Frax V3: A Deep Dive

Throughout 2023, the Frax core team continued to roll out new products and updates that contribute to the vision of what they consider to be the “Holy Trinity of DeFi”: a stablecoin, liquidity, and lending services. In doing so, the team focused primarily on the launch of its liquid staking product and the continual development of its Fraxlend money market. While the launch and adoption of these new products have been impressive, the FRAX stablecoin, the cornerstone of the protocol, continued to shrink in market share. The stablecoin has lost ~$330M in market cap since January 2023, which paints an ugly picture when compared to DAI’s retention as a market leader. It is important to note that FRAX is still an undercollateralized stablecoin, with the collateral ratio (CR) sitting at ~95%, whereas DAI is overcollateralized. The protocol is currently prioritizing the accumulation of enough collateral to bring the CR to 100%.  

The past few months at Frax enabled the team to focus on a major development, and what is potentially the final iteration of the stablecoin: Frax V3. Frax V3 introduces a RWA strategy to the protocol through staked FRAX (sFRAX) and FRAX Bonds (FXBs). In doing so, demand for FRAX can now be more competitive with DAI, granting Frax the potential to expand its market share in the decentralized stablecoin sector. Frax V3 attempts to bring exposure to short and long duration yields onchain. The protocol also recently deployed its first iteration of frxGov, a fully onchain governance module that will gradually begin to control all contracts within the protocol over the next year. This should greatly enhance the decentralization of the protocol over the long run. 

FinresPBC: Frax’s RWA Entity

Before bringing Frax V3 to mainnet, the protocol needed a reliable method to hold treasury bills and other RWAs offchain. In response, governance passed FIP-277, which selected Financial Reserves and Asset Exploration (FinresPBC), a non-profit entity, to serve as the offchain custodian to facilitate the RWA strategy. This means that the protocol can withdraw onchain assets to gain exposure to RWAs, and then pass the corresponding returns back to the protocol, without charging performance fees. FinresPBC can hold USD deposits in FDIC insured savings accounts, purchase/sell US treasury bills, and mint/redeem USDP and USDC stablecoins. In addition to treasury bills, FinresPBC has the authority to purchase Federal Reserve Overnight Repurchase Agreements and select shares of money market mutual funds. 

Frax’s FinresPBC arrangement differs slightly from Maker’s RWA structure. Instead of outsourcing the offchain strategy to multiple custodians like MakerDAO does (BlockTower Andromeda, Huntingdon Valley Bank, etc), Frax plans to run all offchain operations solely through FinresPBC. This should make the reporting process less complex, as stakeholders can receive monthly reports through one source, rather than having to scroll through multiple threads on the MakerDAO forum and waiting for each partner to post an update on balances. As operations scale, governance can elect to onboard more partners, and the protocol will continue integrating reporting functionality. 

FinresPBC has absolutely no role in Frax development or operations. It strictly exists to facilitate offchain strategies. The entity currently utilizes Lead Bank to handle all financial activity, but it is looking to partner with more banks in the future with a prioritization on compliance. Frax’s goal is to eventually become eligible for a Federal Reserve Master Account (FMA), and FinresPBC lays the foundation for this. While stablecoin regulation to date has been largely unclear, the protocol’s willingness to legally incorporate an entity demonstrates a commitment to compliance.  

sFRAX