frxETH v2: Leading LSD into a new era and innovative highlights

The wait is finally over, Sam Kazemian recently announced frxETH v2. Through innovative means such as market interest rates, Frax Finance is pushing frxETH to a new peak in the LSD field.

In the next article, I will deeply analyze the exquisite design of frxETH v2.

Some background information first.

frxETH is one of the fastest growing LSDs, having amassed over 233.4;K ETH in over a year. This exponential growth is mainly due to the synergy between sfrxETH and the frxETH-ETH pool on Curve.

While it is important to ensure the quality of early validators, ;Frax in version; 1; relies on internal validators. To solve this problem,; frxETH version; 2 introduces new mechanisms to further decentralize; frxETH; and improve the efficiency of the lending market.

I will be discussing around:

1. Basic concepts of Liquidity Source Discovery (LSD)
2. What makes;frxETH v2 innovative
3. Market-based interest rates
4. Programmable lending market

The basic idea of LSD

The core idea of LSD is very simple, which is to create a lending market based on Ethereum. Users can lend Ethereum collateral and obtain tokens representing rights and interests as certificates. Borrowers can use this collateral to run validator nodes and pay interest to creditors.

What is certain is that; P2P pledge pool is the most efficient and decentralized model. At the same time, "LSD" like "stETH" and "rETH" are essentially yielding stablecoins anchored to "ETH".

However, the annualized rate of return on ;LSD; is limited by the cost of staking. Rocket Pool; annualized rate of return is; 3.69%;,; Lido Finance; is; 4.3%;. This is because rewards must be distributed from a larger pool of funds before being distributed to LSD holders.

Innovative highlights of frxETH v2

So, what innovations does ;frxETH v2 have?

In order to create a truly decentralized ;LSD; project, ;frxETH v2 introduces some innovative mechanisms, the most important of which include:

• Floating rate based on market and utilization rates
• Programmable lending market

Let's do a quick recap of frxETH v1:

In ;Frax v1, users deposit ;ETH; and get ;frxETH. Users can stake;frxETH;earn;sfrxETH;earn rewards, or pair it with;ETH-frxETH;pairs to earn;CRV on;Curve Finance;.

In ;frxETH V2, users can "borrow" validators based on the loan-to-value ratio (LTV). To "borrow" a validator, a user must first stake a certain amount of ;ETH (possibly more than ;8;ETH), which gives them the right to borrow and run a validator on ;Frax Finance;. At the same time, borrowing interest is directly deducted from the user's "ETH" and validator rewards.

The diagram below gives an overview; the architecture of frxETH V2, for simplicity I will only focus on the circled area:

Market based floating rate is an innovation

Unlike other protocols,

frxETH v2 does not use fixed rates; instead, it relies on dynamic floating rates based on:

• Utilization
• Market supply and demand

Borrowers can view and transact at floating rates in real time, which provides node operators with more profitable options.

Let's illustrate with an example:

If the borrowing rate is low (with a large number of lenders or;ETH;pledgers), users can "borrow" a validator, perform the validation operation, and pay interest to the lender (ie;sfrxETH;holder). At the same time, the verifier can keep all the bonuses, such as; MEV, priority pen, etc.

On the other hand, if interest rates increase (demand is higher than supply), then running validators may not be profitable. At this point, the user may choose to:

• Debt repayment

• Abandon validators

• Wait for more profitable opportunities

With floating interest rates, experienced node operators can formulate strategies based on market interest rates and obtain more profitable options.

Penalty mechanism:

Penalty mechanisms kick in when a validator fails to do some work. As the total value of validators decreases, the loan-to-value ratio (LTV) of borrowers will increase. If the ;LTV; reaches an unhealthy level, validators will be retired in order to maintain the stability of the protocol.

Programmable lending market

veFXS; holders propose new collateral types (e.g. new chains or ;Tokens)

Design new borrowing terms through governance, including minimum bid amount, interest rate, etc.

Allow different user groups and use cases to obtain customized lending conditions

in conclusion

Overall, programmability endows; frxETH v2 with a flexible and extensible framework. This will help develop more application scenarios and create a new lending market.

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