Frax's DeFi Trinity Stack

Guest contributor Daesu lays out why he thinks Frax will be a leader the next bull run in crypto.

Oct 13, 2022
Frax's DeFi Trinity Stack

Editors note: this article was written by Daesu, an intrepid Flywheelpod listener and now contributor. Check out Daesu’s Substack or Twitter for more content.

The Frax Trinity Stack is one of the most innovative protocols in DeFi. This up and coming set of products for the Frax ecosystem has accomplished something no one else has. If you haven’t read up on Frax, its stablecoin, and the suite of DeFi products builty around it, please refer to the docs any time while reading this.

First things first, why is it called the Frax Trinity Stack?

Frax has merged the three major pillars of DeFi, swapping, lending, and money markets into one product stack:

  • Fraxswap: a decentralized exchange for swapping tokens, providing liquidity, and DCAing with Time-weighted Automated Marker Maker (TWAMM) orders.
  • Fraxlend: a money market for lending crypto assets to borrowers to earn an interest rate. Borrowers can access Frax liquidity that is ideal for leverage and liquidity needs.
  • FRAX stablecoin: earn by providing FRAX to different liquidity pools on Curve, Convex, Uniswap, Fraxswap. FRAX can also be supplied to lending protocols (Fraxlend, Olympus). Rewards are in various tokens (FXS, CRV, CVX).

The Frax ecosystem is governed by the FXS token. By locking FXS for up to 4 years for veFXS, voting power is earned by lockers and can be redirected to different gauges every 10 days. The vote weight of these gauges defines how future weekly FXS emissions are distributed (87.5k FXS). This allows markets that need Frax liquidity to compete for emissions. veFXS holders also receive a part of the Frax protocol revenues as FXS.

Liquidity providers can also benefit a boost up to 100% on the yield earned on specific Frax based LP tokens (stable and volatile pairs that have a gauge). Generally between 4 veFXS and 2 veFXS per 1 FRAX in LP are required to earn the max boost.

Frax is also a revenue-generating protocol with approximately $68m in annualized revenues thanks to their Protocol Owned Liquidity of $1.4bn. It is deployed into separate Automated Market Operation (AMO) controllers (Curve, lending, liquidity, investor) to have better control of the FRAX peg.

As an example, the POL in the curve AMO acts as a “floor” for FRAX to allow buying and selling on the open market that won’t drop the FRAX price by more than 1%. The AMO is configured to allow no more than 1% drop of the peg before recollaterizing (the docs describe well the whole functioning of the AMO).

The different AMOs generate fees and rewards in the various governance tokens where POL is deployed. The rewards earned by the AMOs bring the total value of Frax’s treasury above the Collateral Ratio. All of the excess value is used to do buybacks of FXS on the market and redistribute them to the veFXS holders. Frax also uses its cash flow to bribe vlCVX holders on Votium in order to deepen liquidity for FRAX pairs on Curve.

When the activity is high in defi or there is high demand for FRAX, the yield can be pretty juicy. Since the demand is pretty stable currently, veFXS APY mainly depends on the velocity of FRAX in the market.

The Frax protocol allows users to access the best yields for stablecoins thanks to Frax’s CVX voting power (they are the #1 holder of vlCVX) and a decent amount of liquidity to be flexible.

A profitable strategy for users who want to be long ETH and earn yield is the following:

Lend ETH on Fraxlend and borrow Frax. Then, choose a pool that matches your risk profile on the staking page, and provide liquidity. Stake the LP tokens and collect the rewards. For Fraximalists, relock the FXS rewards as veFXS.

Fraxswap was not involved in this example but you can swap rewards tokens to ETH for auto-compounding per example, or in another strategy, swap borrowed FRAX to WETH to get leverage.

That’s why I call it the Frax Trinity Stack. An all-in-one app. You’re using an equivalent of Aave + Uniswap + DAI in the same platform with some tweaks. That’s pretty awesome and it’s a decisive path to adoption because the first moves of a new defi user will be greatly simplified by using the Frax app.

But is there a real advantage to stay in the Frax ecosystem if the yield becomes higher elsewhere (on DAI pools per eg) or if the wind isn’t blowing in the direction of stablecoins?

My answer until recently was not so convincing. Yield farming is competitive. Now I’m sure that you’ll not have a better APY elsewhere than in the FRAX ecosystem. What has changed so quickly?

New details about the ETH liquid staking derivative by Frax protocol were recently released (thanks to the core dev Jack in the great flywheelpod here).

Everything we know about FrxETH so far
A summary of the latest interview with Frax Core Dev Jack Corddry

It will be a dual token model composed by frxETH and sfrxETH.

How does it works? Deposit ETH to get frxETH. The Frax protocol stakes the ETH in its own ETH validators. The staking yield will then be distributed to sfrxETH holders. The end-user has two options:

  • Provide liquidity on the soon to be launched frxETH-ETH pool on Curve. This pool will be a stable pool, we can consider frxETH like a stablecoin tied to ETH.
  • Stake frxETH to get sfrxETH. Only sfrxETH gets the staking rewards in ETH. The price of sfrxETH will rise as staking rewards accumulate.

The floor yield will be equivalent to the staking rewards collected by the Frax validators.

What’s really interesting here is that you may get a better yield in the frxETH-ETH pool than with sfrxETH.

Frax protocol will redirect a portion of his CVX voting power to this pool, so the emissions + the fees should provide a yield way higher than the 5% ETH staking yield.

What’s the game theory in play?

We can assume that not every frxETH holder will stake to sfrxETH because the yield might be higher in the Curve pool. But all the ETH converted to frxETH will be staked by FRAX into its validators.

So sfrxETH should benefit a higher yield than the base staking yield because the total staking rewards gained by frax validators aren’t distributed to all users who converted their ETH to frxETH, but only to those who hold sfrxETH. It can bring convergence between the two yields, and so increase the threshold for sfrxETH staking yield.

Why not directly create a sfrxETH-ETH pool?

FrxETH is the Defi composable version of the ETH staking derivative. Frax wanted to create a dual token model rather than a wrapped version of the same token due to the rebasing issues of other ETH staking derivatives. Rebasing tokens are harder to integrate in defi protocols because their values change every block, which screws with smart contracts.

Let’s go back to the frxETH/ETH pool. We can imagine that this pool will receive a FXS gauge and a potential 2x max boost (you need to lock 4x the amount of your deposit in veFXS to max it). If this pool attracts a lot of veFXS votes, it can be a non negligible bonus on top of the CRV and CVX rewards.

Now you can lend ETH and borrow FRAX (Fraxlend) > swap it to ETH (Fraxswap) > stake it to frxETH (Frax product) > deposit it into the curve pool and get potentially +7.5% yield on ETH.

There are rumors that Lido will start to acquire CRV or CVX, proving the value of the firepower that Frax has in the Curve wars and the advantage they’ll have every time they jump on a new product involving Curve.

Ultimately, a majority of ETH holders might switch to Frax ETH for higher yield in the more composable staking derivative to get more leverage by borrowing more ETH.

If Frax keeps the frxETH-ETH peg tight and the yield high, they’ll attract massive market share, expanding the FRAX supply due to leverage on frxETH through Fraxlend.

I’ll finish on this because if everything is executed correctly, one of the new narratives in a few months can simply be “why should we ever leave the Frax app?”

NFA, DYOR. Thanks for your time.

Take care, Daesu.

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