Star project Frax(FXS) on LSD Section <Hotbit Research>

8 min readMar 12


Understanding The Advanced Functions and Nature of LSD Through Frax

As Shanghai upgrade is becoming imminent, the popularity of LSD has been growing increasingly, with the competition among relevant projects getting intensified as well. Today, we will briefly introduce Frax Finance and the sources of its income.

Frax Finance Ecosystem

The Frax Protocol issues innovative, decentralized stablecoins and contains subprotocols to support them. The Frax Protocol currently issues 3 stablecoins: FRAX, FPI, and frxETH.

The Frax Protocol also has 3 subprotocols within it that integrate its stablecoins: Fraxlend, Fraxswap, and Fraxferry.

Core concepts to understand the unified Frax Finance ecosystem include:

  • Three Stablecoins– The Frax Protocol currently issues 3 stablecoins. FRAX, a USD pegged asset. The Frax Price Index (FPI) stablecoin, the first stablecoin pegged to a basket of consumer goods creating its own unit of account separate from any nation state denominated money. FraxEther (frxETH), pegged to ETH for use as a replacement for WETH in smart contracts.
  • Fraxswap, a native AMM — Fraxswap is the first AMM with time weighted average market maker orders used by the Frax Protocol for rebalancing collateral, mints/redemptions, expanding/contracting stablecoin supply, and deploying protocol owned liquidity onchain.
  • Fraxlend, permissionless lending markets — Fraxlend is the lending facility for Frax-based stablecoins allowing debt origination, customized non-custodial loans, and onboarding collateral assets to the Frax Finance economy
  • Fraxferry, optimistic transfer protocol for Frax-based tokens — Fraxferry transfers natively issued Frax Protocol tokens across many blockchains.
  • Frax Share (FXS) as base layer governance token — Frax Share (FXS) is the governance token of the entire Frax ecosystem of smart contracts which accrues fees, revenue, and excess collateral value. FPIS is the governance token of FPI only and splits its value capture with FXS holders.
  • Gauge Rewards System — The community can propose new gauge rewards for strategies that integrate Frax-based stablecoins. FXS emissions are fixed, halve each year, and entirely flow to different gauges based on the votes of veFXS stakers.

Considering the fact that the main purpose of this article is to analyze Frax’s sources of incomes, first, we need to know more about

frxETH and sfrxETH

ETH in the Frax ecosystem comes in two forms, frxETH (Frax Ether), and sfrxETH (Staked Frax Ether).


frxETH acts as a stablecoin loosely pegged to ETH, so that 1 frxETH always represents 1 ETH and the amount of frxETH in circulation matches the amount of ETH in the Frax ETH system. When ETH is sent to the frxETHMinter, an equivalent amount of frxETH is minted. Holding frxETH on its own is not eligible for staking yield and should be thought of as analogous as holding ETH.


sfrxETH is a ERC-4626 vault designed to accrue the staking yield of the Frax ETH validators. At any time, frxETH can be exchanged for sfrxETH by depositing it into the sfrxETH vault, which allows users to earn staking yield on their frxETH. Over time, as validators accrue staking yield, an equivalent amount of frxETH is minted and added to the vault, allowing users to redeem their sfrxETH for a greater amount of frxETH than they deposited.

What are the differences between frxETH and sfrx ETH? Why are they designed like this? In short:

  • frxETH = The stETH without staking rewards.
  • sfrxETH = wstETH,plus frxETH’s staking rewards

The design of frxETH is quite unique. When you deposit $ETH into Frax, you will receive 1:1 of frxWTH, just as 1 ETH = 1 wETH. In order to obtain staking incomes, you must stake your frxETH into sfrxETH. In case that only half of all users choose to stake their frxETH into sfrxETH, then the stakers of sfrxETH will receive 2 times of incomes.

Take a look at Convex, you will find that the Base vPAR of stETH-ETH is much higher than that of frxETH-ETH pool, why? The reason is that LPs may receive stETH’s staking rewards as well, which allows Lido to distribute less LDO rewards to reach target APR and liquidity.

Frax holds a huge amount of CVX, which may be used to bribe CRV rewards. Considering the fact that the popularity of algorithmic stablecoins is decreasing, Frax may intend to use CVX into other channels. Frax may substitute the staking rewards in Curve with CRV rewards, which may be the reason that frxETH is designed to obtain staking rewards.

Frax Finance enjoys a relatively high income among all projects in the DeFi ecosystem, with its APR (Annual Percentage Rate) over 7%. After serving as LP, the income of Convex/Curve is even higher, which is over 10%. However, the price of frxETH has not merely decreased, which may lead to the fact that the investors will not receive relevant incomes from the decrease and increase of the price of frxETH. Frax charges 10% of commission from its node providers, but until recently, it seems that Frax has not paid any bonus to any node providers, which means that Frax is comparatively centralized. Overall, FXS is suitable for those DeFi users who are either more professional or familar with Frax/Curve ecosystem.

Considering the fact that the rewards of ETH staking are comparatively equal, then what happened to those LSD projects with high incomes? As the saying goes: if you don’t know the source of income, then you are the source of income.

Incentives of Protocol Assets

First, we uses an arrow chart to analyze the income distribution system of Frax/frxETH by marking the sources of incomes with red colour:

  1. FXS token incentives means directly offering the interests of Frax Finance to frxETH Pool.
  2. The vlCVX/veCRV voting controlled by Frax indirectly prompts CRV/CVX to provide incentives to frxETH Pool.
  3. ETH’s staking incentives

We can see that the incentives are overall provided by Frax Finance, no matter directly or indirectly, with just the forms and packages of such incentives being different. We can generate a clearer view of the distribution regarding the source of incomes by simplifying the chart above:

  1. The protocol asset/income of Frax Finance encourages frxETH.
  2. The staking incomes of both frxETH and sfrxETH are allocated to sfrxETH.

By enjoying “double” staking rewards exclusively, the APR of sfrxETH is consequently higher as well.

We can see from the analysis above that the extra incomes of frxETH are generated from the direct or indirect subsidy of protocol assets.

Someone may ask: is such model mentioned above like an unlimited circulation like Matryoshka dolls then?

Well, actually:

Protocol assets involve opportunity costs, for example, vlCVX/veCRV themselves can be used to gain bribery incomes.

  1. As long as the protocol is not a scamcoin, it requires empowerment, for example, commission deducted from incomes, and when the protocol has reached a certain scale, the value of commission charge will almost reach the same level as bonus, and then there will be no extra income anymore.

The meaning of such model:
It is expected that the popularity of LSD will increase drastically after the Shanghai upgrade, which may lead to scale effects in its development. Hence, by taking the advantage of such development, users will receive substantial incomes.

Are such extra incomes sustainable?

The increase of the values of staking assets / protocol assets will undoubtedly dilute the extra incomes, in case that the value of protocol assets increases compared with ETH due to various causes such as their prices, such progress of dilution will be extended, and vice versa. In another word, the model involves conspicuous reflexivity. Hence, despite the fact that the nature of such model is bonus, a delicate packaging is also required, as the value of the protocol assets can be increased and promoted through more exciting descriptions and introductions for positive feedback.

Arbitrage Based on Interest Margins

The nature of increasing incomes through lending protocols for the purposes of leverages and staking is actually arbitrage based on interest margins. Despite the fact that it appears that the deposit party is in a relatively disadvantaged position, the lender also undertakes extra risks of LSD protocol and liquidity. The lending protocol serves as the channel through which the interest rates of staking are transmitted into native assets.

Take stETH for example, what’s the operating method and incomes of revolving loans?

Processes of Operation:

Suppose that you hold 1 ETH, and that stETH/ETH =1

  1. 1ETH exchanged into 1 stETH
  2. 1 stETH deposits into AAVE, AAVE stETH’s LTV(Loan to Value) is 69%
  3. Borrow 0.69 ETH from AAVE

Repeat the 3 steps mentioned above

By following the progress above, you will hold

  • Asset: 1+0.69+0.69*0.69…. = 1/(1–0.69) = 3.2 stETH
  • Debt: 0.69+0.69+0.69*0.69… = 0.69/(1–0.69) = 2.2 ETH
  • Multiple of Leverage 3.2/1 =3.2 at last

The calculation of incomes are listed as below

Suppose stETH Staking APR=5.5%,The APR of ETH loan=2%

  • Annualized Staking Income: 3.2*5.5% stETH
  • Annualized Loan Interest: 2.2*2% ETH

The total income will be (Staking income — loan interest)/Capital=(3.2*5.5% stETH- 2.2*2%


Note: Many times of repeated operations also involve relatively huge costs of gas fees, the users may also borrow ETH through flash loans, but flash loans also involve their costs.

Extra Workload, Extra Incomes

The unprofessional but simple description of Re-staking, so-called borrowing the security of ETH mainnet through third parties, can be listed as below:

  1. The operations of networks and applications require nodes to guarantee their security.
  2. In order to guarantee security, the wrongdoings of nodes will be punished
  3. The nodes are required to keep a certain amount of security deposits, and in case any nodes are involved in any misconducts, the deposits will be confiscated.
  4. The deposit should be capital efficient, so staking assets are used as collateral since ETH staking is the main source of yield.
  5. The management of staking assets, such as the transfers and confiscation of staking assets, requires someone to execute, and this is re-staking.
  6. You serve as the node for any third party by undertaking extra workload, and the third party will surely pay you relevant salaries.

Overall, the source of the third types of extra incomes are generated from the incentives of protocol assets, arbitrage based on interest margins and undertaking extra workloads. It is worth stressing that further complicated functions will surely bring further risks as well. Hence, it is necessary to evaluate whether the extra incomes will cover the extra risks, as any sources of incomes may become the sources of incomes for those “scientists”.

Originally, LSD involves the interactions of offline entities such as validators, which in turn involves comparatively huge workloads. However, the advanced functions mentioned above in this article convert the comparatively huge workloads into relatively basic and simple tasks through the operating method of packaging LSD assets with lower entry barrier than traditional LSD and more colorful functions, which worth us to keep an eye on the future trends of such functions.

Where To Buy FXS?

FXS can be purchased through several popular exchanges including Hotbit. Purchasing FXS through Hotbit is a comparatively rapid process which includes only several simple steps. The first step is to register a Hotbit account (in case you don’t have one). After finishing the registration, you may continue to trade through the transaction pair of the spot trading function of FXS/USDT.

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FXS/USDT | Hotbit



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