EigenLayer and Frax: The Next Generation of Cryptoeconomic Security

EigenLayer offers a unique opportunity for Frax to utilize its resources to earn revenue securing a new wave of decentralized systems and soon enough... itself.

DeFi Dave

Jan 19, 2023

EigenLayer and Frax: The Next Generation of Cryptoeconomic Security

The advent of Bitcoin kicked off a decentralized security “space race” and we aren’t talking about going to the moon here. In just a decade, cryptoeconomic security has transitioned from the consensus layer all the way to the protocol layer. Bitcoin showed how transactional security could be enforced in an adversarial environment while Ethereum would later enable meaningful applications to implicitly gain the security guarantees of the underlying network. .

The problem with network security is that it tends to follow power laws and in that regard, Bitcoin and Ethereum dominate the areas of hash rates and stake values. New networks are forced to sell their soul (to more often than not mercenary actors) in order to bootstrap enough security guarantees. Building your own trust network from the ground up is costly and resource intensive, limiting potential innovation. But what if there was a way to bring the security of Ethereum to not just applications and middleware but to *anything* that requires a trustless network?

What is EigenLayer?

Enter EigenLayer, a general-purpose market for cryptoeconomic security that connects applications, middleware, bridges, data availability, rollup sequencers, etc. to Ethereum validators. The exchange that happens is that these decentralized protocols and networks outsource “trust” to Ethereum validators that “restake'' their ETH. Restaking is the rehypothecation of staked Ethereum by adding extra slashing conditions. In return, restakers earn extra yield for their services for enabling trust within a decentralized system. Rehypothecation is a common practice in banks where collateral held as an asset on a balance sheet is used to take a new liability and in return the original collateral holder receives favorable terms such as a lower borrowing rate.

Ultimately, EigenLayer creates a whole new landscape of ripe opportunities throughout the Ethereum stack. Networks experimenting with different VMs can utilize EigenLayer to bootstrap liquidity, data availability on-chain becomes a real possibility, and applications can focus on just building the best product possible instead of worrying how decentralized their trust network is.

How EigenLayer Works

The two pillars that underlie EigenLayer’s system are pooled security and free-market agency. Ethereum validators can ‘opt-in’ to EigenLayer’s smart contracts and agree to new slashing conditions in order to obtain additional yield, and in return, EigenLayer receives the right to withdraw the staked ETH in case penalties are incurred by the validator. While Ethereum validators can have up to 50% of their stake slashed for penalties on mainnet, by opting into EigenLayer, validators give EigenLayer’s smart contracts permission to withdraw the remaining 50%.

Free-market dynamics allow clients (protocols, networks, etc.) and validators the choice of either how much security they desire to receive or how much security they want to supply. By allowing protocols to decide who has permission to secure their network and, conversely, validators to choose which protocols they want to bootstrap, a competitive market is be created that selects the highest quality clients and best performing validators. And in time, the pooling of security that is facilitated by EigenLayer liberates protocols from the constraints of worrying about decentralization by infusing the robust security of the Ethereum network in a seamless manner.

How EigenLayer Can Supercharge FrxETH

FrxETH is the native ETH LSD token of the Frax protocol which has had explosive growth since its inception. A key reason for this is it’s two-token system that consists of FrxETH (a ERC-20 wrapper that is the equivalent of WETH) and sFrxETH (a ERC-4626 vault that earns validator yield). This LSD design has proven to be one of the most thoughtful ones live today and Eigenlayer presents the ideal opportunity to extend FrxETH’s revenue streams so stakers can earn additional yield.

In order for FrxETH to properly be integrated into EigenLayer, I propose the following:

Create new ERC-4262 vaults (for example, esFrxETH) for those who want to participate in EigenLayer validators. More research needs to be done in how to safely and effectively manage this part of the stack but this will offer stakers optionality that would not exist with any other LSD.
Develop a governance process in deciding which EigenLayer clients to support. Since it is an open market of networks to choose from, the Frax community can decide which ones to secure. This can be similar to how gauges are decided.
Since every network is different, FrxETH can develop a methodology of tranches for each network that is supported, allowing stakers to optimize for yield and risk management.

By creating separate vaults for each EigenLayer network, FrxETH will be able to cater to stakers who want to take on more risk as well as protect stakers who only want to secure mainnet. Furthermore, EigenLayer provides FrxETH the opportunity to forge deeper partnerships with protocols and networks before they even launch a token. Just imagine, at first Frax can guarantee cryptoeconomic trust at a network level and then when the client is ready provide cryptoeconomic incentives at the application level to ensure liquidity.

From a security perspective, an example of a network in the future that esFrxETH can bootstrap is Frax itself. In the past, there have been mentions of a potential Fraxchain or Frax rollup which would act as a settlement layer of any Frax stablecoin (FRAX, FPI, FrxETH) transactions. Instead of seeking outside sequencers, Frax can insource them from FrxETH. While developments like this is some time away, it is still important to consider the potential and benefits of such an integration.

Conclusion

EigenLayer provides a way for protocols, networks, systems, etc. to outsource their security and Ethereum validators a way to maximize their stake all while increasing the vigorousness of the entire Ethereum network stack. EigenLayer particularly presents a unique opportunity to LSDs to earn more yield on top of what they receive from securing mainnet. A main issue for most LSDs though is they need to be able to separate the tranches of risk which is likely to become a particularly tricky issue, especially if resources are being spent to establish sufficient liquidity for the primary mainnet LSD. Yet, because of how FrxETH is structured, Frax does not need to worry about fracturing liquidity since its incentivizations efforts are only directed at the FrxETH-ETH pair on Curve. All and all, EigenLayer and Frax is poised to make for a fruitful collaboration that ultimately makes the trust and security of Ethereum more robustful as well as economically efficient to do so.