What Is the Frax Protocol (FRAX)?
FRAX is the first fractional-algorithmic stablecoin that is built on the Frax protocol. The protocol is an open-source permissionless project that runs on the Ethereum network. The Frax protocol aims to replace digital assets that have a fixed supply, with a highly scalable algorithmic currency.
The main features of the Frax crypto project include:
- Dual-token system. There are two tokens that run on the protocol – FRAX and FXS. FRAX, as you already know, is a stablecoin. FXS, on the other, is the governance token of the protocol that helps to generate income from fees, seigniorage, and extra collateral value. Since 2020, FXS tokens can be locked to generate veFXS for bigger boosts, unique governance privileges, and other system advantages;
- Run by the community. Frax is a community-governed protocol that places a strong emphasis on an algorithmic approach that has no active management;
- Frax utilizes Uniswap and Chainlink oracles. The FXS and FRAX prices, as well as the amount of collateral, are taken from Uniswap, as the Chainlink oracle provides the accurate USD rate (taking the average price of a pair). This computation mechanism makes FRAX more stable when compared to the dollar.
The Founders of the Frax Protocol
In 2019, software developer Sam Kazemian came up with a unique idea for a fractional-algorithmic stablecoin. The idea was born from the fact that most projects with the algorithmic monetary policy were prone to fail. Thus, he decided to combine algorithmic monetary policy with collateralization to try and solve this issue.
Engineers Travis Moore and Jason Huan helped him realize the idea, which resulted in the creation of the first fractional-algorithmic stablecoin.
What Is FRAX?
In essence, FRAX is a stablecoin, which means that it manages to keep its price stable even when the crypto market fluctuates. One FRAX is pegged to $1 at a 1:1 rate.
However, FRAX is a unique type of stablecoin because one part of its supply is algorithmic, while the other is backed by collateral. The FRAX price on the market determines the proportion of collateralized and algorithmic supply. The Frax protocol has built-in swap capabilities that enable buyback and recollateralization which are used to control the amount of collateral.
For instance, the amount of collateral backing is increased once the FRAX price drops below $1. However, once the FRAX price rises above $1, the collateral backing is decreased.
Even though any cryptocurrency can serve as collateral according to the FRAX protocol's design, its first iteration primarily takes on-chain stablecoins as payment. This lowers the collateral's volatility and facilitates a seamless transition to greater algorithmic ratios.
Frax has a pool contract, which is dedicated to storing USDC as collateral. The ecosystem's governance allows for the addition and deletion of pools. More volatile cryptocurrencies can be added to the governance pool as the Frax system develops.
Since FRAX is a stablecoin, its supply is dynamic. It changes in order to maintain the FRAX price pegged to $1. Contrarily, there is no inflation schedule in the protocol for FXS tokens, which have a fixed supply of 100 million tokens.
By adding the right quantity of its component pieces to the system, FRAX stablecoins can be minted. Since FRAX was fully collateralized from its inception, minting it just required putting collateral into the minting contract. During the fractional phase, on the other hand, the right amount of collateral had to be put down. Besides that, the right amount of FXS had to be burned in order to mint FRAX.
Arbitragers can strike a balance between the supply and demand of FRAX in the open market by minting and redeeming FRAX from the system for $1. A user must constantly input $1 into the system in order to mint new FRAX.
If the market price is higher than the price objective of $1, there is a potential for arbitrage to mint tokens by adding $1 in value to each FRAX and selling the tokens for more than $1 on the open market. If the FRAX price is less than $1, on the other hand, there is an opportunity for arbitrage to redeem FRAX tokens by buying them at a lower price on the open market and redeeming them for $1 of value from the system.