frxETH TVL plummets, the variables hidden behind the LSD points war

Written by: StableScarab
Compiled by: Tyler

As the highest-yielding ETH LSD, why has the frxETH launched by Frax Finance suddenly seen a decrease of 100,000 ETH in TVL over the past three months?

This article aims to help everyone understand the fiercely competitive ETH staking market and the deeper 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 has helped it become the current highest-yielding ETH liquid staking derivative (LSD):

Because in addition to traditional staking forms, other use cases of frxETH also enhance the annual percentage yield (APY) of sfrxETH, so since its launch in November 2022, the yield of sfrxETH has not only exceeded that of stETH by 24% during the same period but has even surpassed rETH by 40%.

So why has frxETH's TVL significantly declined despite the high yield?

It's simple: points, points, and more TMD points!

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

Therefore, from the data charts, February 5, when Eigenlayer opened deposits, coincided with the peak of frxETH's TVL.

Arbitrage Balance between frxETH and sfrxETH

Why do some frxETH users choose not to re-stake and are willing to cede their earnings to sfrxETH users?

Because Frax Finance provides frxETH users with another earning option—depositing frxETH into the Curve frxETH/ETH liquidity pool to earn LP rewards.

From the user's perspective, Frax Finance actually offers two earning paths for frxETH:

• First, stake ETH to obtain frxETH, then deposit into the frxETH/ETH liquidity pool to earn Curve rewards while ceding their frxETH staking rewards;
• First, stake ETH to obtain frxETH, then re-stake it as sfrxETH, thus earning their own staking rewards while additionally receiving the frxETH staking rewards ceded by the first group of users;

Theoretically, choosing between the Curve frxETH/ETH liquidity pool (frxETH) and choosing to re-stake (sfrxETH) will gradually form a dynamic arbitrage balance due to the differences in yields, keeping the yields of the two different choices within the same range.

According to data from the Frax Finance official website, as of June 12, the yields of both options are indeed quite close: the Curve frxETH/ETH liquidity pool (frxETH) yields 2.72%, while re-staking (sfrxETH) yields 3.42%, and their proportions are also roughly similar.

Behind the LSD Points War

In the competitive landscape of LSDs, points belong to the "incentive" category, which are temporary rewards used to attract investors to participate in projects. This is useful for launching projects but does not mean it is permanently effective.

Everyone knows that points will not last long, all point models are unsustainable strategies—points will eventually be converted into other assets, leading users attracted by high incentives to migrate to other projects.

However, re-staking itself is a very effective technical narrative that can provide users with additional earnings, and Frax Finance also plans to directly offer native re-staking services in frxETH v2.

In this process, whether a suitable incentive system can be designed determines whether this service can continue to function effectively. This is also the underlying reason for Frax Finance's design of the Flox mechanism—Flox, as a block space incentive program for Frax Finance's new L2 Fraxtal, is mainly distributed alongside the tail token of FXTL.

Since Flox will check users' assets and on-chain interaction activities, 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," featuring functionalities and characteristics including:

• EVM equivalence. Fraxtal utilizes the OP stack as its smart contract platform and execution environment, allowing project teams to deploy applications as quickly, securely, and cost-effectively as with 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 core team of Frax Finance;
• Block space incentives (called Flox). This feature rewards users and developers—any account or smart contract that spends gas and interacts with any smart contract on the network will receive "Fraxtal Point System" (FXTL) points based on the Flox algorithm, which can later be converted into tokens;
• frxETH as a gas payment token;

Additionally, according to official disclosures, Fraxtal will launch alongside major Ethereum infrastructure providers, including Fraxscan from Etherscan and various DeFi-related services such as Safe, Chainlink, Axelar Network, and LayerZero.

So why do I believe frxETH will revive? In addition to the native re-staking feature, frxETH v2 will also introduce the following new functionalities:

• Decentralized validators;
• Higher node capital efficiency;
• Performance incentives for node operators;

Most importantly, Fraxtal will use frxETH as gas fees, and burning frxETH can increase the annual percentage yield (APR) of sfrxETH.

Good things take time, and whether frxETH can become an outlier in the Ethereum liquid staking track is worth deep observation.