Fractional Stablecoins

November 21, 2023 - Around 2 mins mins to read

Fractional Stablecoins are a type of stablecoin and cryptocurrency that combines collateral backing with algorithmic stabilization. There are different versions of the fractional stablecoin model, including those backed by liquidity or allowing partial redemptions. However, the core concept remains the same: the protocol creates more stablecoins than it can redeem with its value. A stablecoin is a digital asset based on blockchain that aims to maintain a fixed price, usually $1. To ensure their usability and credibility as a payment method, stablecoins must be backed by fiat cash, cryptocurrency, or on-chain tokens that can be redeemed or exchanged. This backing is referred to as collateral. A fractional stablecoin is backed in two ways: through collateral and algorithmic adjustments. It has a collateralization ratio of less than or equal to 100%, meaning it can be backed by a fraction of its supposed total value in real dollars or cryptocurrency. This approach improves capital efficiency by reducing the amount of idle collateral required. In other words, fractional stablecoins have a larger circulating supply of tokens than liquidity or collateral. They typically incorporate algorithmic mechanisms that incentivize economic behavior and game theory to prevent bank runs. If the price of a fractional stablecoin exceeds $1, the algorithmic systems generate new stablecoins until the price returns to $1. Conversely, if the stablecoin is overcollateralized, the available stablecoins or tokens are burned. Purely algorithmic stablecoins face challenges in terms of bootstrapping, slow growth, and extreme volatility, which contradicts their purpose as stablecoins. Fractional stablecoins use algorithms to adjust collateral and maintain their peg by generating or burning stablecoins or digital tokens. The author of this content is Sam Kazemian, the founder of FRAX. FRAX is a fractional algorithmic stablecoin that combines collateral backing with algorithmic stabilization. It is the only fractional stablecoin that has consistently maintained its peg since its inception. FRAX is an open-source and permissionless project that aims to bring a truly trustless, scalable, and stable asset to the future of decentralized finance. Kazemian is an experienced blockchain entrepreneur and crypto enthusiast, having co-founded Everipedia, a blockchain-based knowledge base. His crypto journey began in 2013 at UCLA, where he started mining crypto in his college dorm room. Today, he is a frequent guest lecturer at UCLA, covering topics such as crypto, computer science, and entrepreneurship.