Authors: ultimatepro, benjamine
FRAX can always be minted and redeemed from the system for $1 of value. This allows arbitrageurs to balance the demand and supply of FRAX in the open market. If the market price of FRAX is above the price target of $1, then there is an arbitrage opportunity to mint FRAX tokens by placing $1 of value into the system per FRAX and sell the minted FRAX for over $1 in the open market. At all times in order to mint new FRAX a user must place $1 worth of value into the system. The difference is simply what proportion of collateral and FXS makes up that $1 of value. When FRAX is in the 100% collateral phase, 100% of the value that is put into the system to mint FRAX is collateral. As the protocol moves into the fractional phase, part of the value that enters into the system during minting becomes FXS (which is then burned from circulation). For example, in a 98% collateral ratio, every FRAX minted requires $.98 of collateral and burning $.02 of FXS. In a 97% collateral ratio, every FRAX minted requires $.97 of collateral and burning $.03 of FXS, and so on.
The protocol at times will have excess collateral value or require adding collateral to reach the collateral ratio. To quickly redistribute value back to FXS holders or increase system collateral, two special swap functions are built into the protocol: buyback and recollateralize.
Anyone can call the recollateralize function which then checks if the total collateral value in USD across the system is below the current collateral ratio. If it is, then the system allows the caller to add up to the amount needed to reach the target collateral ratio in exchange for newly minted FXS at a bonus rate. The bonus rate is set to .20% to quickly incentivize arbitragers to close the gap and recollateralize the protocol to the target ratio. The bonus rate can be adjusted or changed to a dynamic PID controller adjusted variable through governance.
The opposite scenario occurs when there is excess collateral in the system than required to hold the target collateral ratio. This can happen a number of ways:
In such a scenario, any FXS holder can call the buyback function to exchange the amount of excess collateral value in the system for FXS which is then burned by the protocol. This effectively redistributes any excess value back to the FXS distribution and holders don't need to actively participate in buybacks to gain value since there is no bonus rate for the buyback function. It effectively models a share buyback to the governance token distribution.
An AMO module is an autonomous contract(s) that enacts arbitrary monetary policy so long as it does not change the FRAX price off its peg. This means that AMO controllers can perform open market operations algorithmically (as in the name), but they cannot arbitrarily mint FRAX out of thin air and break the peg.
Frax allows anyone to propose an AMO strategy via governance
One such AMO strategy is minting FRAX to lend on Compound or Cream to allow anyone to borrow FRAX by paying interest instead of the base minting mechanism and further to improve its liquidity
AMO does not lower the direct collateral ratio (CR) because FRAX minted into money markets don’t enter circulation unless they are overcollateralized by a borrower through the money market
The cash flow from lending can be used to buy back and burn FXS thereby the lending AMO creates a new avenue to get FRAX into circulation by paying an interest rate set by the money market.
The AMO can also increase or decrease the interest rate on borrowing FRAX by minting more FRAX (lower rates) or removing FRAX and burning it (increase rates).