Messari: Detailed explanation of the operation mechanism and development status of Frax, an algorithmic stablecoin project

DAI (pegged 1:1 to the US dollar) created by MakerDAO is arguably one of the first and most successful stablecoins. Launched in 2017, DAI is now used for lending services throughout the DeFi ecosystem, or as a fiscal reserve token for project parties. DAI is minted when collateral is placed into the smart contracts of the MakerDAO protocol. To add a layer of stability, MakerDAO requires DAI to be over-collateralized, but this makes DAI less capital efficient.

In 2018-2020, as more users and platforms use stablecoins to earn profits, many protocols use stablecoins to expand digital products, and DAI, USDT and USDC have become the more common stablecoins in DeFi. But USDC has an inherent risk of centralization, it relies on USD, and MakerDAO's DAI is minted largely with USDC as collateral. In any case, the adoption of MakerDAO's DAI business and the platform itself has drawn industry insiders' attention to the necessity and growth potential of stablecoins in the Web3 ecosystem.

Before FRAX goes live on the Ethereum mainnet, i.e. before December 21, 2020, stablecoins are either fully collateral-backed (such as DAI) or fully algorithmically backed (no collateral-backed). First announced in May 2019 (then known as Decentral Bank), Frax Finance is a “fractional-algorithmic stablecoin” protocol. The project was created by Sam Kazemian, Jason Huan and Travis Moore. FRAX aims to be “the world’s first decentralized stablecoin, with a supply of tokens that are partly backed by collateral and partly algorithmically stabilized.”

FRAX is the first stablecoin to combine fully collateralized (like MakerDAO's DAI) and fully algorithmic stablecoin design principles to create a new scalable, trustless stable on-chain currency. FRAX is pegged 1:1 with the US dollar in an attempt to maintain the exchange rate of 1 FRAX = 1 US dollar.

FRAX's growth has been unforgettable. In Q4 2021, with the release of Frax v2, FRAX gained mass adoption and linkage to the entire DeFi system. As of January 25th, the Frax project funding pool is earning an average of $500,000 per day (about $180 million annualized) through the AMO (Algorithmic Market Making Program) that the team launched early in the fourth quarter of 2021. During the same period, the supply of FRAX climbed from less than $500 million to a staggering $2.6 billion.