The frxETH TVL plummeted, the variables hidden behind the LSD points war

Author: StableScarab

Compiled by Tyler

As the highest-yielding ETH LSD, why has Frax Finance's frxETH suddenly decreased by 100,000 ETH TVL in the past 3 months?

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

What is frxETH?

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

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

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

Very simple, points, points, or TMD points!

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

So from the data chart, the time node of Eigenlayer's open deposit on February 5th happened to be the highest point of frxETH TVL.

Arbitrage balance between frxETH and sfrxETH

Why do frxETH users choose not to stake for a second time and are willing to transfer their earnings to sfrxETH users?

Because Frax Finance provides another income option for frxETH users - depositing frxETH into Curve's frxETH/ETH liquidity pool to earn LP income.

From a user's perspective, Frax Finance actually provides two revenue paths for frxETH:

• First, stake ETH as frxETH, then deposit it into the frxETH/ETH liquidity pool to earn Curve rewards, while surrendering the staked frxETH rewards.
• First stake ETH as frxETH, and then stake it again as sfrxETH, so that while obtaining the staking rewards, you also get additional staking rewards from the first part of frxETH transferred by users.

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

According to Frax Finance's official website, as of June 12th, the yield of the two is also relatively close: Curve's frxETH/ETH liquidity pool (frxETH) is 2.72%, and the secondary stake (sfrxETH) is 3.42%. The proportion of the two is also basically the same.

The behind-the-scenes of the LSD points war

In the competition pattern of LSD, points belong to the "incentive" category, which is used to temporarily reward investors to participate in the project, which is useful for launching the project, but does not mean it is permanently effective.

It's also clear to everyone that points won't last long, and all point models are unsustainable strategies - points will eventually be converted into other assets, leading users attracted by high incentives to switch to other projects.

However, restaking itself is a very effective technical narrative 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 play a role, which is also the underlying reason why Frax Finance designed the Flox mechanism - as a block space incentive plan for the new L2 Fraxtal of Frax Finance, mainly distributed with the tail token FXTL.

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

According to the latest official documentation, Fraxtal, as an L2 network, is also a modular Rollup blockchain with a roadmap for 'fractal scaling', and its functions and features include:

• EVM Equivalence. Fraxtal uses OP stack as its smart contract platform and execution environment, enabling projects to deploy applications as quickly, securely, and cost-effectively as Optimism and Base.
• Modular Rollup. Fraxtal will have multiple components and middleware for other chains and networks to use, connect, deploy L3, and build upon. Currently, Fraxtal uses a separate Data Availability (DA) module developed by the Frax Finance core team;
• Block Space Incentive Measures (referred to as 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 receive 'Fraxtal Point' (FXTL) point rewards based on the Flox algorithm, which can be converted into tokens later;
• frxETH Gas Payment Token;

Furthermore, according to official disclosure, Fraxtal will be launched in collaboration 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 closely observing whether frxETH can become a unique player in the Ethereum liquid staking track.