Frax v3 is coming. Soon™.

Sam K has been dropping cryptic hints on Telegram and Twitter Spaces about Frax v3, FXB, BAMM and FPI. One thing that’s stuck in our collective heads is how Fraxbonds will work to bring treasury yields on chain.

So let's dig deeper into what we know about Frax v3 and how it will scale Frax with Fraxbonds.

What is Frax v3?

In March of this year USDC depegged after Silicon Valley Bank failed and questions quickly arose about the solvency of Circle’s bank deposits. Over the course of 3 days, the USDC price dipped to $.92 and dragged Frax down with it. In the wake of this crisis the protocol needed an upgrade to its core stablecoin product to ensure this type of depeg would never happen again.  

Frax Finance Founder Sam Kazemian calls Frax v3 “"the final stablecoin.” It's a new system that will allow Frax to own the entire monetary stack from top to bottom.

How does Frax v3 work?

From what we know so far based on what Sam K has said in Telegram and published on the governance forums, Frax v3 will be dependent on Financial Reserves and Asset Exploration Inc Public Benefit Corporation (FinresPBC) to connect TradFi yields to Frax.

In FIP-277, Sam K proposed establishing Finres “to provide the Frax Protocol access to safe cash-equivalent assets and near Fed rate yields for the benefit of all without seeking to make profit from this relationship or charge fees”

Finres will hold Frax collateral on its books and be able to do the following with it:

1. Hold US Dollar deposits in FDIC Insured IntraFi savings accounts & earn yield on such accounts.
2. Mint/Redeem Paxos USDP stablecoins & earn yield.
3. Mint/Redeem Circle USDC stablecoins & earn yield.
4. Hold/Purchase/Sell United States Treasury Bills in segregated brokerage accounts & earn yield.

So based on this it probably will do the following.

1. Open an account at a bank or several banks where it will hold cash in a FDIC secured savings account. In the FIP Lead Bank was mentioned as the first institution Frax would work with. However, other institutions were called on for their services and other on-chain solutions like Ondo and Open Eden might be eligible as well.
2. Receive USDC and USDP from the treasury, convert it from stablecoins to cash, and then hold the cash in a savings account(s)
3. Invest the cash into T-Bills with the help of a brokerage (like Paxos?)
4. Send all the yield earned from the savings and brokerage account back to Frax by minting USDP/USDC and transferring it to the treasury.

It’s unclear how much collateral Finres will hold. We would guess somewhere between $100-200m worth of collateral to start and then this would grow as operations streamline and more TVL flows into the protocol.

It’s also unclear how this will affect existing liquidity pools. In a previous deal that Paxos proposed to MakerDAO that they “offered to pay Maker 45% of the current Federal Funds Rate, which currently stands at 4.3%, on all USDP deposited in the PSM,” as reported by The Defiant. While Frax doesn’t have a PSM to invest FRAX into for yield, it does have the FRAXPP and FRAXBP base pool which is paired to USDP and USDC. Paxos/Circle could take a daily average TVL number and pay out interest accordingly to that figure. We will find out more soon once Finres is onboarded.

What we have learned about in the past week though is that Fraxbonds is a game changer for Frax v3.

What is Fraxbonds (FXB)

Fraxbonds are “decentralized utility tokens that denominate a debt in FRAX stablecoins at a certain timestamp” according to Sam K. FRAX holders will be able to buy discounted FRAX at a later date in the form of Fraxbonds or FXBs.

So for example, you could buy $1 worth of FRAX 2 years from now for $.90. When you swap the FRAX into the bond, the protocol now owns that collateral can do what it needs to ensure sufficient income is earned to pay the debt in two years.

FXBs automatically convert into FRAX at designated maturity dates annually on January 1st. Frax will offer 1, 2, 3, or 4-year terms for FXBs. This will allow Frax to bring the yield curve on chain (at least for 4 years heh).

Frax will earn this debt by taking the collateral backing the FRAX, USDC or USDP, and then use FinresPBC to swap the collateral into cash and then invest it into treasuries with the nearest date to expiration or even other yield markets like Fraxlend, Aave, or Compound, if the yields are high enough.

In a sense, Frax is becoming a bank-like structure. It acquires cash from FXBS, then gets to earn yield. Unlike a bank, it's not rehypothocating collateral or obtaining untenable amounts of leverage through fractional reserve lending.

Here’s where the secret sauce comes in…

Depending on the date, you can’t always buy bonds with the exact duration you need. Sam K says that “one way to make sure that FXBs mature with FRAX being fully backed is to match them with the closest T-bill yield maturity. But it's not a requirement nor a guarantee/legal obligation.” This means that Frax will have periods where it is sold 4 months of yield for the cost of a 3 month t-bill. In the 4th month, when the bonds matures, Frax will have another month to earn extra yield, that will go straight to veFXS.

According to Sam K, FXBs are “infinitely scalable” as Finres can purchase unlimited amounts of treasuries and pass the yield on.

FXBs will of course be included into Frax’s Curve/Convex Flywheel. Sam K said that each expiry should have its own pair in Curve with staking locks and incentives passed down from Votium bribes. FXB’s probably will be added to Fraxlend or crvUSD debt markets, but not much has been said about this yet.

So all in all, FXB is poised to take FRAX to a new level, one that is infinitely scalable and can bring a treasury yield curve on chain. This will mark a new turning point for Frax and its entire product suite.