Overview of FRAX v3

sFRAX is a specific feature within the FRAX ecosystem, with FRAX v3 being the underlying protocol that supports this feature (as well as the entire ecosystem). The performance and functionality of FRAX v3 directly impact the operation and efficiency of sFRAX.

Relationship between sFRAX and FRAX v3

The relationship between sFRAX and FRAX v3 can be understood through their different roles and functionalities within the Frax Finance ecosystem. In simple terms, sFRAX is a specific application of the FRAX stablecoin within the Frax Finance ecosystem, while FRAX v3 represents the latest version of the entire FRAX stablecoin protocol. Some other characteristics include:

• sFRAX, as an application of the FRAX stablecoin, is directly influenced and supported by the FRAX protocol, including FRAX v3.
• Updates and improvements in FRAX v3, such as higher collateralization ratios and direct anchoring to the US dollar, may enhance the attractiveness and reliability of sFRAX as an investment tool.
• The performance and efficiency of sFRAX partially rely on the overall health and efficiency of the FRAX stablecoin protocol (i.e., FRAX v3).

FRAX v3 Updates

The release of FRAX v3 signifies a significant advancement for Frax Finance in the stablecoin space. This version aims to improve the market competitiveness and reliability of the FRAX stablecoin through a series of innovative features and upgrades. Here is an overview of the main updates in FRAX v3:

Fully Collateralized

The v3 version continues to increase the collateralization ratio (CR) of the stablecoin, with the goal of always maintaining the CR above or equal to 100%. This is a response to the market’s increased sensitivity to “undercollateralized” stablecoins, particularly after the UST incident.

For example, imagine borrowing from a bank where the bank requires you to provide assets of equivalent or higher value as collateral. This is how FRAX v3 operates, ensuring that each issued FRAX stablecoin is backed by assets of equal or higher value. It’s like a lending system, but with a guarantee of 100% (or even more) secure collateral.

Directly Peg to the US Dollar

The goal of FRAX is to achieve full pegging to the US dollar without relying on other mainstream stablecoins. When the Collateralization Ratio (CR) reaches 100%, Chainlink oracles and a reference exchange rate approved by governance will be used to confirm the anchoring status to the US dollar.

For example, when traveling abroad and needing the local currency, you would want your currency to maintain a stable exchange rate with the US dollar. This is how FRAX v3 operates, with its value directly pegged to the US dollar and unaffected by the fluctuations of other cryptocurrencies like Bitcoin or Ethereum.

Dynamic Yield Referencing the IORB

The v3 version adopts the Federal Reserve’s “Interest on Reserve Balances” (IORB) as a reference standard for protocol features, such as sFRAX staking rewards.

Adjustments to the collateral asset categories are made based on changes in the IORB.

For example, just as banks adjust deposit rates based on central bank interest rates, FRAX v3 uses the Federal Reserve’s Interest on Reserve Balances (IORB) to adjust its yield structure. When the IORB is higher, FRAX tends to invest in US Treasury bonds for higher returns, and when the IORB is lower, it shifts towards on-chain assets.

Removal of Multi-signiture

The v3 smart contracts operate fully on-chain through the frxgov module, eliminating the need for multisignature (multisig) control.

For example, multisig is like a company requiring multiple executives to sign off on a decision. FRAX v3 removes this requirement, making the entire system fully automated and decentralized, like an automated machine that doesn’t require multiple human supervision.

Non-Redeemable Nature

Unlike some overcollateralized USD stablecoins, FRAX is non-redeemable. Its functionality is achieved through asset collateralization, AMO smart contracts, and governance actions, resulting in a valuation equivalent to the US dollar.

For example, if you hold a token, you would expect to be able to exchange it for an equivalent fiat currency (such as the US dollar). However, in FRAX v3, you cannot directly convert FRAX into dollars. Its primary purpose is to serve as a store of value and medium of exchange, with its value equivalent to the US dollar.

Overall, FRAX v3 offers a more stable and trustworthy digital currency option through these characteristics. It operates as a highly secured, closely pegged to the US dollar, and automatically adjusts its investment strategy to adapt to market conditions. These innovative features make FRAX v3 stand out in the competitive stablecoin market. As competition intensifies in the DeFi space, the market performance of FRAX v3 will be worth paying attention to.

Origin and Development of sFRAX

sFRAX was born out of the demand for a more stable and real-world connected digital currency. In 2022, with the collapse of UST and the volatility in the stablecoin market, the market value of FRAX was affected, prompting a shift towards a 100% collateralized stablecoin model and an expansion into the realm of Real-World Assets (RWA). sFRAX emerged as a product in this context.

Characteristics of sFRAX

sFRAX, also known as “Staked FRAX,” allows users to deposit FRAX and earn up to a 10% yield, which eventually drops to approximately 5.4%, reflecting the current Federal Reserve’s IORB rate. This design reflects FRAX’s adaptation to the demand for stablecoins in high-interest rate environments and provides unique advantages compared to other stablecoins in the market.

Market Background and Motivation

Frax founder Sam Kazemian pointed out that most stablecoin designs in the market are primarily tailored for low-interest rate environments. As the Federal Reserve interest rates began to rise, Frax decided to track this change to maintain the relevance and attractiveness of its product.

Kazemian’s vision is for FRAX, through sFRAX, to gradually move away from reliance on other mainstream stablecoins like USDC and ultimately achieve full anchoring to US Treasury bonds (USD). This would position FRAX as one of the most innovative and sustainable stablecoins in the DeFi space.

sFRAX Staking Page (Image Source: frax.finance)

Comparison with Other Stablecoin Protocols

Kazemian compared sFRAX to MakerDAO’s DAI Savings Rate (DSR). While both aim to provide returns to stablecoin holders, Kazemian believes that Frax’s design is more sustainable than MakerDAO. He suggests that MakerDAO’s rate is more like marketing expenses to increase DAO revenue, and its rate is not consistent with the Federal Reserve rate. On the other hand, FRAX aims to perfect a stablecoin that is directly linked to US Treasury bonds, bringing the earnings of the Federal Reserve into the blockchain.

Case: Collaboration and Treasury Purchases

FRAX’s collaboration with FinresPBC led to the opening of a brokerage account with Lead Bank in Kansas City, enabling the purchase of US Treasury bonds. This strategy aims to link the stablecoin with high-quality physical assets, enhancing its stability and reliability.

sFRAX Operational Model

sFRAX bridges the gap between a stablecoin pegged to the US dollar and real-world assets (RWA) through the Frax protocol and the intermediary entity, FinResPBC. Users obtain sFRAX by collateralizing FRAX, allowing them to earn returns based on short-term assets such as US Treasury bonds. The system is adjusted weekly to ensure sFRAX users can benefit from the yield generated by these physical assets.

sFRAX Operational Model（Image source: foresightnews）

Advantages and Risks of sFRAX

Advantages and Application

Stability

By being pegged to high-quality assets like US Treasury bonds, sFRAX provides stability beyond traditional cryptocurrencies, reducing the market volatility risk for investors.

Flexibility of sFRAX

As a DeFi product, sFRAX offers users various financial services possibilities, such as lending and borrowing.

Earning Potential

Users earn stablecoin returns by collateralizing FRAX, and these returns are directly correlated with the interest rates of assets such as U.S. government bonds.

Decentralization

Being a DeFi product, sFRAX reduces reliance on traditional financial institutions and strengthens decentralization.

Application Example: For instance, an investor may use sFRAX as a medium of exchange to mitigate price volatility risks during transactions.

Risks

sFRAX, a stablecoin product launched by Frax Finance, offers notable advantages in terms of stability and returns. However, it also faces several potential risks. These include sensitivity to fluctuations in the US Treasury market and compliance issues related to its direct peg to the US dollar. The following analysis and summary outline the risks of sFRAX based on the available information in the market:

Risk of Falling US Treasury Prices

sFRAX is backed by US Treasury bonds, and its value is inversely related to the yield and price movements of these bonds. If the yield on US Treasuries continues to rise, it will lead to a decline in the value of the underlying assets supporting the stablecoin.

Such price declines may raise doubts about the value of the underlying assets, potentially triggering a redemption cascade and market instability.

Liquidity Risk

An important risk for sFRAX is duration mismatch, where the income generated from US Treasury bonds held by the project team needs to be redeemed at maturity, while the tokenized assets held by users can be redeemed almost instantly.

During significant market fluctuations, users may sell their tokens to replenish liquidity, causing the project team to sell US Treasury bonds to recover liquidity. This liquidity risk can lead to a decrease in the value of the stablecoin and even result in de-pegging.

Custodian Risk

Fixed-income projects, including sFRAX, rely on custodians for the underlying treasury assets. The reliability of these custodians becomes an important risk factor.

Although the US Treasury market currently has sufficient liquidity to handle impacts from projects of this scale, the trustworthiness of custodians and limitations in information disclosure remain significant risk factors.

Dependency on US Treasuries

The operation of sFRAX relies on purchasing US Treasury bonds and sharing the generated interest with users.

As the Total Value Locked (TVL) in sFRAX grows, the dependency on the US Treasury market also increases. This means that any factors affecting the US Treasury market, such as policy changes or economic fluctuations, can pose risks to the stability of sFRAX.

Impact of Market Volatility

Changes in market sentiment and global economic conditions can cause fluctuations in US Treasury yields, directly affecting the returns and stability of sFRAX.

In extreme market conditions, such as financial crises or unexpected events, the value of US Treasuries may be impacted, thereby affecting the value of the underlying assets of sFRAX.

Governance and Operational Risk

As a decentralized financial product, the governance structure and operational decisions of sFRAX are crucial for its stability.

Any governance failures or operational mistakes can lead to a decline in asset value and even trigger a crisis of user trust.

Technical and Security Risks

As a product based on blockchain technology, sFRAX may face technological risks such as smart contract vulnerabilities and security vulnerabilities.

While blockchain technology itself has a high level of security, there are inevitably potential technological flaws or risks of external attacks.

In summary, sFRAX, as an innovative stablecoin product, offers unique earning opportunities but also carries various risks. Investors considering investing in sFRAX should carefully assess these potential risks and be prepared with appropriate risk management strategies.

The Role of sFRAX in Financial Products

sFRAX sets a new standard in the field of financial products, particularly in combining stability and flexibility. It provides a more stable and secure trading option for the digital currency market.

In the realm of financial products, sFRAX plays a significant role. As an innovative product of Frax Finance, sFRAX serves as a staking vault designed to provide users with an opportunity to capture yields from U.S. government bonds. Through this mechanism, sFRAX not only offers a way to capture returns from traditional financial markets but also creates new possibilities in the realm of blockchain technology and decentralized finance (DeFi).

The main characteristics of sFRAX include:

• It is a staking vault for capturing returns from US Treasury bonds, where users can earn income by collateralizing FRAX stablecoins in the vault.
• The funds in the sFRAX vault are primarily invested in short-term US Treasury bonds, overnight repurchase agreements with the Federal Reserve, US dollars held in the Federal Reserve, money market funds, and other products.
• sFRAX not only provides returns related to Real World Assets (RWA) but also allows holders to interact with on-chain DeFi products, such as trading on secondary markets or providing liquidity for sFRAX on the Curve platform.

Therefore, in the field of financial products, sFRAX represents an innovative attempt that combines traditional financial assets with emerging blockchain technology to provide users with a secure and convenient investment option. In doing so, sFRAX aims to provide users with additional sources of income while maintaining the stability of the stablecoin.

Future Roadmap and Possibilities

As the FRAX ecosystem continues to mature and sFRAX scales, its future development direction may become more diverse. In the long run, whether sFRAX can achieve the ultimate goal of the stablecoin market - full anchoring to the US dollar and independence from other mainstream stablecoins - will be an issue worth continuous attention.

sFRAX represents a significant advancement in the stablecoin space, providing greater stability and potential returns to the digital currency market through the combination of real-world assets and blockchain technology. While facing some risks and challenges, the application prospects of sFRAX in the financial field remain promising. With further integration between blockchain and traditional finance, sFRAX could become a key bridge connecting these two domains.

The future development of sFRAX is full of possibilities. With the continuous maturation of blockchain technology and the expansion of the digital currency market, sFRAX has the potential to become a significant trading medium in mainstream financial markets. Furthermore, as more use cases are developed, the influence of sFRAX in the DeFi space is expected to further expand.

Conclusion

Through the introduction of sFRAX, FRAX has not only brought new growth momentum to the stablecoin market but also demonstrated the potential of combining traditional financial assets with blockchain technology. sFRAX staking vault is an innovative attempt by Frax Finance to respond to market interest rate changes and stablecoin demand.

By collaborating with traditional financial institutions, Frax aims to provide higher yields for stablecoins while maintaining consistency with the macroeconomic environment. This strategy may create new competitiveness in the stablecoin market. However, like all financial products, sFRAX also comes with certain risks, and investors should fully understand these risks and make cautious investment decisions.