The frxETH TVL plummets, the variables hidden behind the LSD score war

Original author: StableScarab

Original text compilation: Tyler

As the highest-yielding ETH LSD, why has Frax Finance’s frxETH, which was launched, suddenly reduced its TVL by 100,000 ETH in the past 3 months?

This article aims to help everyone understand the competitive ETH staking market and the underlying factors reflected by Frax Finance.

What is frxETH?

frxETH is the Ethereum stablecoin launched by Frax Finance, generated directly by staking ETH, and frxETH (sfrxETH) adopts a dual token design, which also helps it become the highest-yielding ETH liquidity stake derivative product (LSD) at present:

Because in addition to traditional staking forms, other use cases of frxETH will also increase the Annual Percentage Yield (APY) of sfrxETH, so since its launch in November 2022, the yield of sfrxETH has not only been 24% higher than that of stETH during the same period, but also 40% higher than rETH.

So why did the TVL of frxETH plummet significantly under high yield?

Very simple, points, points, or TMD points!

The staking frenzy has swept the LSD market - Eigenlayer offers rewards to users who lock ETH, attracting a huge TVL, and the liquidity staking yield is even higher.

So, from the data chart, the time node for the opening of Eigenlayer deposits on February 5th happens to be the peak point of frxETH TVL.

Arbitrage Balance between frxETH and sfrxETH

Why would frxETH users choose not to stake for a second time, and be willing to transfer their earnings to sfrxETH users?

Because Frax Finance provides frxETH users with another revenue option - storing frxETH in the frxETH/ETH liquidity pool on Curve, and receiving LP rewards.

From the user’s perspective, Frax Finance actually provides two revenue streams for frxETH:

• Stake ETH as frxETH first, then deposit into the frxETH/ETH liquidity pool to earn Curve rewards while transferring your frxETH staking rewards away.
• First, stake ETH as frxETH, then stake it again as sfrxETH, so that while obtaining staking rewards, you can also receive additional staking rewards from the frxETH transferred by the first group of users.

In theory, choosing the frxETH/ETH liquidity pool (frxETH) on Curve and choosing secondary staking (sfrxETH) will gradually form a dynamic arbitrage balance due to the difference in yield, thereby keeping the yields of the two different choices in the same range.

According to Frax Finance’s official website, as of June 12th, the yields of the two are indeed similar: Curve’s frxETH/ETH liquidity pool (frxETH) is 2.72%, and the secondary stake (sfrxETH) is 3.42%, and their proportions are also similar.

Behind the LSD Points War

In the competition pattern of LSD, points belong to the “incentive” category, which is used to attract investors to participate in the project as a temporary reward, which is useful for launching the project, but does not mean permanent effectiveness.

Everyone is also very clear that points will not last long, all point systems are unsustainable strategies—points will eventually be converted into other assets, leading to users attracted by high incentives to shift to other projects.

However, restaking itself is a very effective narrative technique that can provide users with additional income, and Frax Finance also plans to directly provide native restaking services in frxETH v2.

In this process, whether a suitable incentive system can be designed determines whether the service can continue to be effective, which is also the underlying reason for the design of the Flox mechanism by Frax Finance - Flox, as an incentive plan for the new L2 Fraxtal block space of Frax Finance, is mainly distributed with the tail tokens of FXTL.

As Flox checks users’ assets and on-chain interactions, any user holding frxETH on Fraxtal can easily earn FXTL.

• EVM Equivalence. Fraxtal uses the OP stack as its smart contract platform and execution environment, enabling project teams to deploy applications as quickly, securely, and cost-effectively as Optimism and Base.
• **Modular Rollup.**Fraxtal will have multiple components and middleware for use, connection, deployment of L3 on other chains and networks, and currently uses a separate Data Availability (DA) module developed by the core team of Frax Finance;
• Block Space Incentive Measures (called Flox). This feature is used to reward users and developers - any account and smart contract that spends Gas and interacts with any smart contract on the network will be rewarded with “Fraxtal Point” (FXTL) points based on the Flox algorithm, which can be converted into tokens later.
• frxETH as the token for paying Gas;

In addition, according to official disclosures, Fraxtal will be launched with major Ethereum infrastructure providers, including Fraxscan and Safe from Etherscan, as well as various DeFi-related services such as Chainlink, Axelar Network, and LayerZero.

So why do I think frxETH will recover? In addition to the native heavy staking function, frxETH v2 will also introduce the following new features:

• Decentralized Validators;
• Higher node capital efficiency;
• Node operator performance incentives;

Most importantly, Fraxtal will use frxETH as Gas fees, burning frxETH can increase the Annual Percentage Rate (APR) of sfrxETH.

Good things take time. It is worth observing whether frxETH can become a unique player in the Ethereum liquid staking track.