Many stablecoin protocols have entirely embraced one spectrum of design (entirely collateralized) or the other extreme (entirely algorithmic with no backing). Collateralized stablecoins either have custodial risk or require on-chain overcollateralization. These designs provide a stablecoin with a fairly tight peg with higher confidence than purely algorithmic designs. Purely algorithmic designs such as Basis, Empty Set Dollar, and Seigniorage Shares provide a highly trustless and scalable model that captures the early Bitcoin vision of decentralized money but with useful stability. The issue with algorithmic designs is that they are difficult to bootstrap, slow to grow (as of Q4 2020 none have significant traction), and exhibit extreme periods of volatility which erodes confidence in their usefulness as actual stablecoins. They are mainly seen as a game/experiment than a serious alternative to collateralized stablecoins. Frax attempts to be the first stablecoin protocol to implement design principles of both to create a highly scalable, trustless, extremely stable, and ideologically pure on-chain money. The Frax protocol is a two token system encompassing a stablecoin, Frax (FRAX), and a governance token, Frax Shares (FXS). The protocol also has a pool contract which holds USDC collateral. Pools can be added or removed with governance.
Although there's no predetermined timeframes for how quickly the amount of collateralization changes, we believe that as FRAX adoption increases, users will be more comfortable with a higher percentage of FRAX supply being stabilized algorithmically rather than with collateral. The collateral ratio refresh function in the protocol can be called by any user once per hour. The function can change the collateral ratio in steps of .25% if the price of FRAX is above or below $1. When FRAX is above $1, the function lowers the collateral ratio by one step and when the price of FRAX is below $1, the function increases the collateral ratio by one step. Both refresh rate and step parameters can be adjusted through governance. In a future update of the protocol, they can even be adjusted dynamically using a PID controller design. The price of FRAX, FXS, and collateral are all calculated with a time-weighted average of the Uniswap pair price and the ETH:USD Chainlink oracle. The Chainlink oracle allows the protocol to get the true price of USD instead of an average of stablecoin pools on Uniswap. This allows FRAX to stay stable against the dollar itself which would provide greater resiliency instead of using a weighted average of existing stablecoins only.
FRAX stablecoins can be minted by placing the appropriate amount of its constituent parts into the system. At genesis, FRAX is 100% collateralized, meaning that minting FRAX only requires placing collateral into the minting contract. During the fractional phase, minting FRAX requires placing the appropriate ratio of collateral and burning the ratio of Frax Shares (FXS). While the protocol is designed to accept any type of cryptocurrency as collateral, this implementation of the Frax Protocol will mainly accept on-chain stablecoins as collateral to smoothen out volatility in the collateral so that FRAX can transition to more algorithmic ratios smoothly. As the velocity of the system increases, it becomes easier and safer to include volatile cryptocurrency such as ETH and wrapped BTC into future pools with governance.