Proposal: Add support for FRAX

Proposal to add support for FRAX
Updated to fit the ARC template

Add FRAX as an asset on Aave
I’m a Frax community member helping with integrations.

References

Summary

FRAX is a redeemable stablecoin with a dynamic collateral ratio that adjusts based on market demand. Frax is unique among recent stablecoin designs in that each FRAX is always redeemable for $1.00 worth of assets from the Frax protocol. This has kept the price of FRAX in a relatively tight band around $1.00, making Frax an ideal asset to borrow and lend against on Aave. Frax is already integrating with Aave and is currently the 4th largest aUSDC holder and growing, demonstrating a strong synergy between the communities.

v2 of the Frax protocol was recently announced and introduces a lending module that can be built directly onto Aave. This would enable the Frax protocol to supply large amounts of FRAX to Aave on demand. The first step towards this integration is the addition of FRAX and FXS as assets on Aave.

Overview

FRAX is a redeemable stablecoin with a dynamic collateral ratio that adjusts based on the market demand for FRAX. Currently, each FRAX is collateralized by approximately $0.87 USDC and $0.13 of the Frax governance token, FXS. When the price of FRAX is at or above $1.00, the protocol gradually lowers the collateralization ratio of USDC to FXS. When the price of FRAX is below $1.00, the protocol gradually increases the ratio. FRAX can always be minted or redeemed by the protocol for $1.00 of assets, which counterbalances significant price deviations from the $1.00 target. Frax emphasizes a highly autonomous approach with no active management of the price stability function.

The Frax community recently approved the investment of system collateral, currently approximately $96m USDC, into yield bearing USDC. Accordingly, the protocol began supplying USDC to Aave to earn a return on this collateral. Frax already has over 15,000,000 aUSDC and will continue increasing deposits on Aave, demonstrating a strong synergy between the Frax and Aave communities. Frax is currently the #4 largest holder of aUSDC. Continued growth of the Frax protocol and system collateral could lead to Frax becoming one of the larger suppliers of USDC to Aave.

Positioning within Aave Ecosystem

The Frax community is very active and looking for venues to lend and borrow FRAX. Aave should enjoy increased revenue from the lending and borrowing of FRAX, as well as additional USDC deposits as the Frax collateral pool grows. While Frax is often lumped together with “algorithmic stablecoin” protocols, a closer analysis shows that the Frax protocol is in fact stable and capital efficient.

Frax recently announced v2 of the Frax protocol. v2 introduces algorithmic market operations controllers (AMOs). AMOs are autonomous contracts that build on the base Frax protocol without disrupting it’s operation. The team has proposed incorporating lending AMOs directly into decentralized lending markets. The lending AMO could be built directly on Aave to supply large amounts of FRAX from the protocol to Aave. This would effectively create a FRAX dispenser on Aave, somewhat analogous to the Fed discount window, where borrowers could borrow directly from the FRAX protocol via Aave. A direct integration with Aave will also make supplying FRAX more attractive to other market participants because there is a guarantee of FRAX liquidity directly from the protocol, avoiding the pitfalls of high utilization rates on money markets. This integration could drive significant TVL and fees to Aave.

A direct integration with Frax via a lending AMO contract will offer Aave users the ability to effectively mint and redeem stablecoins on demand via Aave. From a borrower’s perspective, direct protocol integration should keep the supply relatively steady, which should keep borrowing costs low and predictable. This would make FRAX an ideal stablecoin to borrow. To realize this integration, FRAX and FXS need to first be added as collateral on Aave.

Project History

The project launched in December 2020. The project is currently using snapshot voting for governance. The project has deployed Compound Governor Alpha; it is fully functional but awaiting the minimal threshold of FXS to be emitted. There is a 48 hour timelock for governance.

Frax underwent a significant expansion and contraction withing the first 2 months of launch, providing a stress test for the protocol. In a three week period, the supply of FRAX increased over 5x, from approximately 25m to 134m. The supply of FRAX then contracted by approximately 33%. FRAX maintained a tight band around $1.00 throughout the cycle. The team has subsequently released updates to the protocol to smooth volatility during expansions and contractions, most importantly the updated PID controller for the protocol. V2 of the protocol also includes an interest rate module, intended to dampen FXS volatility during periods of contraction.

Given that FRAX is a stablecoin, FRAX’s stability around $1.00 is obviously important and worth reviewing. Warp Capital performed the following analysis independently in February. There have been no notable changes or deviations for FRAX since this analysis was performed:

From inception FRAX has maintained the peg of $1, trading within the normal range. Figure 1 illustrates the USD price for the last 30 days of stablecoins from different groups: fiat-backed like BUSD, GUSD etc.; algorithmic with overcollaterization like sUSD, DAI; elastic like AMPL and algoseignorage like BAC, ESD and FRAX. The noticeable divergence is present for BAC and ESD – fully algoseignorage without any collateral. Also, elastic AMPL converges to the peg with the high volatility.

Figure 1. Last 30 days stablecoins performance vs. USD

Figure 2. Last 30 day performance without 3 aforementioned algorithmic stablecoins that have experienced high volatility (AMPL, BAC, ESD). As we see FRAX goes in line with other stablecoins demonstrating alike volatility.

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Figure 3. Last 30 day stablecoin performance vs USD excluding sUSD.

If we exclude sUSD which has the big spike at the beginning of 2021, we will get the performance illustrated on Figure 3. Figure 3 shows the dynamics of the remaining stablecoins and as we see FRAX is within the range of other stablecoins.

Here is an updated view of FRAX’s stability taken from the FRAX app:

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Given that FRAX is highly collateralized (currently approximately 87% collateralized by USDC and interest bearing USDC like aUSDC) and FRAX’s initial Aave LTV is likely to be lower than the collateralized amount, there is a high likelihood that FRAX used as collateral on Aave would effectively be over collateralized by USDC and equivalents. This should reduce the downside risk for Aave as a protocol.

It is also worth noting that there is also approximately $60m of Uniswap, Sushiswap and FRAX-3Pool LP tokens locked within the Frax protocol. A significant portion of this is locked for greater than 2 years. This provides guaranteed liquidity for FRAX and provides significant benefits to the stability of the protocol in times of volatility.

FRAX Usage and Emission

FRAX is a stablecoin that can be freely minted and redeemed via the Frax protocol. Currently, Frax is mostly used in AMM trading pairs and to liquidity mine the Frax governance token, FXS. Through constant building (FRAX AMOs as an example), integrations (like Aave) and performance / awareness over time, FRAX should build organic usage as a stablecoin. The team has no ability to arbitrarily mint or redeem FRAX in the contract.

Market, Social and Contract Data
FRAX currently has a $110m market capitalization with an average daily volume of $9m during March 2021. FRAX is the #9 token on Uniswap based on liquidity ($102m)

Frax’s telegram is the main social channel with 5,600+ members. The contracts were deployed December 16 2020. There have been 53k transfers and currently 851 holders, however 97.5% of the supply is currently deposited as liquidity on decentralized exchanges. Given Frax liquidity mining, it is likely that significantly more users exist but have staked their tokens in liquidity pools to receive rewards.

Security Considerations

Frax has undergone extensive code reviews and an audit by Certik (linked above). Frax is in the process of undergoing additional audits. The protocol currently has approximately $300m TVL.

I appreciate you taking the time to review. Please let me know if you have any questions or concerns.

Vote
  • Add FRAX
  • Don’t Add FRAX

0 voters

46 Likes

Additional Community Links:

Discord: https://discord.gg/4XdPtT5c

Twitter: https://twitter.com/fraxfinance

34 Likes

It’s a very new token so I don’t think it will have any LTV on aave. But people would absolutely love to borrow this!

36 Likes

Can definitely build up the LTV over time. Also, I think there would be significant demand for borrowing against FXS. It’s a much more volatile than FRAX but the LTV should reflect that. Meanwhile Frax has been stable over this time.

38 Likes

The Frax team has also announced v2 of the protocol - Frax v2: Algorithmic Market Operations | by Sam Kazemian | Mar, 2021 | Medium

v2 introduces algorithmic market operations controllers (AMOs). AMOs are autonomous contracts that build upon the base Frax protocol without disrupting it’s operation. The team has proposed incorporating lending AMOs directly into decentralized lending markets. The lending AMO could be built directly on Aave to supply large amounts of FRAX from the protocol to Aave. This would effectively create a FRAX dispenser on Aave, somewhat analogous to the Fed discount window, where borrowers could borrow directly from the FRAX protocol via Aave. This could offer Aave users an open ended supply of a low interest stablecoins, while minimizing liquidity risks for other FRAX lenders on Aave. This could drive TVL and fees for Aave and make it a hub of Frax based borrowing and lending.

There is interest from the Frax community to build this lending AMO for Aave. The first step is to add FRAX and FXS as assets on Aave. Let’s make it happen!

39 Likes

Edited my original post to fit the ARC template - please let me know if I missed anything or if you have any questions.

1 Like

Hello I’m from the AMPL community. I support this, would love to borrow FRAX. DAI often commands high borrow rates as it seems to be the only decentralized and trusted stablecoin at the moment. FRAX looks like it might be able to be added to that list soon.

Friendly reminder that AMPL is not a stablecoin though :slight_smile:

2 Likes

Thanks kbambridge - that is a great reminder. The language around AMPL, Frax, and stable assets is quite muddled at this point. I’ve found that a lot of people are dismissive of FRAX because the word algorithmic is anywhere near it. Lots of education to do - reminds me a little bit of people dismissing a project because it was an ICO. Lots of good projects came from that era, even if some ICOs were blatant money grabs.

FRAX Risk Assessment

FRAX is a redeemable decentralized stablecoin with a dynamic collateral ratio that adjusts based on market demand. FRAX can be minted or redeemed for $1.00 worth of assets from the Frax protocol. At the current market set collateral ratio, over $0.85 of each FRAX is backed by USDC, while the balance is backed by the Frax governance token FXS.

If onboarded to Aave, FRAX can be supplied for yield or borrowed against collateral, introducing new borrow and lend demand for Aave. FRAX has emerged as a compelling alternative to centralized stablecoins and an integration with Aave brings more utility to the FRAX ecosystem.

FRAX Smart contract Risk: C

The FRAX contract launched in December 2020 and has a smaller number of transactions when compared with other stablecoins on Aave. The FRAX contracts have undergone extensive code reviews and audit, while holding a TVL over $300m. The FRAX contracts have also gone through a major FRAX expansion and contraction cycle without issue.

FRAX Counterparty Risk: C+

FRAX has a limited number of holders, however the protocol acts as the largest market participant where all FRAX can be redeemed for $1.00 of assets at any time. The FRAX contract has no permissions, including minting or redeeming FRAX, though the Pool contract has a function to pause the minting and redemption of protocol collateral in an emergency.

FRAX Market Risk: B

FRAX has a healthy market cap for a growing stablecoin ($132MM). While FRAX has a reasonable average daily volume, it does not account for any mints or redemptions directly from the protocol. In the event Aave users need to exit a large position of FRAX, the protocol will redeem 1 FRAX for $1.00 of collateral. The protocol programmatically holds enough collateral to back the entire supply of FRAX at FRAX’s collateral ratio. FRAX has been successful in keeping a tight band around $1.00. The volatility calculations for this risk assessment use Coingecko daily data, which appears consistent with other Aave Community Risk Assessments. Using more granular data (without an artificial daily closing price), FRAX’s volatility is likely lower and approaches fully collateralized stablecoins.

FRAX is widely traded on DEXs including Uniswap and Curve. The Uniswap FRAX-USDC pool holds $121MM in liquidity and facilitates ~$2MM in 24 hour trade volume.

A FRAX-USD Chainlink oracle feed is in progress.

FRAX Price
Source

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Frax Overall Risk: B-

FRAX’s overall risk score is largely reflective of FRAX’s age. FRAX performs well from a stablecoin and market risk perspective, however this is offset by the age of the protocol.

Given that each FRAX is redeemable for $1.00 of collateral from the Frax protocol, FRAX as a collateral asset at 65% LTV is 153% collateralized. The collateral can be permissionlessly redeemed at any time.

Proposed Risk Parameters:
LTV 65%
Liquidation Threshold 70%
Liquidation Bonus 5%
Reserve Factor 10%

Variable Interest Rate Model:
UOptimal 80%
R_0 0%
R_s1 4%
R_s2 75%

Rationale
A 65% LTV is 15% lower than USDC and 10% lower than DAI and True USD.
Stablecoins on Aave have historically followed the same curve with an 80% UOptimal in line with BUSD, DAI, GUSD, sUSD, and TUSD. A 0% Base and 4% Slope 1 follows all stablecoins onboarded to Aave. A 75% slope 2 presents a risk profile in between USDC/USDT (60%) and sUSD, GUSD, and BUSD (100%).

We welcome any feedback from the community. Once we finalize the parameters, we can move this to the AIP process.

2 Likes

Borrowers will love this - very little risk adding it for borrowing

2 Likes

Hey, just wondering what the timeline looks like for finalizing these parameters. Thanks.

Looking at the composition of the Frax reserve, I’m not sure it’s suitable to be a collateral asset at this time.

About 15% of FRAX is backed algorithmically by FXS. Without fully reviewing the liquidity, governance, and distribution of the FXS token, I think we should mark this portion as a 0% collateral factor.

The frax-3crv AMO makes up another 25% of reserves. This is exposed to USDT through the Curve 3pool, and considering the high liquidity amplification in the 3pool the downside risk is nearly equivalent to holding USDT directly. Aave gives USDT a 0% collateral factor, so marking this portion to 0% as well makes sense to me.

Yearn’s yUSDC vault is also exposed to USDT risk through participation in Curve pools. So this additional 20% should also be market to 0% collateral factor in my view.

The remaining 40% of reserves is composed of USDC, aUSDC, and cUSDC. These assets are generally pretty safe and we could mark them to USDC’s 82.5% liquidation ratio.

Granting these assumptions, we get 40% * 82.5% = 33% collateral factor.

While FRAX does have the possibility of being safer than the sum of its parts through diversification, currently it has highly concentrated exposure to USDC and USDT credit risk, plus additional smart contract and governance risks mixed in. Governance can always allocate more funds towards USDT exposure as well, so it could be problematic to grant even a 33% liquidation ratio to FRAX. I think adding FRAX is a good idea, but it would make more sense to give it a 0% liquidation ratio for the time being.

2 Likes

I think this is a good analysis. Also noting that the FRAX collateral ratio can also go down as more FRAX is minted, I believe, so we cannot rely on it too much for the LTV.