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Stablecoins continue to make headlines. Circle recently filed for IPO, and central banks are now cautioning financial institutions from getting too heavily involved in these new forms of currency.
A stablecoin in which no single entity can manipulate the supply or backing has significant implications for monetary theory and the global financial system. Decentralized stablecoins have long been the holy grail for blockchain enthusiasts, partly for this reason.
Frax is one entity working at the forefront of decentralized stablecoins. No single entity sets the market value for the $FRAX stablecoin.
Instead, tokens track the price of $FRAX via Fraxlend, the native lending market, and Fraxswap, the native automated market maker (AMM), which continually calculates the token’s market value with the goal of a stable, market-valued price of $1.
Market validation of Frax’s model has so far been consistent. At the time of writing, the Frax ecosystem has multiple digital assets valued above $500mm, including its native stablecoin, $FRAX, and its governance-minimized utility token, $FXS.
The latest addition to the Frax ecosystem is $FXBs, zero-coupon bonds that convert to $FRAX stablecoins upon maturity. This newest addition of discounted face-value bonds comes with the Frax V3 Model, dubbed “The Final Stablecoin” by the organization, and represents a significant step in how decentralized stablecoins function.
In this article, we’ll explore this latest addition to the Frax ecosystem, how Frax uses tokenized real-world assets to differentiate itself in a highly technical and cutting-edge market, and why this new $FXB token, while essential for ecosystem maturity, isn’t technically a real-world asset.
Frax's V3 model marks a significant evolution for decentralized stablecoins. Building on its initial success, Frax improves upon the existing while introducing several new innovative mechanisms to enhance ecosystem stability and utility.
Initially introduced in Frax V2, AMO contracts enforce pre-programmed monetary policy by minting and lending new $FRAX stablecoins. Frax’s V3 model further refines this approach.
For Fraxlend, the AMO mints $FRAX to keep the lending market efficient. Alternatively, Fraxswap uses the AMO contracts to calculate time-weighted averages for strategic market operations.
In both cases, AMO contracts help stabilize the Frax ecosystem.
The inclusion of real-world assets is one way that Frax differentiates itself from other decentralized stablecoin issuers. Frax exclusively focuses on the following:
In all cases, Frax only procures assets close to the Interest on Reserve Balances (IORB) rate set by the Federal Reserve and requires all custodians to report on their asset compositions at least monthly.
Users can stake their $FRAX tokens in the sFRAX vault, which entitles them to a share of Frax’s weekly yield. An ERC4624 vault, sFRAX closely tracks the Interest on Reserve Balances (IORD) rate, with collateral requirements for newly minted $FRAX to be >100%.
The star of the Frax V3 model is the $FXB token, a zero-coupon bond based on time-tested financial concepts from traditional finance. The process is simple: a bond is sold at a discount to its face value and is redeemable at its full face value at a later date. The difference between the purchase price and redemption price represents the investor’s return.
This process is identical for $FRAX and $FXB tokens, which use a derivative of the seniorage shares model. Investors purchase $FXB at a discounted rate, representing an attractive opportunity for the investor and serving as a stabilizing force for the $FRAX token.
Controlling the supply of circulating $FRAX via the issuance and redemption of $FXBs allows Frax to manage the stablecoin's price stability more effectively.
By issuing $FXBs, Frax can absorb excess $FRAX from the market. This process reduces the circulating supply and prevents oversupply-induced price drops.
Conversely, during redemption, $FXBs are converted into $FRAX, increasing supply to meet rising demand to achieve price equilibrium. This dynamic issuance and redemption mechanism of $FXBs enables Frax to algorithmically manage the market supply of $FRAX with more nuance, ensuring its stability against market fluctuations.
Real-world assets are tangible or legally recognized entities existing outside of a blockchain. This definition includes assets like real estate, commodities, stocks, or government bonds, all of which have intrinsic value based on their physical or legal properties.
Frax’s stablecoin $FRAX, backed by government-issued bonds in the form of U.S. Treasuries, inherits the real-world properties of the asset that backs it. This relationship imbues $FRAX with real-world value and credibility and fits it comfortably in the definition of tokenized real-world assets.
However, not all assets in the Frax ecosystem qualify as real-world assets.
The recently added $FXB is a prime example of the nuance in discerning whether a digital asset qualifies as a real-world asset.
While $FXB is intrinsically linked to the RWA-backed $FRAX token, it does not directly tether to a real-world asset. Redemption of the $FXB tokens may trigger the issuance of $FRAX tokens, but the $FXB tokens are not proportionally backed by U.S. Treasuries.
The U.S. Treasuries back the $FRAX token, not the $FXB token.
Instead, $FXB is a derivative instrument of a real-world asset – a financial product whose value is derived from the value of an underlying asset, in this case, the $FRAX stablecoin.
This distinction is crucial in understanding the dynamics of the Frax ecosystem and how real-world assets fit into it.
The distinction between real-world assets like $FRAX and derivative instruments of real-world assets like $FXB is essential for understanding the tokenized real-world asset landscape.
As the industry evolves, we’ll continue to see more ecosystems develop more RWA-derivative instruments.
For investors, RWAs like $FRAX offer a sense of familiarity and assurance, drawing on established principles and legal frameworks of traditional finance. Alternatively, derivative instruments like $FXB, while themselves not RWAs, offer more nuanced opportunities to interact with tokenized real-world assets.
The market benefits immensely from this diversity of instruments. Frax’s V3 model represents a significant, forward-thinking integration of RWAs into the financial landscape while paving the way for future derivative instruments and innovations.
