Introducing stkETH v2: Scaling ETH Liquid Staking & LSTfi on Layer 2s

The case for L2s

L2s (read as Optimism & Arbitrum from here on) have displayed a clear product-market fit for the future of Ethereum scaling. On-chain data* suggests a future where the beacon chain might be the base layer for consensus and L2s are used for execution.

1. Arbitrum & Optimism have seen a net inflow of ~$4.3B by over 983,000 wallets.
2. The current TVL on all L2s combined is ~$9.6B. This is only ~5.5% below its ATH of ~$10.6 billion in April 2023.

Scaling Ethereum

1. L2 users now represent ~30% of all Ethereum Ecosystem users (compared to ~4.5% in July 2022).
2. The average number of daily transactions on Arbitrum & Optimism have grown ~7X since July 2022, overcoming the daily transactions on Ethereum L1. 

For the Users

1. On average, a user saves about 95% in transaction fees on an L2 compared to Ethereum L1.
2. The percentage of total gas used on Ethereum L1 by L2s contract has doubled ( from 2% to 4%) in the last year, indicating more L2 usage. It reached an ATH of 7.34% of all gas spend in April 2023.

*The above data is as of 6 July 2023. All references and sources are mentioned at the end of this blog.

It is not surprising that a wide variety of DeFi protocols (both existing and new) have followed the same path in moving to L2s. Aave, Aura, Balancer, Beefy, Chronos, Curve, Dopex, Gains, GMX, Liquity, Kyberswap, Pendle, Radiant, Timeless, Wombat, Uniswap, Velodrome, Synthetix, Instadapp, Polynomial, Sonne, and the list goes on and on…

ETH Liquid Staking on L2s

The ETH liquid staking landscape on L2s presents a different story. Despite the bridging of LSTs (liquid staked tokens) by liquid staking solutions like Lido and RocketPool, the full potential of liquid staking and L2s remains unexplored.

For instance, only 111,395 wstETH has been bridged to Optimism and Arbitrum to date. This represents a mere ~1.67% of the total ETH liquid staked with Lido.

This can be attributed to three drawbacks present currently:

1. The Pain of Reaching an L2

ETH on L1

To liquid stake ETH on Ethereum and bridge it to an L2, you must navigate through multiple interfaces. This cumbersome process incurs high gas fees and requires you to perform various transactions, such as staking, wrapping, and bridging.

ETH on L2

To swap ETH present on an L2 for an LST, you still need to bridge your ETH to the L2 in the first place. In addition, trading on a DEX might result in capital loss due to price discrepancies compared to liquid staking on the LS protocol directly. There is currently no way to natively liquid stake ETH from an L2.

2. Fungibility between L2s

L2s have helped solve Ethereum’s scaling problem at the cost of fungibility. Fungibility of a token, in this context, means its interchangeability between L2s. Due to the involvement of different bridges, an LST like wstETH on Arbitrum is not the same as wstETH on Optimism. Moreover, it is currently not possible to directly bridge LSTs between these L2s.

This non-fungibility of tokens leads to capital inefficiency as it acts as a major blocker for economic activity and trade to exist between L2s. Even Vitalik believes that cross-L2 use cases are a problem worth solving.

3. Risks & Limitations of Bridges

Bridges open up siloed blockchains to interact with each other. In this case, they enable connectivity & interoperability between Ethereum L1 & L2s. Most L2 bridges use a lock & mint mechanism, where assets are locked in a smart contract on the source chain & minted on the destination chain. Multiple bridge offerings (native & non-native) leads to confusion & inconvenience as different bridges are better in different aspects (speed, security, UX, etc.). The use of bridges also leads to the above mentioned token fungibility issue.

On the other hand, bridges are still a nascent technology & introduce additional smart contract & systemic risks. Ultimately, bridges that connect these chains also limit the scaling of the to & fro of assets between these chains.