FRAX Part 1 - What is a fractional algorithmic stablecoin?

FRAX is an increasingly popular stablecoin that has seen a huge rise in its use across the DeFi space recently. In this article we'll discuss what a fractional algorithmic stablecoin is.

This will be the first installment of a 2 part series on Frax. The second part will cover the partnership with Temple in the Frax Gauge platform and the Frax Wars

FRAX, the Fractional Algorithmic Stablecoin

FRAX is an increasingly popular stablecoin that has seen a huge rise in its use across the DeFi space. It's market cap has exploded recently, increasing from 725M three months ago to over 2.6B at the time of this writing, an increase of 260% in that period and 36% in January of this year alone.

In this article we'll explain why Frax is growing so fast, and what makes it different and more attractive than other stablecoins.

The Market Cap of FRAX in the last 3 months

What sets Frax apart from other stablecoins?

Before the launch of FRAX, stablecoins generally fit into 3 categories:

  1. Collateralized
  1. Algorithmic with no collateral
  1. Overcollateralized with crypto assets

FRAX is a fractional algorithmic stable coin. This means that a fraction of each token is backed by collateral assets, and another fraction by the Frax Share Token (FXS). The ratio of these two in the backing of Frax is called the Collateral Ratio (CR) The collateral in this case is USDC, a stablecoin which exists outside the Frax ecosystem. Every FRAX is backed (at the time of this writing) by $0.85 in USDC and $0.15 in FXS, and this ratio can be changed by the algorithm depending on market conditions.

The Algorithm in action

When the market price of FRAX goes under $1, this is a sign that the market has lost confidence that Frax can maintain its peg value of $1, and the Frax algorithm then increases the CR, meaning that each FRAX required to be backed by a higher percentage of hard collateral (USDC). This action increases market confidence that Frax can maintain its backing, causing the price to rise.

When the price goes higher than $1, the collateralization ratio can be reverted to a lower level, if it was recently raised, or else the extra profit can simply be distributed to FXS holders. This fractional algorithmic system is the factor that sets Frax apart from previous attempts at creating such a stablecoin, and to date FRAX has never broken its peg.

The Frax Share Token (FXS)

FXS is designed to be a complimentary token to FRAX, a value capture token and asset backing. Frax funnels the profits that the protocol generates from seigniorage directly into the FXS token. The very clever strategy implemented by the FRAX protocol is as follows:

  1. Capture revenue and channel it into FXS, which is volatile but should increase in value in the long run as the supply will be limited to 100M tokens. When a user purchases FXS, they are buying a share of the future revenue generation of FRAX.

  2. Use FXS in conjunction with USDC as the asset backing for FRAX.

  3. Increase FRAX liquidity and usage in the wider DeFi space, which will increase revenue even further, boosting the value of the FXS token.

FRAX also plans to launch a new token, the Frax Price Index (FPI), which is designed as an anti-inflation token. Its value will mirror a decentralized version of the Consumer Price Index (CPI) and rise with it. This token will reportedly be part of an airdrop to FXS holders when it is launched.

FRAX thus attempts to capture the best of all worlds. Since the supply is controlled by an algorithm, this means that the operating and minting costs are very low. At the same time however, a FRAX is still backed fractionally by assets, meaning that market confidence in FRAX has held steady at a high level and led to the rapid growth of the protocol.

Temple partnership with Frax

Temple will be working more closely with FRAX in the future. Many products are currently in the works, including a TEMPLE-FRAX LP, and setting up a Temple Shrine in the Frax Gauge platform to start engaging in the FRAX wars. We will explain more about this in part 2.

We take our hat off to the FRAX team, there is a reason Temple chose to launch in the FRAX ecosystem and we are very excited for what the future hold for our protocols working closely together.