Most recent update: [July 8th, 2022]
No securities regulatory authority has expressed an opinion about the Crypto Contracts or Frax Protocol, made available on the VirgoCX Platform, including an opinion that Frax Protocol is not itself a security and/or derivative.
What is Frax?
In the ever-growing world of stablecoins, there are normally a select few that people flock towards to dip their toes in cryptocurrency. The Frax protocol features a stablecoin with a unique offering: it is the world’s first fractional-algorithmic stablecoin, meaning that it is partially collateralized and partially stabilized by an algorithm. Typically, stablecoins can be classified into three categories: collateralized coins backed by an asset, such as Tether; uncollateralized coins stabilized by an algorithm, such as DAI; or hybrid stablecoins which combine both, like Frax.
Frax is an open-source, fully on-chain protocol that operates mainly on Ethereum but is slated to become compatible with other blockchains in the future as well. The ultimate goal of Frax is to provide a scalable, decentralized, algorithmic currency rather than the fixed-supply digital assets that so many other protocols utilize in the market.
Along with the actual stablecoin (FRAX), the Frax protocol is actually a two-token system that also features another coin, Frax Shares (FXS), which acts as the protocol’s governance token. As it is a stablecoin, FRAX is pegged 1:1 to the US dollar, whereas FXS has its own trading price, independent from FXS.
Who is behind Frax?
The Frax protocol was conceived by American software engineer Sam Kazemian, who was the first to come up with the idea of a fractional-algorithmic stablecoin back in 2019. Kazemian thought of the concept when he noticed that, while stablecoins were rising in popularity, none had any mixture of algorithmic stabilization and traditional collateralization; at that point, algorithmic stablecoins had either failed or shut down without any significant breakthroughs in the market. Frax was then designed to measure the market’s response to an offering that was collateralized both algorithmically and traditionally with real assets.
How does it work?
The Frax protocol was the first of its kind when it was introduced, it attempted to solve the problems that lied within both traditionally backed and algorithmic stablecoins. Utilizing its dual token system, FRAX is able to always be pegged at $1, and its collateral ratio is adjusted according to market demands in order to keep it this way, rather than sticking to a predetermined ratio. For example, if FRAX were to rise above $1, then the platform will reduce the collateral ratio; the opposite is true – when FRAX is below $1, then the collateral ratio will be lifted. The collateralization ratio plays a key role: if the ratio is 80%, for instance, this means that 80% of FRAX is backed by collateral like USDC, whilst the other 20% is backed algorithmically.
While it is primarily Ethereum-based, Frax was designed to be interoperable across any chain. To this end, the protocol uses a bridging system that allows it to maintain fungibility, while allowing important functions and developer tools to be deployed among different chains, easing expansion of Frax into developing markets.
Frax Shares (FXS)
Perhaps the most important part of the ecosystem is its governance token, Frax Shares (FXS), the second of the protocol’s dual-token system. To begin with, minting FRAX requires a certain amount of collateral and FXS that need to be deposited into the protocol’s smart contracts. And, as the Frax team intended for the project to be completely community-driven with little in the way of top-down governance, FXS plays an integral role in how the protocol operates – but notably, it is not used to govern how the project is developed, as the management team believed that giving the token fewer functions would result in fewer disagreements amongst the community.
FXS’s operative functions include adding or adjusting collateral pools, adjusting various fees on the network (including minting fees), and refreshing the rate of the collateral ratio.
For community members, the most important function of FXS is that it provides a way to reward active participants in the protocol. One way to participate within the protocol is to act as a liquidity provider: users can earn FXS tokens by contributing to liquidity pools that allow FRAX tokens to become more tradeable around the crypto market, strengthening the token’s peg and usability.
Users that become liquidity providers can use the tokens they have contributed and stake them long term to multiply their rewards (a concept known as boosted staking, found on other decentralized protocols). Two factors influence the boost multipliers: the collateral ratio and the amount of time a user has staked their coins. Notably, time-locked tokens are applied as a boost to the proportion of all the stakes in each pool, meaning that the more tokens someone has locked up, the higher their boost. This is designed intentionally to keep staking competitive among users.
As FRAX is a stablecoin, its supply fluctuates based on the collateral ratio of the protocol. FXS, however, as the primary accrual and investment token, was launched with a supply of 100 million tokens. The novelty of the dual-token system is on display once again here as the more FRAX is utilized in DeFi ecosystems, the higher the value of FXS, as minting FRAX requires burning FXS in the process. This creates scarcity, increasing value for FXS holders. Furthermore, as FXS rises in value, the price stability of FRAX increases as well, creating a positive feedback loop for those who are using FRAX in other DeFi applications.
Drawbacks and risks
One of the most glaring risks for investors is that FXS is, by design, meant to be volatile as it supports the deployment of the protocol’s stablecoin. The price of FXS is heavily dependent on the collateralization ratio of the protocol as well as the amount of FRAX in existence at any given time, as we have noted in the previous section. To this end, investors need to be cautious when dipping their toes into the protocol’s governance token; taking care to understand how the protocol works and how the hybrid collateralization model plays into the price of FXS is the key to mitigating risks when dealing with Frax.
The Frax protocol is an extensive web of functions that make its dual-token system work. For a greater understanding of how the protocol operates in detail as well as the various mechanisms that support the Frax ecosystem, take a look at these in-depth resources here:
Frax’s Official Whitepaper
Frax’s Messari entry
Frax on Phemex Academy
Frax on Securities.io
Frax on CoinMarketCap
Prior to listing Frax on the VirgoCX Platform, VirgoCX performed due diligence on Frax and determined that Frax is unlikely to be a security or derivative under Canadian securities legislation. VirgoCX’s analysis including reviewing publicly available information on the following:
- The creation, governance, and location of Frax Protocol and/or its primary development team;
- The supply, demand, maturity and liquidity of Frax Protocol; and
- Legal and regulatory risks associated with Frax Protocol.
Statutory Rights under Securities Legislation
VirgoCX is offering Crypto Contracts on crypto assets in reliance on a prospectus exemption contained in the exemptive relief decision Re VirgoCX Inc. dated May 30, 2022 (the Decision). Please be aware that the statutory rights in section 130.1 of the Securities Act (Ontario), and, if applicable, similar statutory rights under the securities legislation of each other province and territory in Canada, do not apply in respect of the Crypto Fact Sheet to the extent a Crypto Contract is distributed under the prospectus relief in the Decision.