Original Design
The original Frax framework
⚠️ The original mint/redeem model explained here has been retired in favor of later (V2 onwards) mechanisms and is for historic / information purposes only ⚠️
Frax originally launched on December 20th, 2020. In Frax V1, there was only a single mint/redeem AMO, the fractional-algorithmic stability mechanism. We refer to this as the base stability mechanism. You can read about it in the Core Whitepaper.
In Frax v1, the collateral ratio of the protocol is dynamically rebalanced based on the market price of the FRAX stablecoin. If the price of FRAX is above $1, then the collateral ratio (CR) decreases ("decollateralization"). If the price of FRAX is below $1 then the CR increases ("recollateralization"). The protocol always honors redemptions of FRAX at the $1 peg, but since the CR is dynamic, it must fund redemptions of FRAX by minting Frax Share tokens (FXS) for the remainder of the value. For example, at a 85% CR, every redeemed FRAX gives the user $0.85 USDC and $0.15 of minted FXS. It is a trivial implementation detail whether the protocol returns to the redeemer $0.15 worth of FXS directly or atomically sells the FXS for collateral onchain to return the full $1 of value in collateral – the economic implementation is the same.
This base mechanism can be abstracted down to the following:
Decollateralize - Lower the CR by some increment every time if FRAX > $1
Equilibrium - Don't change the CR if FRAX = $1
Recollateralize - Increase the CR by some increment every time if FRAX < $1
At its fundamental core, the Frax Protocol is a banking algorithm that adjusts its balance sheet ratio based on the market's pricing of FRAX. The collateral ratio is simply the ratio of the protocol's capital (collateral) over its liabilities (FRAX stablecoins). The market 'votes' on what this ratio should be by selling/exiting the stablecoin if it's too low (thereby slightly pushing the price below $1) or by continuing to demand FRAX (thereby slightly pushing the price above $1). This decollateralization and recollateralization helps find an equilibrium reserve requirement for the protocol to keep a very tight peg and maximize capital efficiency of money creation. By definition, the protocol mints the exact amount of FRAX stablecoins the market demands at the exact collateral ratio the market demands for $1 FRAX.
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