DeFi: Frax Finance rolls out on-chain bonds. Will it impact USDT and USDC?
The Total Value Locked (TVL) in tokenized securities with U.S. Treasury exposure has grown 6x, reaching around $790MM in 2023
Today we highlight the following:
DIGITAL ASSETS: Frax Finance Completes V3 Rollout With On-chain Bonds
CURATED UPDATES: Financial Institutions and Adoption; DeFi and Digital Assets; Blockchain Protocols; NFTs, DAOs and the Metaverse
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DIGITAL ASSETS: Frax Finance Completes V3 Rollout With On-chain Bonds
DeFi protocol Frax Finance has completed its V3 iteration through the introduction of FXB tokens. FXBs are ERC20 tokens that resemble zero-coupon bonds and convert to the FRAX stablecoin upon maturity. The primary aim is for the stablecoin to exhibit behavior akin to real US dollars across various market conditions, encompassing both high and low-rate environments. Notably, Frax Bonds are compatible with Curve Finance pools, and their "Algorithmic Market Operations" (AMO) smart contracts conduct auctions of FXBs at a discount to face value.
Although FXBs have quite a limited supply, they represent a significant milestone for on-chain users seeking access to assets that resemble US Treasury bills.
The initial FXB tokens will mature on July 30, 2024, followed by December 31, 2024, and December 31, 2026. Each maturity has a total supply worth $500K, and they are sold through a Dutch auction, where the price is reduced until a buyer is found. At the time of our analysis, all the FXB tokens maturing in 2024 have been purchased.
Frax V3 has also recently introduced Staked FRAX (sFRAX), an ERC4626 staking vault that distributes part of the Frax Protocol yield weekly to stakers in FRAX stablecoins. The sFRAX token represents pro rata deposits within the vault, and the annual percentage yield (APY) aims to roughly track the interest on reserve balances (IORB) rate—considered the risk free rate—of the US Federal Reserve using the IORB oracle.
So we can see how the Frax V3 iteration aims to create a stablecoin that can maintain its value in various market conditions. This trend gained momentum in the past year, with several projects beginning to offer on-chain access to tokenized US Treasury exposure. The Total Value Locked (TVL) in tokenized securities with U.S. Treasury exposure has grown 6x, reaching around $790MM. This was mainly driven by the Stellar-based Franklin OnChain U.S. Government Money Fund and the Ethereum-based Ondo Short-term U.S. Government Bond Fund.
When it comes to stablecoins specifically, it is worth noting that the majority of the market cap is made up of fiat-based stablecoins, which carry significant unhedgeable custodial and regulatory risks. This is because their design requires holding bonds in regulated bank accounts. For example, PayPal’s PYUSD is 100% backed by U.S. dollar deposits, short-term U.S Treasuries and similar cash equivalents, and more than 65% of PYUSD on Ethereum is held in a single address. It is a good reminder that being fully backed by US dollar deposits is only a competitive advantage if the banks remain stable. Lest we talk about Signature, SVB, and Silvergate.
We have seen some attempts to address these issues - there are crypto-collateralized stablecoins like Aave GHO and crvUSD, but they are still quite centralized, with their top holders controlling 19% and 24% of their circulating supply, respectively. Another interesting idea is Ethena Labs’s USDe stablecoin. Briefly, USDe uses staked ETH (such as stETH from Lido) as the initial collateral asset, which generates a yield from staking rewards. To hedge the volatility of stETH, they use short perpetual futures, allowing access to liquidity while keeping assets in decentralized custody. This essentially makes the position Delta neutral, so changes in Ethereum's price do not impact the overall position, resulting in a synthetic dollar position that is stable relative to the price of Ethereum. The company has introduced some unique concepts, such as its defense against negative funding rates, which you can read about here. However, it is important to note that there are theoretical and economic limitations to this approach as well.
Overall, we are intrigued by the idea of an on-chain zero coupon bond released at a discount to face value, but the real potential lies in the growth of interest-bearing stablecoins, like sFRAX or USDe. This goes beyond just using stablecoins for lending services, where rehypothecation is common.
While we have highlighted the potential risks of many fiat-backed stablecoins, we do not anticipate a sudden crash of USDT or USDC. However, the emergence of interest-bearing stablecoin projects is likely to change the landscape, shifting the focus from non-interest paying stablecoins like USDT to those that do. Maybe we will even see Tether share some of that profit with its holders.
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Curated Updates
Here are the rest of the updates hitting our radar.
Financial Institutions and Adoption
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⭐ Ethereum Layer 2 Developer Polymer Labs Raises $23MM In Series A Funding - The Block
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Polygon To Launch 'AggLayer' Focused On Blockchain Interoperability In February - The Block
NFTs, DAOs and the Metaverse
Solana Mobile Announces Second Phone Shipping In 2025 - nftnow
1inch DAO Lawyers Up To Shield Members From Liability - Blockworks
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