Frax Finance Series Part 2: Curve AMO, the Biggest Growth Driver for the FRAX Stablecoin
Frax Finance launched relatively late compared to its competitors in the stablecoin and liquid staking markets, but has managed to grow rapidly. In this article series, we’ll analyze the strategy behind its growth, with a focus on on-chain data and Frax’s mechanics. Through our articles, we aim to convey our thoughts on how to grow a DeFi product in a sustainable way, and we believe that Frax Finance is a good example to follow as it has achieved both price stability and competitiveness against its peers. After a brief introduction to the mechanism, Frax Finance article series will analyze how Frax has grown.
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In the previous article, we discussed the mechanism of Frax Finance. Starting with this article, we will delve into the growth strategies employed by Frax Finance in the stablecoin and Liquid Staking Derivatives (LSD) markets. Alongside, we will present on-chain data analysis results and cover the actual actions that took place on-chain by Frax Finance.
After the introduction of the AMO concept, Frax Finance explored growth opportunities through various forms of AMOs. Notably, the Curve AMO significantly contributed to the rapid growth of FRAX from September 2021 to early 2022. In fact, over 60% of the FRAX issued during that period was through the Curve AMO. Even currently, the majority of FRAX is still issued by the Curve AMO. In this article, we will discuss how Frax Finance utilized the Curve AMO. First, we’ll describe the internal and external environment of the stablecoin market during the growth phase of FRAX.
The internal and external environment during the FRAX growth period
The state of the stablecoin ecosystem
From 2021 to the early part of 2022, competition among stablecoins was fierce, with major stablecoins already establishing their positions in their respective sectors. In the centralized stablecoin sector, USDC and USDT had already dominated the market. They had solidified their roles as the foundational stablecoins in the DeFi ecosystem based on their price stability. In the decentralized stablecoin sector, MakerDAO’s DAI, which had launched early on, held a leading position within the Ethereum ecosystem. In the algorithmic stablecoin sector, Terra Protocol’s UST led the way, while in the leveraged yield farming sector, Abracadabra’s MIM was at the forefront. Notably, UST grew on the back of the stable 20% interest rate offered by Anchor Protocol and MIM expanded through a leveraged yield farming structure for UST deposits.
The primary utilities of stablecoin protocols can be summarized as a stable store of value, a means of payment, an over-collateralized borrowing tool, and a means for yield farming. However, as mentioned earlier, it was challenging for FRAX to replace USDC and USDT as a stable store of value. From a yield farming perspective, it was not easy for FRAX to gain an advantage over UST, which had already accumulated significant capital and grown its ecosystem. Positioning FRAX as a means of payment was also challenging, as the infrastructure for decentralized assets to be used as payment methods was still lacking. Even if such infrastructure were in place, FRAX did not have a distinct advantage over USDC or USDT.
Issues to be addressed for the growth of the FRAX stablecoin
In September 2021, although FRAX achieved a market cap of $300M, it was insignificant compared to other stablecoins (DAI: $6B, LUSD: $600M, MIM: $800M). Frax Finance aimed to achieve both the elasticity of UST and the price stability of DAI through its partially algorithmic stablecoin mechanism. However, in reality, due to its ambiguous utility, there was a lack of demand, and it struggled to increase its issuance.
Due to its mechanism, in order to increase the amount of FRAX issued, the protocol needed to increase the amount of USDC collateral it held. For instance, if the Collateral Ratio (CR) is 0.8 and the amount of USDC collateral is $100M, the protocol can issue up to 125M FRAX (100M * 1/0.8). Therefore, to enhance FRAX’s presence in the stablecoin market, Frax Finance had to provide users with a compelling reason to continuously offer their USDC as collateral and issue FRAX in return.
However, given its nature as a stablecoin, the price stability of FRAX could not be sacrificed at all when creating utility. This is because the moment there’s an issue with price stability, FRAX’s value as a stablecoin would vanish, and users would not want to hold onto FRAX. Additionally, Frax Finance had to utilize the USDC collateral as efficiently as possible to issue a significant amount of FRAX. In essence, for FRAX to enhance its presence in the stablecoin market, it had to address the following challenges.
- Prioritizing and maintaining FRAX’s peg stability.
- Providing users with a sustainable utility that incentivizes them to issue FRAX.
- Making it possible to mint as much FRAX as possible with the protocol’s USDC collateral.
Explanation of Curve AMO
For the reasons mentioned above, Frax Finance began exploring more aggresseive strategies to increase the issuance of FRAX. The project team initially started by interpreting the CR (Collateral Ratio) in a way that would allow for expansive growth of FRAX. Based on this, they operated the Curve AMO, leading to a significant growth in FRAX.
Purpose of Curve AMO
Curve Finance’s Stablecoin — 3CRV pool is one of the effective tools for projects to maintain their stablecoin’s price at $1. Thanks to the Stableswap mechanism, a relatively large amount of FRAX can be exchanged in the market at $1 using the limited USDC, USDT and DAI liquidity provided. The goal of the Curve AMO was also to leverage this feature to effectively create liquidity where FRAX can be bought and sold at $1.
In the long term, Frax Finance aimed to reduce the reliance on the Frax’s base mechanism (referred to as the ‘v1 mechanism’ for convenience) described in the previous article, where FXS and USDC are combined to mint or burn FRAX. Instead, they intended to replace it with the FRAX3CRV pool on Curve Finance operated by Curve AMO. In reality, after the introduction of the Curve AMO, the v1 mechanism was not in operation regularly and only activated when the FRAX price significantly deviated from $1. The v1 mechanism likely required both DEX liquidity to sell FRAX at $1 and DEX liquidity to sell FXS at a reasonable price, whereas the above approach would have had the advantage of concentrating Frax Finance’s assets in the FRAX3CRV pool.
Interpreting CR values in AMO
In explaining the basic mechanics of FRAX, we explained that the CR value represents the amount of collateral against the amount of FRAX issued by Frax Finance. This value is partly due to the algorithmic nature of the stablecoin, meaning that it can have a value below 1, and as the value decreases, more FRAX can be issued against the collateral. This CR value also represents the minimum price that Frax Finance can guarantee to FRAX holders per 1 FRAX, even if the value of FXS in the market goes to $0. A CR value of 0.8 means that for every 1 FRAX issued in the market, the protocol has 0.8 USDC as collateral and can return at least 0.8 USDC per 1 FRAX to FRAX holders under any circumstances.
Based on the concepts explained above, with the introduction of AMO, Frax Finance began to interpret the CR value more aggressively. From this point on, Frax Finance viewed the CR value as the ‘lowest price floor that AMO can guarantee using its collateral for the FRAX already issued in the worst-case scenario’. Moreover, depending on how Frax Finance utilizes its collateral, the CR value can vary even for the same amount of collateral.
For instance, if 100 FRAX have been issued so far and the protocol holds 80 USDC, the traditional CR value would be fixed at 0.8. However, under the new interpretation, if the protocol deposits all 80 USDC as collateral into the Curve Finance’s FRAX3CRV pool, the CR value could be closer to 1.0, higher than 0.8. This is because, according to the stableswap mechanism, 80 USDC alone can maintain the exchange rate of FRAX to USDC near 1:1. Through this shift in perspective, Frax Finance established a driving power to issue FRAX more aggressively based on the AMO mechanism, even with the same amount of collateral.
Estimation of the Collateral Value in Curve AMO
The Curve AMO deposits both the USDC collateral provided by users when minting FRAX and the newly minted FRAX from the Curve AMO into the FRAX3CRV pool as liquidity. One might wonder how these newly minted FRAX tokens are backed since the collateral assets deposited into the Curve pool were already used as collateral for previously minted FRAX. This is possible due to the unique CR value calculation logic that the Curve AMO has.
Curve AMO calculates the value of the collateral based on the number of FRAX (#frax) and 3CRV in the pool (#3crv) at the extreme point. To be specific, Frax Finance assumes the situation where FRAX is continuously sold on the pool, resulting in a 1:CR exchange ratio between FRAX and 3CRV. In such situation, we expect the value of #3crv to be very small because FRAX makes up the majority of the tokens in the pool. The Curve AMO assumes the FRAX price to be $CR (because the exchange rate between FRAX and 3CRV tokens is 1:CR at this point). It multiplies #frax by CR and then adds the value of the remaining 3CRV in the pool (calculated at $1 per #3crv) to determine the collateral asset value of the Curve AMO.
The collateral asset value determined by the above formula is almost the same as the value obtained by multiplying the entire pool size (the sum of FRAX and 3crv liquidity) by CR (ignoring the value of 3CRV in the pool since the majority of tokens in the pool would be FRAX). For instance, if there are 1B each of FRAX and 3CRV in the FRAX3CRV pool and CR is 0.85, the collateral asset value held by the Curve AMO is roughly calculated to be $1.7B (2B * 0.85). This value is greater than the $1B of USDC that the Curve AMO provided to the FRAX3CRV pool. Thanks to this increased collateral asset value, Frax Finance can calculate a higher collateral value relative. Based on this, they issue more FRAX in addition to the previously minted FRAX.
In this approach, while the amount of collateral assets held by Frax Finance remains unchanged, Frax devised a method to inflate the perceived value of the collateral. Based on this inflated value, they established a leverage structure to issue additional FRAX. Ultimately, the value of the collateral assets held by Frax Finance is leveraged to reflect both the value of newly issued FRAX and the original USDC. In other words, through Curve AMO, Frax Finance introduced a technique to leverage the assets held by the project team, based on the liquidity concentration techniques used in DeFi.
The Action of Frax Finance through Curve AMO
How Curve AMO works
Curve AMO manages the liquidity of the FRAX3CRV pool through a strictly protocol-owned liquidity approach. Primarily, the majority of the liquidity in the FRAX pool is managed by Frax Finance through Curve AMO. Depending on the market price of FRAX, Frax Finance directly manages the liquidity of the FRAX3CRV pool. For instance, when the price of FRAX drops, it withdraws FRAX tokens from the pool to adjust the FRAX:3CRV ratio. Conversely, when the FRAX price rises, Curve AMO issues FRAX and supplies it to the FRAX3CRV pool as liquidity, aligning the ratio of FRAX to 3CRV. This operational method offers the following advantages:
- Frax Finance has the capability to issue the majority of FRAX in the market and also holds most of its liquidity. Based on this, the project team can limit the maximum selling pressure that might occur in the market for FRAX. Consequently, they can control the potential decline in its price.
- When the price of FRAX rises due to buying pressure, the number of USDC, USDT, and DAI tokens in the FRAX3CRV pool increases. Since the majority of the pool’s liquidity is owned by Frax Finance, the project team can expand the scale of their collateral assets. On the flip side, when there’s a significant selling pressure on FRAX, the project team can proactively adjust the ratio of FRAX to 3CRV tokens by retrieving and burning FRAX from the pool. This strategy minimizes the outflow of collateral assets like USDC, USDT, and DAI held by the project.
The Impact of Curve AMO
The ratio of FRAX to 3CRV tokens in the liquidity pool. The image above shows the daily average changes in the number of FRAX and 3CRV tokens held in the FRAX3CRV pool. From its start in 2021 until 2023, when the FRAXBP pool was introduced and reduced the liquidity of the FRAX3CRV pool, the balance between FRAX and 3CRV tokens mostly stayed steady. Notably, even with challenges in May and November 2022, like the collapse of Terra Protocol and FTX bankruptcy, the ratio of FRAX to 3CRV remained stable. This suggests that Curve AMO effectively managed the price of FRAX in the FRAX3CRV pool, helping keep its price steady.
Changes in the size of the liquidity pool. The FRAX3CRV pool experienced rapid growth, growing from a TVL of less than $300M in July 2021 to nearly $3B by the end of 2021. The liquidity owned by Frax Finance in the FRAX3CRV pool consistently accounted for over 60% of the total, and more than half of all issued FRAX was always staked in the FRAX3CRV pool. This highlights the significant role the FRAX3CRV pool played in FRAX’s growth, with Curve AMO being a key contributor.
The chart above displays the cumulative net amount of FRAX (left image) or 3CRV (right image) supplied to the FRAX3CRV pool over time, broken down by method (such as AddLiquidity, TokenExchange, RemoveLiquidity, etc.). A positive value means that the supply of that token to the pool was greater than the withdrawal, and a negative value means that the withdrawal of that token from the pool was greater than the supply of that token to the pool.
From October 2021 to April 2022, as the FRAX3CRV pool saw rapid growth, the amount of 3CRV supplied to the pool through TokenExchange, or swaps, was positive and continually increasing, while the amount of FRAX was negative. This indicates that as users purchased FRAX supplied to the pool via Curve AMO, Frax Finance consistently expanded its USDC collateral assets. This is noteworthy because the tokens issued through the leveraged structure created by the Frax Finance team were used to increase the size of the assets held by the project team.
The top three addresses that supplied the most FRAX to the FRAX pool all supplied FRAX to the pool with AddLiquidity alone. These addresses are 0x17e06ce6914E3969f7BD37D8b2a563890cA1c96e (1,766,000,000 FRAX), 0x234d953a9404bf9dbc3b526271d440cd2870bcd2 (205,000,000 FRAX), respectively, 0xd1c63e86d49bbb03077d2fea2def863b5f1d2edf (105,516,858 FRAX) to the pool, all of which are believed to be addresses associated with the Frax Finance team.
Analysis of Main Transaction
A period of growth for FRAX. During FRAX’s growth phase from October 2021 to January 2022, there was a significant increase in the issuance of FRAX. As I’ll detail later in this article, Frax Finance was taking the lead in the Curve wars at this time. This allowed Frax Finance to seed large amounts of CRV rewards into the FRAX3CRV pool, which was creating demand for FRAX. The chart below shows the liquidity changes of FRAX tokens in the Curve pool at that time. Throughout this period, there was a consistent purchase of FRAX using 3CRV tokens, leading to an increasing proportion of 3CRV tokens in the pool. Frax Finance regularly added FRAX to the pool to ensure that the proportion of FRAX remained above a certain level. The cascading increases in FRAX liquidity seen in the chart below can be interpreted as the moments when Curve AMO supplied FRAX to the pool.
The Terra Depegging Incident: Let’s examine the transactions during the period when Terra’s UST destabilized, causing overall instability among stablecoins. The chart below depicts the liquidity changes in the FRAX3CRV pool from May 11th to 13th, 2022, during the UST Depegging event. Due to the growing concerns about algorithmic stablecoins at that time, many addresses were selling off their FRAX. As a result, the pool consistently saw a decrease in CRV3 tokens and an increase in FRAX, constantly disrupting the ratio between FRAX and CRV3. The Frax Finance team intervened by withdrawing FRAX from the pool using the RemoveLiquidity function whenever the FRAX to CRV3 ratio exceeded approximately 1.4:1. The volume of FRAX withdrawn during these interventions was substantial, around $100M per transaction. This strategy helped maintain the price of FRAX in the FRAX3CRV pool and prevented the protocol's USDC collateral from being excessively drained to FRAX sellers. The relevant transactions are as follows. Additionally, you can check out more transaction details where the Frax Finance team withdrew FRAX through our linked Dune Query Table below (0x04f34a, 0x020d32, 0x1d5596, 0x3f95c5).
Wrapping up
When designing tokenomics, two crucial keywords often mentioned are token price defense and creating demand for the token. From this perspective, the Lano Technology team identifies the following points as the driving forces behind FRAX’s rapid rise in the stablecoin competition since 2021. Based on these points, Frax Finance has consistently generated demand for their token. Even as they increased the token’s supply, they managed to control price drops due to massive sell-offs by token holders.
Points in terms of Token Price Defense
Controlling token circulation is closely related to defending its price. Many services have tried to achieve this by offering utilities that burn tokens. While various ideas and techniques have been proposed, few have successfully established a stable tokenomics. However, Frax Finance has incorporated the concept of protocol-owned liquidity better than any other project. They limited the amount of FRAX released into the market to a level they could manage in terms of price defense. As a result, even during rapid growth, FRAX did not experience de-pegging (the only significant de-pegging occurred in March 2023 when the collateral, USDC, dropped to $0.9).
The team controls the token price by holding the majority of its liquidity. Even if there’s significant liquidity in a DEX pool, a project can’t rest easy. This is because liquidity providers can withdraw their liquidity all at once, depending on market conditions, potentially depleting the token’s liquidity. Since the size of the DEX pool’s liquidity greatly influences token price stability, Frax Finance ensured they owned and controlled the majority of the liquidity for FRAX to prevent any potential depletion.
The team adjusted the issuance of FRAX based on the liquidity they could control. FRAX held by regular holders, not the team, can be dumped in the market at any time. Recognizing this, the Frax Finance team limited the amount of FRAX to be issued in the market based on the size of the liquidity they held in the FRAX3CRV pool.
Points in terms of Project Growth
Setting the leverage ratio for assets owned by the protocol. Issuing new tokens to provide holders with yield farming opportunities is akin to leveraging the assets (treasury size, community support) the team holds to issue new assets. In most cases, factors like liquidity shortages and selling pressures cause the pillars supporting the leverage to collapse, leading to a decline in token value. In the case of FRAX, the project team only issued new FRAX to a level where its value could be maintained based on Curve’s Stableswap mechanism. Furthermore, these newly issued FRAX were used to supply liquidity to the FRAX3CRV pool. Many projects struggle with determining how many tokens to issue, but FRAX calculated how much could be issued based on DEX liquidity. Indeed, even amidst various events in 2022, FRAX maintained its price stability. From this perspective, Web3 projects looking to use tokens as ‘leverage’ to drive project growth can reference how much to issue through Curve AMO.
Creating sustainable demand for FRAX. Although not mentioned in the article, it was essential for Frax Finance to continuously generate demand for FRAX through Curve AMO and expand its collateral base through this buying demand. Unlike other projects that issue tokens (in Frax’s case, FXS) to provide rewards to holders and artificially create demand only temporarily, Frax Finance considered incentives that could be relatively sustained in the DeFi ecosystem.
The incentive mechanism utilized by Frax Finance was the CRV rewards from Curve Finance. From the early stages of Curve, Frax Finance secured voting power to ensure that CRV rewards were distributed to the FRAX pool. This strategy generated demand for providing liquidity to the FRAX pool in the market and, consequently, created demand for the FRAX token itself (indeed, the liquidity size of the FRAX3CRV pool was highest when the CRV token price was high). This approach by Frax Finance is more sustainable than simply distributing FXS as rewards. This is because, in the early stages of a project, FXS liquidity might not be well-established, and even a small issuance and distribution of FXS could lead to a price drop. In contrast, CRV has a relatively large liquidity pool, ensuring that Curve Finance’s CRV rewards will be effective for a considerable period. In essence, Frax Finance leveraged an external, larger, and more sustainable yield source to drive its growth.
Conclusion
In tokenomics, the two most challenging issues are defending the token price and generating demand for the token. Particularly, devising a strategy for token price defense is difficult. There’s no clear benchmark for determining how many tokens can be issued at any given time, and it’s unpredictable how much of the issued tokens will be burned or locked up as intended by the project. Lano Technology often refers Frax Finance’s model when proposing tokenomics strategies to our clients. Among them, we frequently suggest strategies based on the Curve AMO for adjusting token issuance.
- Maximizing liquidity supply to their token by utilizing the assets held by the project team as efficiently as possible.
- Proposing a token price stabilization strategy using the liquidity the project team holds in their token’s DEX pool.
- Setting the token issuance volume based on the size of the DEX liquidity held by the project team to stabilize the price.
Through these strategies, we assist web3 projects in focusing solely on generating demand for their tokens through their services (unlike the previous bull market where DeFi grew centered around Yield, we believe that future demand for tokens will be generated from the value of the services the project provides, rather than yield).
