From the FraxETH v2 Lending Market to the Essence of the LSD War
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From the FraxETH v2 Lending Market to the Essence of the LSD War
Implement reasonable economic incentives to build frxETH as an LST that scales with as few trust assumptions as possible.
Navigating Web3 tides with focused insightsAuthor: Yu Zhong Kuang Shui
Although Frax's price performance has been underwhelming, one cannot ignore the fact that the Frax team has consistently delivered products at a high efficiency. Their latest offering is FraxETH v2. What I particularly like about this product is that while deconstructing the LSD sector, it "implements sound economic incentives to build frxETH into an LST with as few trust assumptions as possible." In my view, it is more competitive than Rocket Pool.
So, let’s first discuss: what is the essence of the LSD War?
At its core, the logic of the LSD space is a lending relationship between institutions providing validator node services—centralized entities such as Binance and Coinbase (CEXs), decentralized platforms like Lido, Rocket Pool, and Frax Finance—and users who supply ETH. Users lend their ETH to these institutions, which in turn pay interest—derived from Ethereum staking rewards—while retaining a commission. The LSD War is essentially a competition among these institutions for users’ ETH deposits.
So, what kind of product does FraxETH v2 build?
FraxETH v2 creates a lending market where borrowers are validator service providers and lenders are users. Users deposit ETH into Frax, and borrowers pay interest back to them. The validators' revenue equals staking yield plus MEV income minus the interest paid to lenders. Unlike traditional fixed-fee models, FraxETH employs a dynamic interest rate mechanism: when capital utilization is low, rates are low; when utilization is high, rates rise—until validators’ profits fall below the interest cost.
What happens to idle ETH when utilization is low?
Idle ETH will be deployed into Curve AMO to earn DeFi yields and provide users with a highly liquid exit channel. More importantly, in the design of FraxETH v1, sfrxETH and frxETH were dynamically balanced via staking profits and LP earnings. In v2, beyond achieving decentralization and trustlessness for FraxETH, the system further enhances self-consistent dynamic equilibrium—the foundational logic remains the interplay between Curve AMO and staking balance.
What are the benefits of this approach?
Good money drives out bad. High-quality node operators can maximize their returns through dynamic rate settings. Moreover, FraxETH v2 is decentralized and trustless: node operators must collateralize funds to meet a specific LTV threshold before participating in the FraxETH v2 market. They only need to submit their validator public keys and set the withdrawal address to the protocol's lending market. This fundamentally addresses the issue of centralization in staking nodes.
Personally, I believe Frax’s deconstruction of the LSD War aligns well with what Musk often refers to as "first principles thinking"—that is, returning to the most fundamental truths of a matter, breaking it down into its basic components, and then reconstructing the optimal path toward the goal. This principle originates from a philosophical proposition by the ancient Greek philosopher Aristotle: "In every system there is a fundamental premise that cannot be violated or removed."
@FlywheelDeFi pointed out, the best LST protocol should provide:
1. The most reasonable borrowing rate for node operators;
2. Decentralization, trustlessness, and security guarantees for node operators;
3. The most liquid swap-based exit channel;
4. An optimal token architecture for seamless DeFi Lego integration.
Take a look—doesn’t Frax meet all these criteria?
Strong products attract higher TVL, generating more protocol revenue, which in turn leads to higher staking yields for veFXS, enables the protocol to generate profits, and initiates buybacks of $FXS. As long as the protocol can maintain substantial positive cash flow, it will be better positioned to expand within the token’s secondary market.
In short, I am bullish on this product and on $FXS. The current $FXS price has returned to roughly where it was before the last LSD wave. I’m considering holding long-term and adjusting my strategy based on the performance of FraxETH v2.
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