Author: 0XNATALIE
Recently, five staking service providers, including RocketPool, StakeWise, and Stader Labs, jointly signed a proposal to limit validator shares to below 22%. However, the leading protocol, Lido Finance, with a market share of 32%, has not expressed its stance on this matter. The Ethereum community is concerned about the expanding influence of Lido in the liquid staking market, and criticism from the community is increasing. So, can we improve the Ethereum protocol layer to directly enable liquid staking and eliminate the centralized threat posed by the excessive market share of applications?
The idea of two-tiered staking was initially proposed by Dankrad, a researcher at the Ethereum Foundation, in April 2023. After discussion, Mike, a researcher at the Ethereum Foundation, further expanded and elaborated on the idea. The two-tiered staking mechanism divides staked ETH into two layers: Node Operator Bonds (C1) and Delegated Stake (C2), similar to a graded fund. C1 may still face slashing risks, while C2 does not. The current LST ecosystem relies on the trust users place in node operators, and the main purpose of this approach is to reduce the slashing risks borne by ordinary users when choosing validators and improve capital efficiency.
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Design of Two-tiered Staking
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Node Operator Bonds (C1): C1 holders are node operators who provide network services and maintain network security. These bonds are slashable, and the staked funds may be forfeited if node operators violate network rules.
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Delegated Tokens (C2): C2 is the ETH delegated by users to node operators. Unlike C1, the ETH deposited in this part is non-slashable, meaning that even if the staked funds of node operators are slashed, the funds of delegators will not be affected.
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Delegation Ratio (g): Each C1 is eligible to receive g C2 delegations. This parameter ensures the maximum ratio between slashable funds (C1) and non-slashable funds (C2).
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r1 (Rate for Node Operators): r1 is the rate received by node operators, which is usually higher than r2 to compensate for their operating costs and the risks they bear in terms of slashing. Node operators need sufficient rewards to incentivize their participation in the Ethereum network’s validation.
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r2 (Rate for Delegators): r2 is the rate received by delegators, representing the rewards they receive for their delegated stakes. This rate is usually lower because delegators do not bear slashing risks. r2 is considered as an “risk-free rate” of Ethereum, which can be obtained simply by staking without taking any risks.
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LST: Each unit of C2 generates a corresponding local liquid staking token (LST). These LST tokens are specific to each node operator and are minted through their delegations. Only non-slashable ETH can be used to mint LST tokens.
These two interest rates are key components of the design. If r1 is set too high, the reward for becoming a node operator may exceed the reward for delegation, which could lead to more people choosing to become node operators instead of delegating, or the emergence of LST layers based on trust assumptions like Lido. In that case, the Two-tiered staking model would lose its original meaning. If r1 is set too low, there may not be enough incentive for people to become node operators, and the profits from node operation would be compressed, allowing only efficient and large-scale operators to survive, leading to node centralization.
Characteristics and Potential Issues of the Two-tiered Staking Model
In this model, each unit C1 is associated with a certain quantity (with coefficient g) of C2. Typically, C1 can earn a higher interest rate r1 to compensate for the operational costs of nodes and the opportunity cost of holding illiquid stakes. The security of the consensus layer depends solely on C1, which must pass through the activation and exit queues. C2, on the other hand, can be flexibly redelegated.
For example, there are two delegators, Delegator 1 and Delegator 2, and two node operators, Node Operator A and Node Operator B. Each node operator provides 1 ETH bond to obtain authorization. These bonds have interest rate limits and can be reduced. The red and blue dashed lines in the following figure represent the interest earned by each participant. For delegators: delegated stake * r2 = interest; for node operators: (delegated stake + bond) * r1 = interest. Node Operator A has a g value of 19, which means that Delegator 1 delegates 19 ETH to Node Operator A, and A provides 1 ETH bond to obtain authorization. Delegator 1 earns interest of 19 * r2, while Node Operator A earns interest of 20 * r1.
Two-tiered Staking improves capital efficiency by dividing staking into two tiers, allowing more ETH to be used for delegation and increasing liquidity. Continuing the above example, Node Operator A has C1=1 and C2=19 (collateral ratio is 1:19, leverage ratio is 19x), which means that out of 20 ETH, 19 ETH are liquid, resulting in a capital efficiency of 95%. Node Operator B has C1=1 and C2=17 (collateral ratio is 1:17, leverage ratio is 17x), which means that out of 18 ETH, 17 ETH are liquid, resulting in a capital efficiency of 94.4%. In comparison, A has higher capital efficiency but also higher risk because a larger proportion of ETH is used for delegation, while a relatively smaller proportion is used for reduction.
Through different interest rates and reward mechanisms, this mechanism attempts to encourage more people to participate in node operation and increase the decentralization of the network. However, it also raises the issue that some staked assets in the model no longer face the risk of reduction, which may lead attackers to perceive the cost of attacking the network as low. In the event of a large-scale attack, the attacker may only need to attack the reducible portion, rather than the entire network, which reduces the theoretical economic security.
In addition, the proposal raises some open questions. The community’s discussion of these questions helps researchers delve into how new models interact with the existing blockchain ecosystem. Personally, I am particularly interested in whether there is a dynamic way to set interest rates and whether LST will form a monopoly or an oligopoly in the market. How to ensure diversity and competition is also a topic that I look forward to more community discussions on.
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