In today’s edition, we’re diving deep into Frax V3, and the underlying mechanism behind the stablecoins dynamic design.
In response to the massive impact that rising risk-free rates have had on DeFi as a whole, Frax is incorporating U.S. treasuries into their stablecoin design.
Stay alert, stay informed ⬇
Background on Frax V3
Frax Founder and CEO Sam Kazemian describes FRAX v3 as the "final stablecoin" in the stablecoin evolution.
Sam emphasizes that a stablecoin, especially one pegged to the dollar, needs to be robust against different economic climates, from high to low-interest rate environments.
This is akin to the Federal Reserve’s role in determining monetary policy.
Key features of FRAX v3 include:
minimalistic design
on-chain governance
RWA strategy
Full decentralization.
Frax v3 can operate on multiple platforms like Curve and Fraxlend.
V3 is designed to operate under any market condition, making it a universal stablecoin solution.
It’s important to design a stablecoin that can remain stable irrespective of market fluctuations, especially concerning interest rates.
Rates can decrease and increase, and a well-designed stablecoin, like Frax v3, should be able to navigate these shifts gracefully.
Evolution of Frax
Frax V1, the initial iteration, backed its stablecoin with a combination of hard assets such as $USDC and Curve LP tokens, alongside an algorithmic component tied to the governance token $FXS. This made the mechanism analogous to a fractional reserve, hence the name Frax.
Frax V2 brought about significant changes through the introduction of Algorithmic Market Operation (AMO) contracts. These automated market operations set the stage for novel approaches, ensuring a stable peg to the dollar.
Frax V3 uses a permissionless monetary policy enforced by Smart Contracts and managed by non-custodial subprotocols. Key features include:
Full Exogenous Collateralization of $FRAX
Sovereign USD Peg
IORB Oracle
Removal of Multi-Signature Trust Assumptions
Non-Redeemability
The IORB Oracle
IORB is essentially the interest rate the Federal Reserve pays on deposits in the Fed Master Accounts.
When Federal Reserve Chairman Jerome Powell announces rates in his monthly press conferences, he's referring to the IORB rate.
If the IORB rates increase, it will have notable implications in the DeFi space. Protocols that are resilient to these changes will fare best.
If a stablecoin doesn't adjust or track according to the IORB rate, it might lose liquidity as users might switch to other stablecoins that offer rates closer to the IORB.
It's essential for a stablecoin to match or come close to the IORB rate to remain competitive and retain its user base.
Frax’s strategy isn't about expanding into emerging markets for profits, but rather about focusing on the IORB rate. They have a vault called sFRAX for staking FRAX stablecoins.
Partners and custodians aim to provide rates closest to the IORB rate with minimal risk.
The long-term goal of Frax is to have a direct partnership and get a Federal Reserve Master Account. This would mean Frax can directly interact with the entity issuing the IORB rate, reducing the need for an oracle.
Flow of Funds and Process
Sam emphasizes Frax’s healthy relationship with Circle and Paxos.
As users stake $FRAX into the staking vault tracking the IORB rate, they can withdraw $USDC and $USDP through Curve or collateral on the balance sheet.
Staked $FRAX is then converted into fiat through FinresPBC, and channeled via brokerages or other partnerships to earn yield.
When unstaking $sFRAX for $FRAX, the process is reversed: fiat converts back to $USDC via FinresPBC, which then goes on-chain to maintain $FRAX liquidity.
Sam envisions a future where FinresPBC handles all integrations, reporting, and the automated system of fiat-to-fiat coin conversions.
Eventually, $FRAX may serve as more than a decentralized dollar peg stablecoin but also as an almost official way for redemption to obtain fiat directly from a Fed Master account.
$sFRAX and FXB 0.00%↑
$sFRAX is a specialized savings account for the Frax ecosystem.
It's designed to cater to multiple strategies, both on the blockchain (on-chain) and outside of it (off-chain).
The current contemporary DeFi environment includes prevailing low rates which are heavily influenced by the IORB rate.
The IORB rate has deterred lenders from platforms such as Aave and Compound.
In contrast, when DeFi rates are zero or close to it, lending platforms were thriving in the previous bullish market conditions.
In such a scenario, $FRAX could potentially play a pivotal role if DeFi rates returned to near zero levels.
Sam underscores the importance of ensuring protocol safety, especially during bullish times.
$FRAX has a good track record, emphasizing the need to be vigilant against smart contract risks and oracle risks.
In the current environment where the U.S. dollar issuer offers tantalizing interest rates, Sam believes that $FRAX's design allows it to stay competitive and relevant.
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