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To understand the challenges inherent to LST-Fi, it's important to delve into the architecture of the current LST system. With ETH built on a PoS network, we've entered a new era of finance where the network state resembles sovereign debt. The structure of this debt includes:
- Interest Rate Pricing: ETH holders act as buyers by depositing into an LST pool, while validators borrow this liquidity to secure the network. As the network thrives, both holders and validators share the profits of the PoS network. However, holders are at the supply end, and validators are at the demand end, thereby shaping the yield structure.
- Term Structures: On top of the yield, various term structures serve holders and validators, leading to the emergence of several staking service providers including Lido, Rocket, Stafi, Swell, and Frax.
So, what are the main challenges of LST-Fi?
Unlike DeFi, which takes ETH/USDT as the base asset layer, LST-Fi takes stETH/rETH as its base asset layer. We should consider LST (LSD token) as an ETH-pegged asset with a term structure. From the perspective of DeFi, the challenges are quite clear.
- 1.Liquidity Fragmentation: Each staking service provider issues their own type of LSTs with unique mechanisms, like Swell and Frax v2, leading to increasing fragmentation.
- 2.Yield Term Structure Limitations: Various types of LST represent ETH risk-free rates up to roughly five years out at different maturities, resulting in diverse yield structures.
- 3.Validator's Risk Centralization: The complexity of validator risk profiles increases with multiple validator services, introducing stake centralization risk along with slashing and penalty conditions.