TLDR;

• Frax is emerging as a leader within the Real World Asset (RWA) narrative, after launching sFRAX last week.

• Frax’s buyback mechanism introduces an intriguing asymmetric risk/reward dynamic to the market, where accumulating FXS between $5 to $6 becomes an attractive proposition.

• frxETH v2 allows Frax’s validator set to become more decentralized and lowers the barrier for entry.

• Based on the success of other appchain launches, Fraxchain could be a game changer when it launches next year.

• We are bullish on the trajectory of Frax Finance over the next 6-12 months, in addition to the FXS token in relation to the rest of the altcoin market.

Introduction

This article outlines our bullish thesis on Frax Finance over the next 6-12 months, with several key factors driving its positive outlook. The buyback program, frxETH V2 adoption, Fraxchain launch, and Frax v3 and sFRAX all represent significant catalysts for growth and valuation appreciation. The intersection of Frax Finance and the real world asset (“RWA”) narrative also presents a unique opportunity for investors, as the protocol is leveraging this trend through innovative products like sFRAX and FXB.

We will dive into:

1. Buybacks

2. Catalysts

3. RWA Narrative

This piece does not introduce Frax’s key principles and history. However, If you want to get up to speed you can read our intro to Frax Finance piece here: An Intro Guide to the Stablecoin Revolution.

Buybacks

The Frax Finance buyback program, which was passed a few months ago, is a key factor within our positive outlook on the FXS price. The program involves:

• A $1 million TWAMM over 30 days when the price is below $5, which is stopped (even when the TWAMM is midway) when the price is above $5.

• A $1 million TWAMM over 30 days when the price is below $4, which is stopped (even when the TWAMM is midway) when the price is above $4.

This program, which involves purchasing FXS tokens worth $1 million over 30 days when the price falls below certain thresholds, carries profound implications for the protocol's stability and long-term growth.

1. Signalling a valuation floor to the market

At first glance, the buyback program appears focused solely on elevating FXS prices. However, its true significance lies in signalling a valuation floor to the market. By actively intervening when the price nears the $4 or $5 thresholds, Frax Finance is telegraphing a strategic message to investors - a commitment to maintaining a minimum value for FXS tokens.

2. Acquiring FXS cheap to be used in the future

A robust FXS price and the ability to acquire FXS at lower costs via buybacks enhance the functionality of Frax's AMOs. This efficiency ensures that emissions are used optimally, underlining the importance of the buyback program in enhancing protocol functionality.

3. Accruing value to protocol owned liquidity (POL)

POL is a measure of the liquidity that Frax Finance owns and controls. When Frax Finance buys back FXS tokens, it is increasing its POL. This can help to improve the stability of the Frax ecosystem and make it more attractive to users and investors.

4. Asymmetric Risk/Reward Dynamics

The buyback proposal introduces an intriguing asymmetric risk/reward dynamic to the market. By establishing a clear price floor at $5, the protocol creates a scenario where accumulating FXS between $5 to $6 becomes an attractive proposition, as the downside risk is minimized.

Catalysts

frxETH V2 adoption…

With a current Total Value Locked (TVL) of 275k ETH, equivalent to over $420M, Frax has carved a niche for itself in the burgeoning $20 billion Ethereum Liquidity and Staking Derivatives (LSD) market. The key to its success lies in its innovative frxETH v1, which introduced a stablecoin pegged to ETH and an interest-bearing LSD token. However, it is the upcoming frxETH v2 release that promises to revolutionize the industry further.

Background - frxETH v1 Success and Challenges

Frax Finance's initial foray into the LSD market with frxETH v1 was met with resounding success. The unique dual-token system comprising $frxETH (ETH pegged stablecoin) and $sfrxETH (interest-bearing LSD token) provided users with attractive yields and numerous utility options, including liquidity provision (LPing). Despite its achievements, the centralized nature of validators posed challenges, limiting scalability and true decentralization.

Innovation - frxETH v2 Unleashes Decentralization and Efficiency

Frax Finance's innovation in frxETH v2 addresses the limitations of its predecessor. The protocol now enables the decentralization of the validator set, a critical step toward a more robust and scalable network. Unlike its competitors, Frax allows permissionless borrowing of validators at a significantly lower collateral requirement of just 4 ETH. This lower threshold enhances capital efficiency for node operators, maximizing their leverage on proof-of-stake yields. Moreover, the automatic ejection of validators in case of excessive slashing mitigates systemic risks, ensuring the protocol's stability.

Key Features of frxETH v2

1. Best-in-Class APR

FraxETH v2 maintains its reputation for offering industry-leading Annual Percentage Rates (APR), attracting users and investors seeking optimal returns on their assets.

2. Fully Decentralized Validators

Frax's shift to decentralized validators ensures a more secure and censorship-resistant network.

3. Highest Node Operator Capital Efficiency

By requiring only 4ETH as collateral, frxETH v2 allows node operators to earn more staking rewards, as well as enable more participants to run nodes.

4. Deep Liquidity

The protocol's decentralized nature and lower collateral requirement encourage greater participation, resulting in deeper liquidity pools, enhancing the overall trading experience for users.

Fraxchain Launch

The upcoming launch of Fraxchain, their Layer 2 solution, marks a significant milestone in their journey.

Why Fraxchain?

Frax Finance’s strength lies in its diverse range of financial products. By consolidating these services on their own Layer 2 network, Fraxchain enhances efficiency and reduces costs. Users can seamlessly swap, lend, bridge, stake, and perform other functions within the ecosystem, all at a fraction of the cost they might incur on other platforms.

Fraxchain will be a “hybrid-rollup” that requires frxETH to be used as gas. This means that with increasing usage, frxETH would be burned for transactions, hence resulting in more yield for sfrxETH - every frxETH that onboards to Fraxchain reduces the available supply eligible to stake as sfrxETH.

Catalyst for Re-Rating

The launch of Fraxchain as a catalyst for re-rating is a compelling aspect. The crypto market has witnessed low activity Layer 2 solutions commanding significant market capitalizations, many over $100 million, a trend that Fraxchain is poised to leverage. Projects like $INJ have demonstrated substantial gains post-transitioning into an app-chain, rising 6x YTD ($570 million gain in market cap) showcasing the potential for significant valuation appreciation.

The imminent launch of Fraxchain’s testnet by the end of the year, followed by the full launch in early 2024, marks a crucial phase for Frax Finance.

Frax v3 and sFRAX

Frax revealed Frax v3 docs last week, a revolutionary upgrade, whilst launching sFRAX, a key component designed to navigate various market conditions and optimize yield for its users. This move marks a significant milestone for the Frax ecosystem, positioning it as a robust and adaptable solution in the stablecoin market.

Frax v3 and sFRAX: A Game-Changer in Stablecoin Ecosystem

At its core, sFRAX operates on a straightforward model. When users deposit FRAX into the sFRAX ERC-4626 vault contract, an equivalent amount of stablecoins (USDC or USDP) held in the treasury is allocated to FinresPBC. FinresPBC, acting on behalf of the Frax DAO, strategically invests these stablecoins into safe cash-equivalent assets such as FDIC-insured accounts, short-dated T-bills, Repos, and select money market mutual funds. This process allows sFRAX to harness off-chain capital effectively, generating yield and ensuring the stability of the stablecoin.

In addition, Fraxbonds (FXBs) are part of Frax v3 - ERC20 tokens that are sold at a discount and converted to 1 FRAX upon maturity. FXBs will have labels like FXB1-1-2024, indicating maturity dates.

Key features of sFRAX

1. Access to Risk-Free Yield

Frax v3's introduction of sFRAX addresses a critical gap in the stablecoin market - the ability to access risk-free yield akin to US T-Bill yield. In a landscape where other stablecoins struggle to provide competitive yields, Frax stands out by leveraging FinresPBC. With short-term T-Bill yields currently at 5.5%, sFRAX provides users with access to higher yields, preventing capital outflows and enhancing the platform's attractiveness in the market. This strategic move ensures Frax users can earn attractive yields on-chain in high-interest rate environments.

2. Adaptability to Market Conditions

sFRAX's dynamic nature equip the protocol to handle diverse market conditions. During periods of low interest rates, Frax can attract speculative capital via frxETH and sfrxETH, driving growth for the protocol. Conversely, in high-interest rate environments, sFRAX's robust strategy ensures a steady income for the protocol, creating a win-win situation for investors and the Frax ecosystem. This adaptability not only safeguards the protocol but also ensures sustained profitability for users.

3. Scalability and Growth Potential

Since its launch, sFRAX has absorbed a significant volume of FRAX, indicating strong market acceptance, having absorbed over 40 million FRAX since its launch last week.

Frax Finance and the Real World Asset (RWA) Narrative

The traditional finance landscape is evolving, as real world assets (RWAs) are at the beginning stages of becoming tokenized. Traditional financial assets, like private equity, credit, and bonds, are integrating blockchain technology to reduce cost, and enhance accessibility, efficiency and transparency. This movement, although in its infancy, has gained significant traction, evident in initiatives by global banks and leading crypto platforms. For example, JPMorgan carried out its first live blockchain-based collateral settlement transaction last week involving BlackRock and Barclays. Amid this landscape, Frax Finance stands out as a revolutionary force, leveraging the RWA narrative through innovative products like sFRAX and FXB.

The intersection of Frax Finance and the RWA narrative presents a unique opportunity for investors. With innovative products like sFRAX and FXB, Frax Finance is not only adapting to the changing financial landscape but also shaping it. As the RWA narrative gains steam, Frax Finance's strategic positioning and forward-thinking approach could position itself for substantial gains in the next bull run.

Wrapping up…

Our investment thesis on Frax Finance is undeniably bullish, underpinned by a comprehensive analysis of key factors shaping its trajectory over the next 6-12 months. The integration of strategic initiatives such as the buyback program, frxETH V2 adoption, Fraxchain launch, and the groundbreaking Frax v3 and sFRAX offerings position Frax Finance at the forefront of innovation in the crypto market. Moreover, Frax Finance's intersection with the Real World Asset (RWA) narrative highlights its ability to not only adapt to unfavourable market conditions but shape the evolving financial landscape.