On February 1st, 2023, we released Frax Finance: Examining The Protocol’s Holy Trinity of De-Fi, offering updated insights on some of the themes covered here.

FRAX is a hybrid algorithmic stablecoin whose model is similar to that of UST. However, while UST is now 7.5% backed by exogenous collateral (i.e. BTC), FRAX is 84.5% directly backed by exogenous collateral, making it less reliant on the algorithmic component. This model is in contrast to an overcollateralized stablecoin such as DAI, whose CR ranges from 101-175%. Importantly, FRAX’s collateralization ratio is not static, but rather increases or decreases based on demand for the stablecoin (we dive into these mechanics later on in this post).

What are the benefits of this hybrid algorithmic model? To start, the more overcollateralized a stablecoin is, the more expensive and restrictive it is to create. This factor also impacts lending markets. For example, given that FRAX currently has a collateralization ratio of 84.5%, it’s able to offer cheaper borrowing rates than that of DAI, USDC and UST (UST borrowing rate is currently pegged at 20% given the Anchor rate). The Frax protocol is looking at lending and borrowing as one of the many ways it plans to differentiate itself over the long-term, the aspects of which we will dig into today.

Influence over stablecoin interest rates creates an extremely powerful lever for Frax to pull. As it gets more widely distributed and adopted, it will have the power to undercut and eventually influence these rates across the entire crypto economy. Coined by Andrew Kang of Mechanism Capital, this gives Frax similar powers to that of a central bank’s operations, impacting market wide interest rates, liquidity and asset prices.

FRAX’s Growth and Stability

So what has propelled FRAX’s growth thus far and how does it maintain its peg?

In V1, FRAX initially started out as a fully collateralized stablecoin. Then, as demand for the stablecoin increased over time, the CR decreased accordingly. The algorithmic portion of FRAX was backed