Part collateral, part algorithmically stabilized stablecoin, FRAX is the world’s first fractional algorithmic stablecoin. The Frax protocol is ideologically pure, extremely stable and highly scalable on-chain money consisting of a two token system. The stablecoin Frax (FRAX) and the governance token Frax Shares (FXS).
As cryptocurrencies soar, they become too stable coins
In addition to economic uncertainty and global financial instability, cryptocurrencies are evolving rapidly. Pushed aside by the masses as ‘fake’ online money for years, the gap between fiat and crypto was grim until stablecoins started to bridge the gap. Linked directly to fiat currency prices, stablecoins have provided much-needed stability that many traders, global institutions, and countries need to join the crypto space.
As the demand for cryptocurrencies continues to rise, so does the demand for stablecoins and their development. This is evidenced by the current stablecoin market cap (market cap) of nearly $ 80 billion, an increase of more than 70,000 percent since mid-2017.
While stablecoins have revolutionized the world of crypto and provided interoperability, there are always pros and cons. For instance:
- The stability of a stablecoin is directly tied to the asset it is linked to. If it asset drops, so does the stablecoin. In a fiat ‘flash crash’, the stablecoin will also fall in value.
- The goal of the crypto space is towards decentralization. Stablecoins aim to reduce volatility, but are partially centralized – and thus go against the goal of crypto.
- Investors are not that interested in stablecoins as compared to cryptocurrencies due to minimal change in price movements.
- Custody risk / on-chain over-collateralization of collateralized stablecoins.
FRAX tries to overcome these above mentioned pitfalls and risks by offering the first reliable stablecoin protocol. The Frax protocol uses algorithmic central banks that, conceptually, algorithmically adjust supply to ensure price stability remains constant.
This article will break down the complexity of the Frax protocol and show the impact of FRAX on the stablecoins customization world.
What is FRAX?
Part collateral, part algorithmically stabilized stablecoin, FRAX is the world’s first fractional algorithmic stablecoin.
The Frax protocol is ideologically pure, extremely stable and highly scalable on-chain money consisting of a two token system. The stablecoin Frax (FRAX) and the governance token Frax Shares (FXS).
A stablecoin is a cryptocurrency that aims to provide price stability by linking to a reserve – usually fiat. Unlike standard stablecoins, algorithmic stablecoins maintain price stability by generating or burning the number of stablecoins / digital tokens available.
If the price rises above $ 1, the algorithmic system will produce new stablecoins until the price returns to $ 1. This process works in reverse by burning available stablecoins / tokens.
How does it work?
The Frax stablecoin protocol is both fractional and algorithmic. The FRAX stablecoin delivery, which takes its name (FRAX) from the protocol’s fractional algorithmic stability mechanism, is the first collateral algorithmic of its kind. This symbiotic combination ensures that stability is maintained:
- If FRAX trades below $ 1, the protocol will lower the collateral ratio – in 0.25% increments
- If FRAX is trading above $ 1, the protocol will increase the collateral ratio – also in 0.25% increments
Through governance, the refresh rate and step parameters can be adapted to the purpose of stablecoin and ensure stability through economic changes. Rather than getting a price in USD by averaging the prices of stablecoin pools on Uniswap, FRAX does it differently. By calculating a time-weighted average of the Uniswap pair price and the ETH: USD Chainlink oracle, the Frax protocol can obtain a true USD price.
Move the Stablecoin space forward
Unlike other stablecoins, FRAX’s fractional algorithmic protocol ensures that price fluctuations are absorbed with fractional algorithmic responses to maintain true USD price stability. By merging the combination of fractional stability and algorithmic mechanism, the Frax protocol aims to further develop the stablecoin space through FXS.
The FXS governance token recently introduced the Algorithmic Market Operations Controller (AMO). An AMO automates FRAX’s arbitrary monetary policy to ensure that the collateral ratio does not fall and the price (and stability) of FRAX changes. For the first time in human history, FXS is facilitating a fully decentralized system that is not hindered or controlled by any national state or corporation. By running algorithmically open market operations, AMO controllers cannot hit FRAX and therefore break the peg. This ensures that the stability of the base layer of FRAX remains untouched and ideologically pure.
Many stablecoin errors and instabilities have occurred since their inception.
Compared to Tether – whose price did not lack all stability at times – the Frax protocol prevents the price from falling below or above $ 1. While stablecoin Tether’s history has always shown a rapid recovery, that has never prevented the price from plunging to a low of $ 0.9 or rising to a high of $ 1.21.
Compared to DAI and other collateralized stablecoins, the clear advantage of the FRAX stablecoin is a reduced risk of over-collateralization. When stablecoins such as DAI and others rely entirely on collateral, they risk moments of instability when rapid changes occur, such as flash crashes. In addition, collateral to back up the supply of stablecoins can be a very expensive endeavor. The Frax protocol consistently reduces these costs and replaces them with algorithmic measures – effectively lowering supply-side costs by reducing the hypercolateralization of DAI with a CR cleared by the market (currently 86%).
Algorithmic central banking
Algorithmic stablecoins spawn a new asset class that is both automation-driven and mathematically accurate. Using a part fractional, part algorithmic composition, FRAX stablecoins are the first mix between collateralized and algorithmic stablecoins, assimilating all the benefits of both types. This new and evolving class of stablecoin is driving innovation directly to pioneering algorithmic central banking.
The concept of algorithmic central banking is a fairly new and evolving concept, but with endless potential, it aims to revolutionize modern monetary policy. As a mathematical, automated and stable programmatic system that is price conscious, algorithmic central banking stabilizes the price without human intervention. If the price rises, the offer is automated to increase and balance until the stable level of $ 1 is reached again. The same is true again in reverse order.
Compared to the Fei protocol – an incentive stablecoin that aims to maintain a liquid market where ETH / FEI trades close to the ETH / USD price – FRAX functions very differently.
Where FRAX stabilizes price through its fractional algorithmic protocol, FEI uses direct incentives (DI) that can cause FEI price to lack some stability. FEI’s DI can often punish sellers and reward buyers in times of volatility.
For example, buying FEI in early April 2021 would result in buyers receiving more than 1 FEI per $ 1. On the other hand, at the same time, sellers would lose by selling FEI below $ 1 in value. This instability has effectively prevented FEI from functioning as a stablecoin: FEI has not kept its $ 1 peg, and the protocol governance token TRIBE has fallen by about 50% since launch.
FRAX’s algorithmic stablecoin features automation that fractionally reduces the FRAX price to $ 1 – ultimately maintaining the value of $ 1 regardless of market action / swings. FRAX has maintained the link since its inception in December 2020.
A new dawn for Stablecoins?
The Frax protocol addresses the many risks associated with stablecoins while building on their benefits. By deploying the use of AMOs, FRAX stablecoins in addition to the FXS governance token provide reliable stability that is both a fully decentralized and highly scalable on-chain solution for market instability. Compared to Tether or DAI, there is no risk of excess collateral and rapid market fluctuations affecting FRAX.
Building on the scheme of purely algorithmic stablecoins such as FEI, FRAX and FXS stand as two pillars on the foundation of algorithmic central banking. With each development, stability continues to improve in a market as volatile as crypto: the recent Curve AMO, for example, puts FRAX and USDC collateral to work to liquidate the protocol and tighten the link.
Recent introductions to the Float Protocol – which fluctuates in the same way as fiat currencies – and the Rai Reflex Index – which algorithmically maintains its own stability – continue to show the continued evolution of the stablecoin market.
As this market adapts to economic needs and obstacles, the mainstream acceptance of crypto and stablecoins is increasing. As one of the latest crypto innovations, FRAX is pioneering a new approach to stablecoin mechanisms and as such is leading the stablecoin space.
To learn more about FRAX and its unique fractional algorithmic approach to stability, visit their website here.
Read the FRAX documentation: https://docs.frax.finance/v/en/
Follow FRAX on Twitter: https://twitter.com/fraxfinance
Join the FRAX community on Telegram: https://t.me/fraxfinance
Keep up to date with the latest developments from FRAX on Github: https://github.com/FraxFinance
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