Table of Contents
-
Introduction and TL;DR
-
Hybrid Collateral Model
-
Modular AMO Architecture
-
Maintaining Overcollateralization
-
Real World Asset Risks and Rewards
-
Independent Dollar Peg Reliability
-
Expanding OnChain Governance
-
sFRAX and FXB Derivatives
-
Governing Token Supply
-
Tying Yields to Fed Rates
-
Conclusion
-
Additional Details on FRAX Evolution
So, we finally have the FRAX v3 documentation. Yeah, I’m going to share some thoughts on it.
Before that, here’s a TL;DR
Some key features of FRAX v3:
-
It uses a combination of onchain and offchain collateral to maintain its peg. Onchain collateral comes from lending and liquidity providing in decentralized protocols like Fraxlend and Curve. Offchain collateral comes from real-world assets like US Treasuries held by custodians.
-
The protocol aims to maintain a collateral ratio (CR) of >=100% at all times. This means the dollar value of collateral backing each FRAX is equal to or greater than $1.
-
The peg mechanism aims to track the US dollar independently rather than pegging to other stablecoins like USDC or DAI. Enabled by using Chainlink oracles and other reference rates approved by governance.
-
It removes multi-sig dependencies (not completely) by having an onchain governance module called frxGov that controls parameters and strategy.
-
FRAX is non-redeemable, meaning holders have no direct claim on the underlying collateral. The protocol simply aims to maintain the 1:1 peg.
-
Algorithmic Market Operations (AMOs) are autonomous smart contracts that execute monetary policy by interacting with lending and trading protocols. This modular approach allows adding/removing stability mechanisms easily.
-
Real-world assets (RWAs) like T-bills are used when yields are high to generate maximum returns for stakers. Custodians manage RWAs while optimizing yield.
-
sFRAX is a staking derivative that attempts to pay yield close to the Fed's risk-free rate by deploying staked FRAX into RWAs.
-
FXBs are tokenzed debt that represent a future obligation to deliver FRAX. They allow yield curve formation and forward selling of protocol debt.
My thoughts on this
I feel that the use of both onchain and offchain collateral is interesting-- it provides decentralized stability through AMMs like Curve, while also allowing the protocol to tap into potentially higher yielding RWAs like T-bills when available. The blend aims to optimize yield for stakers.
Using both onchain and offchain collateral is a savvy move by the FRAX team. It gives them the best of both worlds.
-
On one hand, tapping DeFi protocols like Fraxlend and Curve provides transparency and decentralization. No central point of failure. FRAX gains stability through those fully onchain mechanisms.
-
But sometimes, good old-fashioned RWAs like T-bills offer juicer yields. So when those opportunities arise, FRAX can pivot to using offchain collateral held by custodians.
The beauty is that real-world yields tend to be lower risk and more stable than the roller coaster returns in DeFi. So, blending both sources diversifies risk.
Here's the clever part - FRAX can dynamically shift between on- and offchain collateral based on which one offers the best yield at the time. This flexibility aims to optimize profits for sFRAX stakers.
- For instance, when T-bill yields rise, FRAX can back more stablecoins with RWA collateral. The extra yield can go to stakers. But if T-bill yields drop, no problem - FRAX simply shifts back to the transparency of onchain collateral.
So this hybrid approach gives FRAX the perfect combo.
Decentralized DeFi yields plus centralized real-world yields.
That blend allows for optimizing staking returns across different markets. Pretty ingenious if you ask me!
In summary, each FRAX upgrade expands capabilities to enhance decentralization, stability, and yield opportunities - progressively mastering algorithmic stablecoin design.
But let’s dive deep into detail.
The use of modular AMO (Algorithmic Market Operations) contracts is a flexible design approach that provides FRAX with a lot of room to evolve.
The AMO architecture is a total game-changer for FRAX. It makes the protocol insanely adaptable. AMOs are like autonomous robots executing trading strategies by hooking into external DeFi protocols.
So FRAX can easily plugin to any new platform just by deploying a custom-coded AMO module. Want to tap into Curve or Fraxlend? Build an AMO for it. The integration possibilities are endless.
Adding or removing stability features is as simple as shipping a new AMO contract. No messy core protocol changes required. This sets up FRAX to rapidly evolve as the DeFi ecosystem grows.
As hot new protocols emerge, I could totally see FRAX whipping up AMOs to take advantage. For instance,
-
they could deploy an AMO specifically designed to leverage their own Fraxswap AMM. Use it to automate arbitrage and stabilize FRAX price, or
-
create AMOs to optimize lending on cutting-edge platforms or supply algorithmic stablecoins. The modular approach means they can prototype ideas without bureaucracy.
AMO contracts serve as adapters between FRAX and external DeFi constructs. This flexibility means FRAX can smoothly expand as new opportunities arise in the fast-paced DeFi landscape.
Even if specific AMO stablecoin tactics fail, FRAX remains resilient. The contracts anticipate change.
The modular architecture basically future-proofs FRAX for creativity and evolution.
Maintaining a collateral ratio >=100% should provide a lot of price stability during periods of volatility.
This likely comes at the cost of minting/burning FRAX to maintain the peg, which may impact revenue.
Maintaining over 100% collateral means each FRAX is backed by $1+ in assets. So there's a thick cushion absorbing price drops before the peg wobbles.
For example, if Bitcoin collateral crashes 50%, the collateral ratio just drops to 200% instead of going critical under 100%.
This huge over-collateralization buffer prevents death spirals during volatile times. It keeps the peg solid. However, holding the ratio steady above 100% requires active supply management. As asset values swing, FRAX must be minted and burned to keep the ratio perfect.
Minting new FRAX when collateral drops dilutes revenue. Burning supply when values spike also reduces protocol income. So an ultra-stable peg comes at the cost of concentrated revenue upside compared to letting ratios float more freely.
There's a trade-off between ironclad stability from high collateral and potential income growth from volatility. But look, protecting the peg is the priority. Robust stability supports long-term growth even if short-term revenue suffers during swings.
A few revenue hiccups are totally worth it for resilience and inspiring user confidence in the peg.
Using real-world assets as collateral is a classic risk vs reward scenario for FRAX.
The upside is RWAs can provide extra stability and juicy yields compared to just crypto assets. T-bills and such offer returns tied to lower risk real-world rates. Nice!
But the catch is that RWAs need custodians to handle the offchain accounts. So there's some centralization and trust baked in. Unlike onchain assets, we can't fully inspect RWA accounts. Custodians need to share regular reports and audits to confirm holdings are legit.
How much visibility custodians will provide is still an open question. More transparency means less mismanagement risk. A key factor.
Also important is how much control token holders get over setting collateral rules, accessing accounts, and appointing auditors. More sway reduces custodian power.
Strong oversight protections are a must to keep centralized risks in check as RWAs are integrated.
Now, FRAX isn't reinventing the wheel here - other DeFi heavyweights are using RWAs too. So there's merit to the approach when done properly.
FRAX plans to blend both crypto and RWAs based on market conditions. This diversifies the balance sheet.
And get this - nothing is set in stone. The community can guide RWA adoption and evolution in a decentralized way. Oversight can improve over time.
With transparency and collaboration, I believe the pros can outweigh the cons.
Now, FRAX v3 uses both crypto collateral and real-world assets held by custodians to maintain its peg - best of both worlds.
The onchain collateral comes from lending and trading fees earned when people use FRAX in DeFi protocols like Fraxlend and Curve. No centralized control there.
As users lend or add liquidity with FRAX as collateral, those deposited crypto assets start generating yield. This helps grow the collateral ratio organically.
Then, for offchain collateral, FRAX uses US Treasuries held by partners like Finres. The dollar value of the Treasuries also backs the peg. The Treasury bonds provide interest payments as an additional revenue stream to support the peg. The custodians handle all the financial plumbing to manage the Treasuries properly on FRAX's behalf.
This combo of decentralized DeFi collateral and real-world assets custodyed by partners gives FRAX flexibility to stabilize the peg.
In a nutshell - onchain activities generate crypto backing, and offchain custodians handle real-world assets. The two collateral sources work together to keep FRAX firmly pegged to $1.
FRAX v3 aims to peg to the US dollar directly rather than targeting other stablecoin baskets.
Unlike other stablecoins pegged to crypto asset baskets, FRAX v3 pursues a direct peg to the US dollar itself. This sovereign peg mechanism incorporates Chainlink and other approved oracles to source real-time USD price data.
Pursuing an independent dollar peg is ambitious yet carries risks. Without pegging to other stablecoins, FRAX must rely entirely on its own oracle inputs. Any manipulation or inaccuracies in those feeds could temporarily break the dollar peg and cause FRAX to diverge from broader stablecoin prices.
Proper decentralization and security of the chosen oracles is therefore essential. Faulty data could significantly disrupt FRAX's ability to track the dollar accurately.
However, FRAX v3 mitigates this oracle risk through its new onchain governance module frxGov. Token holders now have full control to select oracle sources, set collateralization ratios, and adjust incentives related to the peg.
This onchain governance eliminates previous multi-signature dependencies. If the sovereign dollar peg strays off course, the community can directly realign parameters as needed.
So while a standalone dollar peg depends heavily on reliable oracles, putting governance onchain allows responsive course correction and community control over the stability mechanisms.
FRAX v3 expands onchain governance through the new frxGov module while retaining some centralized multi-signature influence.
While FRAX v3 expands onchain governance through frxGov, it retains complementary offchain governance processes for discussion and coordination.
Before frxGOV, the governance of FRAX was not fully decentralized. Key Frax stakeholders took most actions through Gnosis Safes, which are multi-signature wallets that require multiple approvals to execute transactions. Pre-v3 allowed core teams to move faster via multi-sig. But this concentrated power rather than fully decentralizing control.
frxGov gives more governance influence to token holders based on their commitment and stake levels via weighted voting.
Users can propose and vote on changes onchain like:
-
Collateral ratios
-
Oracle selections
-
Incentive designs
-
New integrations
-
Parameters
-
Upgrades
There is, hopefully, full transparency in frxGov proposals and votes. But offchain forums are still used to test ideas before bringing them to vote.
For urgent changes, frxGov has a fast-track voting option bypassing the normal process. This balances decentralization with pragmatism.
While not fully eliminating centralized influence, the expanded community participation in frxGov is a major step towards decentralized governance for FRAX.
Also, the sFRAX staking derivative allows FRAX holders to earn additional yield by depositing their stablecoins into the sFRAX liquidity pool.
The pooled assets are deployed into RWAs like US Treasuries in an effort to generate returns approximating the Federal Reserve's risk-free rate. This provides investors with relatively safe yields on their staked FRAX, while the protocol benefits from RWA revenue.
FRAX Bonds (FXBs) are tokenized debt instruments representing future FRAX obligations that the protocol sells to raise capital upfront. FXBs enable the creation of a yield curve, as earlier bond maturities generate less interest for holders than longer dated ones. The bonds are tradable on secondary markets. This innovative design allows for decentralized yield curve formation and forward selling of protocol debt obligations.
Controlling mint/burn to maintain the peg consumes protocol revenue.
The core idea is that algorithmic stablecoins inherently require supply interventions to maintain the peg, but both excessive constriction or expansion of supply can be detrimental. As such, governance needs to strike a structured balance between stability and growth when calibrating FRAX mint/burn response parameters.
Maintaining the 1:1 USD peg inherently requires FRAX to actively manage supply by minting or burning tokens when collateral value changes. However, excessive intervention can negatively impact revenue growth and adoption.
Minting new FRAX in response to drops in collateral value dilutes the protocol's ownership percentage of the total supply. This reduces fee captures as the protocol controls a smaller portion of FRAX. On the other hand, burning FRAX when collateral value spikes shrink the circulating supply itself, which generates fees.
Overly restricting supply could also limit uptake and usage growth if there is inadequate FRAX available to facilitate trade. On the contrary, leaving supply too unconstrained during collateral fluctuations risks severe deviation from the $1 peg and damages confidence.
Calibrating FRAX supply changes requires adept judgment to address significant deviations while avoiding over-correction. Excessively erratic actions could perversely incentivize intentional attacks on the peg. Thus, properly configured collateral ratio defenses should activate prior to resorting to minting or burning.
FRAX necessitates supple yet measured supply adjustments. However, the collateral ratio, redemption rate, and built-in stabilization mechanisms furnish additional instrumentation for governance to balance upholding the peg against optimizing growth. To summarize key factors:
-
The collateral ratio permits dynamic tightening or relaxation of the peg based on prevailing market conditions.
-
The redemption rate applies fees or bonuses to arbitrageurs contingent on the extent of price divergences, promoting natural correcting behaviors.
-
The stabilization mechanism directly intervenes during substantial deviations through minting/burning and external trades to restore equilibrium.
-
AMOs facilitate diversification across assets and protocols to generate yield and optimize capital utilization.
This multi-faceted toolkit provides governance with nuanced control points to maintain the peg while circumventing excessive constriction of supply. Prudent application enables jointly sustaining stability, revenue, and adoption through calibrated market incentives and targeted intervention.
Lastly, tying sFRAX yields and FXB rates to the Fed's IORB benchmark creates direct sensitivity to monetary policy changes that could meaningfully influence FRAX demand/supply.
IORB stands for Interest on Reserve Balances and is the rate the Fed pays banks on excess reserves held at the Fed. It is a key mechanism through which the Federal Reserve influences broader market interest rates and implements monetary policy.
As the Fed raises or lowers the IORB rate, it affects the overall supply of money and credit in the economy. Higher IORB incents banks to hold reserves, contracting money supply. Lower IORB expands lending and money supply.
By pegging sFRAX yields and FRAX Bond coupon rates to IORB, they will directly react to changes in IORB driven by Fed monetary policy shifts.
For example,
-
If the Fed hikes rates, IORB will increase. This makes sFRAX more attractive to stake as yields rise in tandem. FRAX Bonds also become more lucrative with higher coupon payments. The resulting increased demand for sFRAX and FRAX Bonds can drive increased minting of FRAX stablecoins to access these derivatives. This expands FRAX supply.
-
Conversely, if the Fed cuts rates, falling IORB will decrease sFRAX staking yields and FRAX Bond coupon rates in parallel. This could dampen demand and use of FRAX.
Wrapping Up
In summary, I've explored several important facets of FRAX v3:
-
I outlined the core design features like the hybrid collateral model, AMO architecture, and enhanced stability mechanisms. These provide significant flexibility and optionality.
-
Further examined crucial tradeoffs around revenue, centralization risks, and policy rate exposure that require prudent governance.
-
Then covered supplemental details on FRAX's origins, custodian partnerships, and non-redeemable nature for context.
-
Further analyzed the modular architecture that allows progressive decentralization.
-
And then evaluated the blend of stability, yield optimization, and risks across onchain and offchain domains.
Stepping back, FRAX v3 demonstrates thoughtful evolution in pursuit of robust algorithmic stability. However, realizing the full vision hinges on continually addressing transparency, security, and incentive risks arising from greater interdependence.
By proactively accentuating the benefits while mitigating the potential perils, I believe FRAX can fulfill its promise as a leading stablecoin for the algorithmic future.
Additional Details on FRAX Evolution
-
FRAX originally launched in v1, backed 100% by USDC collateral. This provided initial stability but limited flexibility.
-
The IORB benchmark rate allows sFRAX yields to track the Federal Reserve's policy rates. This gives stakers exposure to low-risk real world interest rates.
-
Finres is the first approved custodian managing FRAX's RWA holdings. Their agreement requires monthly reporting on accounts for transparency.
-
Examples of live AMOs include the Curve and Fraxlend modules described in the docs. These allow accessing external liquidity and lending markets.
-
FRAX is non-redeemable by design. It does not give holders direct rights to collateral, only aims to maintain the 1:1 dollar peg.
-
The evolution from v1 to v3 shows incremental mastery of algorithmic stablecoin design with each iteration, culminating in the current robust architecture.
References:
Thank you for reading through, and subscribe below for regular post updates.
I’d also appreciate it if you shared this with your friends, who would enjoy reading this.
You can contact me here: Twitter and LinkedIn.
You can also buy my keys at friend.tech by searching for 0xArhat.
If you find this deep dive analysis useful, please consider donating to aplusb.eth (Arbitrum, Ethereum, Optimism, Base) and/or by minting an NFT for this & other blog posts by me.