The Importance of Staking Aggregators in the PoS Age
In recent years, more blockchains are transforming their consensus from PoW consensus to PoS consensus. Ethereum will also officially switch to PoS consensus after the Merge which is scheduled to be completed in the second half of this year. At that time, except for legacy blockchains such as BTC, the rest of mainstream blockchains will adopt PoS consensus. The cumulative staking amount of the top ten PoS blockchains has exceeded 88 billion US dollars and return rates are roughly between 4% and 10%. This huge blockchain consensus transition brings huge opportunities to the staking field. According to the estimate of JP Morgan, the staking yields of the entire blockchain industry will exceed $40 billion in 2025.
Main roles in the staking industry
There are three main actors in staking which are node operators, staking service providers, and users who need staking services (in practice, a protocol can assume multiple roles at the same time).
Node operators are the cornerstone of the entire staking and blockchain field. They need to use physical devices to continuously run blockchain clients, maintaining the consensus. When one node operator successfully generates a new block, it can get block rewards generated by the blockchain’s native token inflation, the transaction fee of transactions updated by the new block, and the possible MEV revenue. In order to prevent nodes from going offline, making mistakes, or malicious behaviors, node operators need to stake a certain amount of blockchain’s native tokens, ensuring that users’ loss due to node’s’ errors or malicious behavior could be compensated.
Users are the demand side of the entire ecosystem, hoping to provide funds and obtain staking benefits. Although running a node can obtain low-risk native token returns, there are many obstacles for retail users to run a node by themselves: First, running a node usually requires a minimum amount of stake (for example, operating an Ethereum node requires staking at least 32 ETH), pricing out majority of retail users; Second, some blockchains, such as Solana, put high requirements on the performance of nodes’ hardware, which also restricts common users who do not have enough funds to purchase high-performance hardware to run nodes by themselves; Third, operating a node requires users to keep devices online all the time and avoid mistakes or malicious behavior, because it will result in a certain amount of staked tokens being slashed; Fourth, the staked funds need to be locked for long periods to boost the network security (the extreme case is that currently Ethereum stakers can never get their funds back before the consensus totally switching to PoS), incurring a high opportunity cost.
These obstacles led to the emergence of staking service providers who enabled users to enjoy the benefits of staking without running nodes by themselves. Users can deposit any amount of funds into the staking service provider smart contract and the smart contract will allocate funds to trusted node operators with more professional hardware and expertise to obtain staking benefits and return them to users. Staking service provides could be divided into centralized companies like Coinbase and decentralized protocols. Current mainstream decentralized staking service protocols include Lido, Stader, Rocket, etc and Lido is occupying an overwhelming dominance with over $8.48 billion in TVL.
How does the staking aggregator work?
Staking aggregator is the most common model among decentralized staking service providers, including protocols such as Lido and Rocket. Staking aggregators could be divided into custodial/non-custodial or centralized/decentralized according to the method of fund custody during the staking period and the method of governance, but their fundamental business model is straightforward: similar to banks or lending protocols, staking aggregators attract user funds and allocate them to different channels to obtain revenue for users and charge a certain percentage of commission.
Take staking ETH in Lido as an example, for users, when they deposit their ETH in Lido, they will receive the same amount of staking derivative — stETH token. Users can use this staking derivative in other DeFi protocols to earn additional yields. For Lido, it will distribute the funds to whitelisted node operators when the deposits reache 32 ETH. After Lido obtains the ETH staking income, it will charge 10% of the income and distribute the remaining 90% to users, resulting in a corresponding increase in the number of stETH tokens users hold. Half of the 10% fee will be distributed to node operators as a reward and the other half will be stored in the Lido treasury as an insurance to make up for users’ loss if node operators’ funds are slashed. Rocket protocol uses a tranching solution to guarantee the safety of users’ funds: Users and node operators provide 16 ETH respectively and when stake punishment happens, node operator’s funds will be slashed first.
Lido does not run nodes by itself but cooperates with node operators. It currently adopts a whitelist mechanism, that is, Lido DAO votes to determine whether a node operator can enter the whitelist and the maximum amount of funds that can be allocated to the node operator. At present, Lido has cooperated with 22 nodes and since node operators have been censored by Lido DAO. They do not need an equal amount of ETH as collateral to ensure the safety of user funds, improving the capital efficiency of node operators.
The strong value capture of staking aggregators
The value generated in the staking ecosystem will be distributed among node operators, staking aggregators and users. The services provided by node operators are relatively homogeneous, and users would switch between different operators seeking higher rate of return, leading to an intense price competition among node operators and most of the value will flow to staking aggregators and users.
The bargaining power of staking aggregators is stronger compared with node operators since the services and security provided by different staking aggregators vary widely. Aggregators usually aggregate the service supply side and serve as the entry point for the demand side. Currently, aggregators in Web3 cannot directly generate advertising revenue through user traffic like aggregators in Web2. The value mainly comes from the service fee paid by users who use the aggregator.
DEX aggregators vs Staking aggregators
The ability of Web3 aggregators to capture value varies due to reliance on the services required by users. For example, the basic business model of DEX aggregators is to search the best swap route for users and conduct the swap. It is relatively simpler for DEX aggregators to find the best route and finish the swap due to the composability of DEXs and the standardization of swap service. Furthermore, users can simply go to the various DEX to complete the swap by themselves according to the route suggested. On the other hand, funds allocation requires a comprehensive consideration of various factors such as operator’s expertise and reputation due to the low service standardization of node operators. It is relatively more difficult for retail users to complete the whole staking process by themselves. Therefore, professional staking aggregators are able to capture more value as compared to DEX aggregators
The key staking derivative
The core competitiveness of staking aggregator is the staking derivative since it provides many advantages for staking aggregators and users. The most obvious one is that stakers can stake their funds while continuing to use them in other DeFi protocols to earn yields, reducing the opportunity cost of users. The more important advantage, as mentioned in Paradigm’s paper, is that staking derivative will allow leading staking aggregators to generate network effect: the native token peg stability, use cases, and user acceptance of staking derivative will enhance each other to form a positive feedback loop, attracting more users to use the leading staking aggregator. In the end, the winner takes all.
Lido, the current leader of staking aggregators, provides users with their own staking derivative stETH when they deposit ETH in this protocol. The ETH peg stability of stETH has strengthened due to Lido’s rising popularity and leading lending protocols such as Maker and AAVE also enable users to use stETH as loan collateral. Though this stability was threatened amidst recent crypto market turbulence, the discount of stETH has since recovered to around 2%. The peg stability and wide acceptance of stETH are the key and the moat to Lido’s current dominance of market share.
The future trustless staking aggregator
Due to the strong network effect brought by staking derivatives to leading staking aggregators, the staking field may be more centralized than the mining field in the future, seriously threatening the security of networks such as Ethereum. Therefore, establishing a trustless staking aggregator is urgent for both staking aggregators and the whole ecosystem. Even if a decentralized trustless staking aggregator completely monopolizes the market, the security of Ethereum can still be maintained as long as node operators are sufficiently dispersed. The current leader Lido also plans to become a completely trustless protocol by creating a trustless node admission mechanism through solutions like Secret Shared Validators, node operator score, tracking validator performance, etc. instead of the current review of Lido DAO.
In the consensus transition from PoW to PoS, the total addressable market of the staking sector undoubtedly has huge growth potential. The staking aggregator will become an important player in the PoS era due to the value it provides in the staking field. Lido is currently in an absolute leading position, but as more and more competitors enter this field, the use of staking derivatives will be the key factor in competition since they can bring the valuable network effect to staking aggregators. Trustless staking aggregators will become an important cornerstone of the staking field and the PoS blockchain ecosystem.