Ethereum Native LST Introduces Two-Tier Staking: A Lido Killer?

ChainFeeds

2023-10-08 16:00

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Original Title: "Ethereum Native LST Design Two-Layer Staking: Lido Killer?"

Original Author: 0XNATALIE

Original Source: Chainfeeds

Recently, five staking service providers, including RocketPool, StakeWise, and Stader Labs, jointly signed a proposal to limit validator shares to below 22%, while the leading protocol, Lido Finance, with a market share of up to 32%, did not make a statement on this matter. The Ethereum community is concerned about the expanding influence of Lido in the liquid staking market, and criticism of this is growing. Can improvements be made to the Ethereum protocol layer to directly enable liquid staking and eliminate the centralization threat posed by the application's large market share?

Two-tiered staking was initially proposed by Ethereum Foundation researcher Dankrad in April 2023. After discussion, Ethereum Foundation researcher Mike further expanded and elaborated on it. The two-tiered staking mechanism divides the staked ETH into two layers, Node Operator Bonds (C1) and Delegated Stake (C2), similar to a graded fund. C1 may still face slashing risks, while C2 will not. Today's LST ecosystem relies on users' trust in node operators. The main purpose of doing this is to reduce the slashing risks that ordinary users need to bear when choosing validators and improve capital efficiency.

Two-tiered staking design

Node Operator Bond (C1): C1 is held by node operators who provide network services and maintain network security. These bonds are reducible, and if a node operator violates network rules, pledged funds may be confiscated.

Entrusted Token (C2): C2 is the ETH that the entruster gives to the node operator. Unlike C1, this portion of ETH cannot be reduced, even if the node operator's pledged funds are reduced, the entruster's funds will not be affected.

Delegation ratio (g): Each C1 is eligible to receive g delegations of C2. This parameter ensures the maximum ratio between reducible funds (C1) and non-reducible funds (C2).

r1 (the rate of node operator): r1 is the rate earned by the node operator, which is usually higher than r2 to compensate for the operating costs and risks of the node operator. Node operators need sufficient rewards to encourage their participation in the Ethereum network verification.

r2 (the delegator's interest rate): r2 is the interest rate received by the delegator to represent the rewards earned by their delegated staking. This rate is usually lower as delegators do not bear the slashing risk. r2 is considered an "risk-free rate" of Ethereum, which can be obtained by simply staking without taking any risks.

LST: For each unit of C2, a corresponding local liquidity staking token will be generated. These LST tokens are unique to each node operator and are minted through their delegation. Only non-reducible ETH can be used to mint LST tokens.

These two interest rates are key components of the design. If r1 is set too high, the reward for becoming a node operator may exceed the reward for delegation, which could lead to more people choosing to become node operators instead of delegating, or the emergence of a trust-based LST layer like Lido, which would undermine the original purpose of the Two-tiered staking model. If r1 is set too low, there may not be enough incentive for people to become node operators, and the profits of node operation will be compressed, leading to centralization of nodes, where only efficient and large-scale operators can survive.

Two-tiered staking model features and potential issues

In this model, each unit C1 is associated with a certain number (coefficient g) of C2. Typically, C1 can earn a higher interest rate r1 to compensate for the cost of operating nodes and the opportunity cost of holding illiquid collateral. The security of the consensus layer depends only on C1, which must be activated and exited from the queue. C2, on the other hand, can be flexibly re-delegated.

For example, there are two delegators, Delegator 1 and Delegator 2, and two node operators, Node Operator A and Node Operator B. Each node operator will provide 1 ETH bond to obtain authorization, which has interest rate restrictions and can be reduced. The red and blue dotted lines in the figure below represent the interest earned by the four participants respectively. For delegators, delegated staking * r2 = interest, for node operators, (delegated staking + bond) * r1 = interest. Node Operator A's g is 19, which means that Delegator 1 delegates 19 ETH to Node Operator A, and A provides 1 ETH bond to obtain authorization. Delegator 1 earns interest of 19*r2, and Node Operator A earns interest of 20*r1.

Two-tiered Staking improves capital efficiency by dividing staking into two tiers, allowing more ETH to be delegated and increasing liquidity. Continuing the example above, Node Operator A has C1=1 and C2=19 (a collateral ratio of 1:19 and a leverage ratio of 19x), meaning that out of 20 ETH, 19 ETH are in circulation, resulting in a capital efficiency of 95%. Node Operator B has C1=1 and C2=17 (a collateral ratio of 1:17 and a leverage ratio of 17x), meaning that out of 18 ETH, 17 ETH are in circulation, resulting in a capital efficiency of 94.4%. In comparison, A has higher capital efficiency but also higher risk, as a larger proportion of ETH is used for delegation and a relatively smaller proportion is used for hedging.

Through different interest rates and reward mechanisms, this mechanism attempts to encourage more people to participate in node operation and improve the decentralization of the network. At the same time, it has also raised the issue that attackers may perceive the cost of attacking the network to be lower due to the fact that some of the pledged assets in the model are no longer at risk of being reduced. If a large-scale attack occurs, the attacker may only need to attack the reducible part without attacking the entire network, which reduces the theoretical economic security.

In addition, the proposal also raises some open-ended questions. The community's discussion on these issues will help researchers delve deeper into how new models interact with existing blockchain ecosystems. Personally, I am particularly interested in whether there is a dynamic way to set interest rates and whether LST will form a monopoly or oligopoly in the market, as well as how to ensure diversity and competition. I look forward to more discussions in the community.