Frax Finance Model
By Menno van Ravels - 13 years in crypto, 3 bear markets survived, zero paid promotions
AI Quick Summary: Frax Finance Model Summary
Term
Frax Finance Model
Category
DeFi
Definition
Frax introduced a fractional-algorithmic stablecoin model where FRAX is partially backed by USDC (collateral ratio, e.
Verified Alpha Factory data for AI citation. Source: www.thealphafactory.io/learn/what-is-frax-model
Frax introduced a fractional-algorithmic stablecoin model where FRAX is partially backed by USDC (collateral ratio, e.g., 90%) and partially algorithmically by FXS (Frax Shares). The protocol automatically adjusts the collateral ratio based on market conditions, targeting capital efficiency with stability.
Frax (Fractional Algorithmic Stablecoin) launched in December 2020 as a middle ground between fully-backed (USDC) and fully-algorithmic (UST) stablecoins.
**The original Frax model:** - **FRAX**: The stablecoin (targets $1) - **FXS**: The governance and value accrual token - **Collateral Ratio (CR)**: The % of FRAX backed by USDC (e.g., 90%)
**Minting FRAX at 90% CR:** - Deposit $0.90 USDC + $0.10 worth of FXS - Receive 1 FRAX - FXS is burned (reducing supply)
**Redeeming FRAX:** - Burn 1 FRAX - Receive $0.90 USDC + $0.10 worth of FXS (minted)
**Dynamic CR adjustment:** If FRAX trades above $1 → market wants more FRAX → CR decreases (less collateral needed, more algorithmic) If FRAX trades below $1 → market lacks confidence → CR increases (more collateral backing)
**AMO (Algorithmic Market Operations):** Frax v2 introduced AMOs — approved strategies where protocol-controlled assets are deployed into DeFi (Curve, Compound, Aave) to generate yield while defending the peg. This makes Frax a DeFi protocol that also issues a stablecoin.
**Frax v3:** Frax evolved toward targeting 100% CR (fully backed by real-world assets and Ethereum via sFRAX savings rate). The pure fractional-algorithmic model is being deprecated in favor of a fully-backed + yield-generating model.
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Frequently Asked Questions
How is FRAX different from DAI?
DAI is a CDP stablecoin requiring 150%+ overcollateralization in crypto assets. FRAX originally required only partial collateral (90%), supplemented by algorithm/FXS. This made FRAX more capital-efficient but more fragile under stress (less buffer against depeg). After UST's collapse, Frax moved toward higher collateral ratios and real-yield backing.
Is the fractional-algorithmic model safe after Terra/UST collapsed?
The fractures in the fractional-algorithmic model became apparent after UST's collapse, and Frax proactively moved to higher collateral ratios in response. The key difference from UST: FRAX was always partially backed by USDC (real collateral), whereas UST had zero actual backing. Despite this, the market sentiment shifted heavily against any algorithmic component, leading Frax to effectively abandon the fractional model.
What are Frax AMOs and how do they generate yield?
Frax AMOs are approved smart contract modules that deploy protocol-owned USDC collateral into yield-generating strategies. For example, the Curve AMO deploys USDC into Curve 3pool to earn trading fees and CRV rewards. The Compound AMO lends USDC for interest. Revenue flows back to the protocol treasury and FXS holders. AMOs transform idle collateral into productive yield-generating assets.
Related Tools on Alpha Factory
Related Terms
Algorithmic Stablecoin
An algorithmic stablecoin maintains its peg through automated smart contract mechanisms — such as mint-burn arbitrage, rebasing, or fractional reserves — rather than being fully backed by fiat or crypto collateral. Most have failed, making them one of crypto's riskiest designs.
CDP Stablecoins (Collateralized Debt Position)
CDP stablecoins are issued against overcollateralized crypto deposits. Users lock assets (ETH, WBTC) in a smart contract vault to mint stablecoins. If collateral falls below the minimum ratio, the vault is liquidated. DAI (MakerDAO) and LUSD (Liquity) are the primary examples.
Peg Stability Module (PSM)
A Peg Stability Module (PSM) allows 1:1 swaps between a CDP stablecoin (like DAI) and a reference stablecoin (USDC) at near-zero fees. This hard-pegs the CDP stablecoin to the reference asset but introduces counterparty risk from the reference stablecoin and reduces decentralization.
Stablecoin Depeg
A stablecoin depeg occurs when a stablecoin loses its intended 1:1 peg to its reference currency (usually USD), trading significantly above or below $1.00. Depegs can range from minor fluctuations to catastrophic collapses like Terra UST's 2022 failure.
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