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Frax Triples in Value as Stablecoin System Takes Shape

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Buoyed by the fast growth of its lending and liquid staking businesses, stablecoin issuer Frax Finance is on a tear to start the new year.  

Its governance token, FXS, has almost tripled this year and is the best-performing token since mid-November, just after the collapse of crypto exchange FTX, according to data from CoinMarketCap. The coin sports a market cap of $749M

FXS has soared since the dark days of November. Source: CoinMarketCap

Frax is, in part, riding a wave of action in liquid staking protocols. It launched its own, frxETH, in October, and users have deposited more than $100M to date, according to Defi Llama. 

But it’s not just liquid staking. The total value locked (TVL) in its lending protocol, Fraxlend, has surged 77% in the past month. The TVL of its exchange, Fraxswap, has grown more than 36%.  

Founder Sam Kazemian insists he isn’t trying to compete with DeFi stalwarts Uniswap, Aave, and Lido.

Novel Approach

“Stablecoins are basically my obsession,” Kazemian told The Defiant in a wide-ranging interview this month.

The dollar-pegged FRAX stablecoin is the fruit of that obsession, and the suite of Frax-branded protocols has one purpose: creating an ecosystem for the stablecoin to thrive. 

He’s taken a novel approach. The two largest stablecoins by market capitalization are purportedly backed by cash or cash equivalents. Decentralized alternatives are generally over-collateralized to hedge against volatility in the assets that back them. 

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FRAX is undercollateralized and backed by a basket of cryptocurrencies that includes Frax’s own token, FXS. The name stands for “fractional-algorithmic,” a term that has given people the “heebie-jeebies” since last year’s $60B collapse of algorithmic stablecoin UST, Kazemian acknowledged. 

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But the projects are fundamentally different. Kazemian insists those differences mean that Frax will succeed where UST failed, and become the “base, risk-free asset in DeFi.” 

‘Trillion-dollar Narrative’ 

Kazemian came to crypto while studying neuroscience and philosophy at the University of California Los Angeles. Like many crypto-curious undergrads, he mined tokens — Dogecoin and Litecoin — from his dorm room. After graduating, he founded a blockchain-based, crypto-focused Wikipedia clone with a friend. That project eventually floundered.

“In 2019, I really thought that the third trillion-dollar narrative in crypto is stablecoins,” he said. “I kind of had this view that none of these [existing] assets are good money.”

In 2019, I really thought that the third trillion-dollar narrative in crypto is stablecoins,” he said. “I kind of had this view that none of these [existing] assets are good money.

Sam Kazemian

From the beginning, he knew that to create a good stablecoin, he would need to do more than make one — he would have to provide it with support. In September, Frax launched an automated market maker, Fraxswap. 

In October, it launched Fraxlend and Frax Ether, a liquid staking protocol. Frax has executed two fundraising rounds, with investments by Crypto,com Capital and Ascensive Assets, according to CrunchBase.

Stablecoin Infrastructure

“If you have the largest and best stable coin, you have to have the most amount of debt denominated in your stablecoin,” he said. “That’s why we have Fraxswap and Fraxlend, so that we also have a place where these stablecoins have a good way to be lent out. … The stuff we do is more about building stablecoin infrastructure than just building a large number of competitor projects or stuff like that.”

He says recent moves in the industry have vindicated his viewpoint.

“Whether other projects and the community notices it or not, everyone is kind of discovering this concept in one way or another. It’s almost like financial natural selection,” Kazemian said, pointing to Curve, the largest decentralized exchange, and Aave, the largest lending protocol. Both announced they would develop and launch their own stablecoins in 2023.

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The founder believes it’s important to build infrastructure to make stablecoins competitive. With a lending market, the protocol can set interest rates and make decisions on collateral. 

“You also need a place to deploy protocol controlled liquidity, which is basically just another way of saying a swap facility, that, like, a central bank has, and make money from [transaction fees],” Kazemian said.

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Sam Kazemian mined Dogecoin and Litecoin while studying neuroscience at UCLA.

He said  Curve and Aave both realized that without being able to issue their own money,they were limited to being a product rather than a central bank.

Ryan Watkins, the co-founder of Syncracy Capital and a former crypto analyst at Messari, agrees – to a point. 

“Maker, Aave, Frax, and Curve are all converging towards the same end game: Stablecoins, stableswaps, and lending bundled into full-stack DeFi banks,” Watkins wrote on Twitter last year. In messages to The Defiant, he said there was no guarantee that approach would work. 

Integrate With Any Project

“Not everything needs to be built in-house,” Watkins said. “Spread resources too far, and you’re never going to be the best at anything – in a world of open source, permissionless protocols, best of breed is likely what wins.” 

The open-source, permissionless nature of DeFi means any project can integrate with any other project.  

“Why would you integrate with the second best?” Watkins said. “[It’s] not like you’re being forced to buy packages or any other kind of lock-in tactic.” 

Frax will also have to shake off the skepticism of being a partially algorithmic stablecoin. After the spectacular collapse of Terra’s UST, a fully algorithmic stablecoin, such projects have been viewed suspiciously, even within crypto. Politicians around the world have suggested banning them.

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Kazemian, in the interview, distanced his project from the term.

“I don’t think that same kind of algorithmic issue is relevant to us anymore,” he said. “Maybe the branding is kind of still with us. But I think the more apt [nomenclature] is that it’s basically a fractional reserve stablecoin.”

Circle’s USDC and Tether’s USDT are purportedly backed by cash or cash equivalents, though such backing has been called into question before. But both are issued by companies subject to regulatory oversight and approval, a fatal sin in the eyes of decentralization maximalists. 

Blue-Chip Cryptocurrencies

Decentralized alternatives, meanwhile, rely on collateral in the form of blue-chip cryptocurrencies, such as Ether, and in the case of DAI, a growing basket of tokenized, real-world assets. 

But those stablecoins are overcollateralized. The assets that back DAI, for example, are worth more than the DAI itself. 

Frax is aiming for 100% collateralization. Even that may be too little for some, wary of the volatility of Frax’s collateral and how it might handle a bank run.

Stable Assets

Kazemian says most of the collateral is in relatively stable assets, like USDC and DAI, with a smaller amount in more volatile assets, like ETH and wBTC. Only 7% of the collateral is FXS, Frax’s governance token, and the goal is to get that number to zero.

“I think its collateral ratio is fine for now,” Watkins said. “Philosophically, I think it makes sense for most stablecoins to gradually lower [their] system collateral ratio as their stablecoin becomes more adopted. But it’s very difficult to execute.”

It’s worked so far: FRAX has held its peg to the dollar despite the myriad crypto crises of 2022.

“There should be collateral, it should not look like Terra,” Kazemian said. “In fact, I think Terra was trying to be more like Frax before it exploded, because they basically wanted to have this dynamically shifting collateral ratio rather than basically having no outside collateral. … They didn’t get there in time.”

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