the pegging of the FRAX Stablecoin to the USD exchange rate is provided by a special contract algorithm known as Algorithmic Market Operations (AMO). AMOs are algorithmic market operations that control the delivery of algorithmic stablecoins.

The FRAX stablecoin was released at the end of December 2020 but is not found on major centralized exchanges. For the most part, the FRAX token is traded on decentralized exchanges such as:

Uniswap,
Curve Finance,
Trader Joe,
KyberSwap, and others.

As of April 2024, the capitalization of the FRAX token is $648 million. According to this indicator, FRAX ranks 7th among the stablecoins, slightly behind another algorithmic stablecoin, USDD, and 216th among all cryptocurrencies.

How does FRAX issuance work?

FRAX differs significantly from most similar tokens, such as USDT, UST, or DAI, in terms of the mechanism for issuing stablecoins. For a user to issue a FRAX stablecoin, they need to deposit a portion in other stablecoins, such as USDT, and another portion in the native management tokens of the Frax Finance FXS platform.

The collateral ratio determines the portion of each collateral asset. If it is 70%, a user needs to deposit 70 USDT and $30 in FXS tokens to issue 100 FRAX. Burning tokens happens similarly: the user contributes 100 FRAX and, in return, receives 70 USDT and $30 in FXS tokens.

Thus, the release of the FRAX token further stimulates demand for the FXS native control token. However, this model has a disadvantage: in the event of an incident, such as the decoupling of the FRAX token from the US dollar exchange rate, the FXS price may also collapse. This is exactly what happened when LUNA and its backed token UST collapsed, a phenomenon known as the "death spiral".

About the Frax ecosystem and the functions of the stablecoin

Like all other stablecoins, FRAX fulfills one of its primary functions — protecting investors from the high volatility of digital assets such as Bitcoin, Ethereum, Ripple, and others.

FRAX stablecoin is issued on over 10 different networks, such as BNB Smart Chain, Solana, Avalanche, Polygon, Optimism, and others, but more than 90% of the liquidity is centered in Ethereum. Users can add tokens to liquidity pools on different networks and earn revenue through trading commissions.

The FRAX token is part of the Frax Finance DeFi-ecosystem, which also includes other stablecoins:

sFRAX is a "staking" version of the FRAX token. In essence, sFRAX is a liquidity token that users receive for stacking FRAX stablecoins, similar to how stETH is issued to holders of staked ETH coins. FRAX holders can stake their stablecoins, earn income, and then do whatever they want with the stFRAX tokens they receive, such as trading or investing them in cryptocurrency. However, to get FRAX back, the user will need to return the deposit in stFRAX tokens in a 1:1 ratio;
Frax Price Index (FPI) — the first stablecoin tied to the Consumer Price Index (Consumer Price Index or CPI) and fully backed by cryptocurrency;
Frax Ether (frxETH and sfrxETH) are two tokens that are wrapped ETH tokens. The first (frxETH) is the Ethereum network's analog of WETH, and the second (sfrxETH) represents the LST token stETH. Frax Ether tokens are also fully backed by cryptocurrency.

On the outlook for FRAX

As market metrics show, Frax is not in such high demand, especially compared to USDT, USDC, and DAI. Even the relatively new First Digital USD (FDUSD) and Ethena USDe (USDe) stablecoins, which only came into existence in 2023, have several times outperformed FRAX in terms of capitalization.

However, it's worth noting that the Frax Finance ecosystem was hard hit by the decoupling of the infamous TerraUSD (UST) from the US dollar exchange rate in May 2022. Immediately afterward, Frax Finance's blocked assets on record (TVL) began to plummet, dropping from $2.25 billion to $1.27 billion in less than a week.

One main reason for this was investors' concerns about the decoupling of the exchange rate of other algorithmic stablecoins, such as DAI and FRAX. However, since March 2023, TVL Frax Finance has seen steady growth, Rising from $411 to $1.15 billion as of April 2024.

Given the poor reputation of algorithmic stablecoins, we can hardly expect FRAX to rank alongside USDT, USDC, and DAI, or at least FDUSD and USDe, at least soon.

The FRAX has lost parity to the USD several times but has not deviated by more than 3%. It's worth noting that over the past year, FRAX has generally become less volatile against the USD, which is a good sign for this stablecoin, and it has also never deviated significantly from the USD over the same period.