A few months after Frax launched in December 2020, the DAO started discussing whether they should look for yield off-chain. MakerDAO had just announced the End Game and was looking for RWA partners to invest part of its billion dollar treasury.
Several other crypto projects like Centrifuge and others lobbied the Frax DAO to approve and whitelist them to invest into RWAs. At the time, however, there was no need to move funds off-chain. Yields in DeFi were sky high, the market was booming, and Frax instead rolled out its AMOs that it used to collect CRV/CVX and farm with.
This strategy worked wonderfully until Luna collapsed. Prices crumbled, billions in paper wealth and borrowing power was destroyed, yields collapsed across the board, and investors left crypto in droves.
The strategies that had earned Frax tens of millions of dollars started to compress and be less effective. Then bond yields globally started to rise rapidly. In the space of a few months, the 30 year bond yield rose from 1.60% to over 5%, a true widowmaker trade.
In 2020, owning USDC was great because interest rates were at 0% and had been for several years. There wasn’t much reason to own US treasuries when crypto prices were skyrocketing.
In 2023, the environment has completely changed. Crypto is in decline, prices are down, and trust in the community was lost after FTX, Celsius and Luna imploded.
Investors now want the risk-free rate in short term US treasuries. US Treasury bond yields have risen rapidly in the past year going from near zero to 5%. Everyone now wants to hold them instead of USDC/USDT, but it's a totally different beast.
Frax has lost significant market share to Maker this year after they started to offer a 5-8% yield on the DSR. Frax never has offered single sided deposit vaults as it prioritized liquidity for its assets. Additionally, any yield that’s paid to single sided liquidity is also profits that could be paid out to FXS holders. So facing the music over its lack yield, Frax has adjusted this year.
Bringing US Treasury bond yield to the blockchain is not easy. As Multicoin Capital co-founder Kyle Samani said, “This is a standard issue. You need to get all relevant parties, such as issuers, underwriters, fund managers, auditors, buyers, sellers, brokers, banks, etc., to agree on the new standard.”
FinresPBC is the RWA custodian for Frax, just like how MakerDAO has entities holding T-bills and money market funds for it.
FinresPBC holds US dollar deposits in FDIC Insured IntraFi savings accounts and earns interest on them. Without seeking profits or collecting fees, it passes all yield it earns back to the Frax DAO.
But to be able to access these yields, Frax has introduced sFRAX and FXBs.
sFRAX offers a single-sided yield for depositors. sFRAX is similar to the DSR (Dai Savings Rate). It's a zero-duration yield vault where anyone can deposit $FRAX into an ERC-4626 smart contract and earn yield in the form of $FRAX stablecoins.
The Interest on Reserve Balances (IORB), which is currently 5.4%, is what the sFRAX will "soft target." If it is not possible, Frax will always prioritize maintaining a 100% collateral ratio for $FRAX before distributing yield to sFRAX.
On the other hand, 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.
It’s all part of Frax’s RWA strategy, and it's very easy to understand.
- Users deposit their FRAX tokens into a vault to get sFRAX.
- The DAO chooses the best option to earn yield based on current market conditions.
- If no good yield sources exist on-chain, Frax’s RWA partner (Finres) takes the FRAX tokens deposited in sFRAX and converts them into USDC.
- The USDC obtained from the conversion is taken off-chain and invested in US Treasuries.
- The receipt of this conversion is then converted to FRAX and transferred to the Frax treasury.
- Users can then buy the FXBs at a discounted rate to capture the yields at redemption.
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.
As Sam Kazemian said “FXBs don’t entitle the holder to any asset offchain and don’t give a legal right to redeem for fiat or anything like that therefore they’re just a utility token within the Frax Protocol. They only guarantee that each FXB converts to 1 FRAX stablecoin on maturity. That’s all.”
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.
All FXB tokens will be ERC20s with deep liquidity in Curve, as well as the usual bribes + FXS gauge incentives.
Given Frax's strategic utilization of the Curve flywheel, @cryptovestor mentions that he anticipates FXB could generate an overall APY ranging from 6% to 8% (U.S. treasuries yield of 5.25% + CRV, CVX, and FXS emissions).
If Frax can get a steady 8% yield on FXBs, what's the next step?
Imagine leveraging this impressive yield up to 9x on platforms like Fraxlend, BAMM, or Curve's LLAMA Lending market, incorporating soft liquidations.
Could APYs get as high as 15% - 25% when FXBs are employed in this fashion?
Like Sam, Kazemian said, “If we stay in a high-rate environment, we have to adapt and build new venues to capture rates. So, yes…sFrax and FraxBonds will be an integral part of Frax v3 and if the MakerDAO eDSR is any clue, degens are hungry for on-chain yield!