Ethereum Foundation DevCon 6 - Staking & Validator Experience Track, 15 Oct 2022

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From YouTube: How to Build a Decentralized Ethereum Liquid Staking Protocol? by Darren Langley | Devcon Bogotá

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https://archive.devcon.org/archive/watch/6/how-to-build-a-decentralized-ethereum-liquid-staking-protocol/

Liquid staked Ethereum is a reliable source of yield and is fast becoming a key primitive in DeFi. Come hear from Rocket Pool about their experience designing a decentralized Ethereum liquid staking protocol.

How do you create a decentralized protocol for staking? What are some of the design trade offs in token design? What tools are available today? What challenges exist due to current L1 structures? What opportunities exist in future upgrades?

Speaker(s): Darren Langley
Skill level: Beginner
Track: Staking & Validator Experience
Keywords: decentralized,staking

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Learn more about devcon: https://www.devcon.org/
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Devcon is the Ethereum conference for developers, researchers, thinkers, and makers.
Devcon 6 was held in Bogotá, Colombia on Oct 11 - 14, 2022.
Devcon is organized and presented by the Ethereum Foundation, with the support of our sponsors. To find out more, please visit https://ethereum.foundation/

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I am Darren Langley and I work on rocketpool, which is a decentralized liquid staking protocol, so at Rocket pool we've spent the last six years building our liquid staking protocol. So today, I'm going to take you through some lessons that we've learned along the way.

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So in this talk we're going to break down what is a liquid staking protocol? What are some of the design choices? uh What are the challenges of building a truly decentralized protocol and then what are the opportunities?

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So it's staking so liquid staking is built on ethereum's proof of stake system.

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um A little tangent I couldn't be more excited that ethereum is now a proof of stake um chain and congratulations to all the researchers, uh core developers and um sort of and coordinators that have made it happen, it's fantastic.

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So when you stake, you are participating in ethereum's proof of stake consensus. Why would you want to do that? So the most important thing is that you're contributing to the security of ethereum. uh We also earn staking rewards for being a good node operator, so her ethereum has a couple of uh kind of barriers. Oh sorry, ethereum mistaking has a couple of barriers. First of all, you need technical experience to run like a validating node.

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You also need a fixed 32 eth per validator.

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um The state eth is actually kind of naturally illiquid. It exists on the beacon chain earning rewards, but you can't really use it for anything else, which is by Design, but most of the 32 East that you stake is not actually at risk, except under the kind of most dire of consequences or situations.

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uh Currently it's also a one-way thing. So withdrawals are coming soon, um but at the moment you you're staking and you're. That's it so uh the rewards from staking East come in two juicy flavors.

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The first one is consensus, rewards um which comes from new eth inflation, and then you get that by kind of Performing, your node operator duties. So that's a testing being part of a sync committee and proposing blocks as I said before, um withdrawals aren't available at the moment, but they will be um potentially after the Shanghai hard Fork uh execution. Will the next type of uh reward is the execution rewards? They come from users, so they uh come from Priority fees which are the non-burnt part of a transaction fee and then potentially Mev.

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If you're extracting Mev, that's actually available today and pretty much in real time. So how a staking protocol captures and then distributes those fees or those rewards is key to its design.

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So how does liquid staking work?

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A liquid Staker deposits, any amount of eth into the protocol and in return they receive a liquid staking token and the ease that they deposited gets matched with the node operator. The node operator interacts with the protocol and deposits, the eth into into the beacon chain.

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Node operators then earn rewards by being good node operators and the liquid staking token accrues the value as yield so to unstake a liquid sticker burns, the liquid staking token for and gets back their ease or actually more East than they put in generally um and you you can either do it kind of in the primary mechanism or you can do it on a secondary Market.

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So this is the very basic outline of how liquid staking works, but as we'll see, every step has some design choices and trade-offs to to be made.

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So why liquid staking so it's kind of important to know why you're doing this? What benefit does it serve? So it turns out that there are significant benefits to ethereum as a whole, so liquid staking encourages greater participation and that in turn, provides greater security and decentralization there's a little star there, because it only contributes to decentralization if the validator set or the node operators are decentralized and not just one entity.

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uh It liquid staking facilitates unstaking through like a primary mechanism through the protocol itself um or on a secondary market, so it reduces validator churn.

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It also Fosters Innovation and capital efficiency and through the use of these liquid, staking tokens in D5.

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Okay, so on this section, I'm going to focus on liquid token design, but there are some equally big design, spaces on the Node operator, side and and some definitely some interesting challenges on that side as well.

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So first thing you realize, when you're designing a liquid staking token is that node operators earn rewards at different rates. They may also be penalized and in worst case scenarios they can be slashed. So there's a couple of ways of handling this.

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The first way is to have a fungible token that shares, rewards and losses across the entire protocol, or you can have a non-fungible token, where rewards and losses are specific to each node operator or each validator, then you can kind of have that this hybrid of the two, um although you've got to be careful, you don't end up in a worst of Both Worlds. Each of these approaches have some different trade-offs and you have to kind of weigh up um which ones so the next one is safety.

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So there is eth backing. You know backing the liquid staking token So. What mechanisms are in place to protect that collateral. Ethereum's proof of stake system is a very forgiving protocol, but it is possible to lose your your stake either partially or in. Like the extreme cases. Fully safety mechanisms built into the protocol need to account for things like slashing protection, aligning incentives and general risk management, so Rewards, so how are rewards delivered to token holders?

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How does the token reflect the yield that the protocol actually is producing? So generally, there are two approaches to this: there's rebasing and non-rebacing.

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So a rebasing token, its exchange rate is like a notional one-to-one with eth, but the quantity increases, so the token increases in quantity over time. That's how the yield uh represents itself or gets delivered with a non-rebacing token, the exchange rate increases, but the quantity is the same. Quantity stays constant, so the the actual token increases in value over time um and there's some there's.

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Definitely some kind of pros and cons of each of these, mainly that so with the rebasing token, it's very simple to understand: you're literally getting more of the token, uh but it's extremely hard to integrate. So when the, if the quantity is changing all the time, that's not really compatible with most D5 protocols with a non-rebacing token, uh it's it's harder to understand, and if you go down that route you'll spend most of your life uh explaining to people what a non-rebasing token is, um but it is much easier to integrate uh it's.

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It's just a standard erc20 and it's supported by most D5 protocols. It actually turns out that a non-rebasing token is more tax efficient as well. So it depends on your jurisdiction, um but within a rebasing token you have like a taxable event every single day, whereas with a non-rebacing token, you have a taxable event new stake and when you unstake.

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So, liquidity by tokenizing um steak teeth, it can be traded on secondary markets such as exchanges. This provides liquidity for people to unstake their eth did the price you pay on secondary markets is dictated by the market, so it may present a liquidity discount or potentially a liquidity like a premium with large orders. There can also be slippage, and so staking protocols can offer like a if they can offer a primary mechanism for unstaking eth, so that you can allow um liquid staking token holders to actually swap back without the discount and without the slippage.

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Both of these mechanisms of undertaking kind of reduce the need for validator churn.

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Okay, so now you've got your token out in the wild I mean everyone's going crazy about it. um You need to start building utility. These come in the form of Integrations with other D5 protocols, so there's kind of like a Maslow's hierarchy of defy Integrations.

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um It goes something like this. You integrate into wallets and explorers. First, then you build up some liquidity. This is the bit that takes time A lot of time to build up liquidity. You need to get a breadth of liquidity and depth of liquidity and that's important to kind of get to the next phases.

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You also need to get good liquidity on layer twos, because you want to build up um support in those in those ecosystems and also provide good ux for stakers. So then, the next layer is Oracles. So once you once you've got some liquidity, you get oracles the next one is D5 protocols, particularly lending platforms, but also kind of options and index platforms and fixed income products and all loads of things.

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The last one is volts, so volts are kind of like yield, optimization and platforms. They sit over top of loads of different D5 protocols and optimize that yield foreign staking protocol is a set of smart contracts that mediates between depositors and node operators, kind of escrows funds into the ethereum's proof of stake system, and then back again on withdrawal. The protocol transparently distributes those funds and ensures that each party receives what they expect.

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In short, withdrawals, aware of most of the action happens.

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Okay, so it's at this point in the presentation. I need to give a bit of a disclaimer. The information on this slide is not final. The capella specification is still being kind of drafted, but at this point this is what it looks like.

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So after the Shanghai, hard Fork, hopefully, um consensus rewards uh will be fully withdrawable or partially withdrawable, so fully withdrawn is a node operator initiated thing, so a node operator submits an exit message. They get processed by an exit, the beacon chain execute they come into this withdrawable state and then their funds are returned to a withdrawal credential.

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At that point they are no longer validating they've done, there's a validator okay, that's full exit with partial withdrawn you're still validating, and in fact this is like an automatic and ongoing process. So um this is this essentially takes skims. The rewards um off the top, so you have 32. Heath is your kind of initial deposit and then anything else you make um on top of that will be kind of continually skimmed and sent to your withdrawal credential automatically by the um the beacon chain and the consensus clouds.

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So withdrawal credentials are a key element of the ethereum spec um and they come in like two types: there's a Xerox zero, which is this BLS signature, credential and 0x01, which is an ethereum address that receives the withdrawn funds.

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So most credentials in use today are 0x0 and that's because they were introduced first and then much later, 0x01 came came ahead, so in the current plan, Xerox zero credentials, we need to be converted into a 0x01 um to allow you to withdraw and there'll be like this special kind of migration process. That'll that'll facilitate that so 0x01 is important because it facilitates the development of these non-custodial staking protocols, um essentially because the 0x01 address can be a smart contract and so that's smart contract can, you know, take custody of funds.

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They can deposit them into the um the beacon chain into the into the deposit contract and then, when it withdraws it can then distribute the funds to all the parties.

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So, building a decentralized staking protocol is easy, not so much.

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There are significant challenges to developing a truly decentralized staking protocol, so as for permissionless being an open and public piece of infrastructure is key to a protocol success, and it's- and it's also it's important for its alignment with ethereum being permissionless, is a is a noble Pursuit and it's critical for ethereum to for retaining its credible neutrality, so being permissionless subsequently leads to trustless designs, which I believe are much more resilient in the long term, like ethereum itself.

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Decentralized staking protocols have to rely on a combination of cryptography and crypto economics to balance incentives and penalties, ensuring that the participants have aligned interests, but it is challenging, but personally, this is what it makes it. This is what makes it interesting work so scaling being a competitive market. Participant is important to ensure that ethereum remains decentralized scaling. A decentralized staking protocol is much harder than scaling a centralized provider.

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The two aren't even really comparable. A decentralized staking protocol has to rely on Ingenuity to scale but never lose sight of its kind of core value. A decentralized staking protocol is actually a community. A community of node operators who are passionate about securing ethereum scaling is certainly a challenge, but it is one that can be overcome so Reliance on oracles, so semi-trusted oracles are essential for decentralized staking protocols. Today, the consensus and execution layer are separate, Concepts and they've only just been merged together.

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So oracles are required to Aggregate and Report validator performance information to the protocol. Smart contracts, there's actually an EIP, that's being considered for Shanghai and it's eip4788. What it does is. It adds access to the beacon chain state route to the execution layer, so that smart contracts can verify proofs about the beacon chain state.

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This is key to reducing the role of these semi-trusted Oracles in the decentralized staking protocols, but it is important generally to combine those two concepts and allow Innovation to particularly around validator status and finality on the execution layer.

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So what are the opportunities.

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Okay, so this might be a bit counter-intuitive, but ethereum doesn't need more stake. It needs more individual node operators, so I believe this quote is from superfizz. So uh thanks Fizz, if you're watching um decentralized, staking protocols, have an opportunity to redress the balance.

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So by lowering the collateral requirement for node operators, there are more potential node operators available by streamlining, setting up a node and running a node, it's easier to onboard new node operators and if you lower the barrier to entry for spinning up a staking business built on top of a decentralized staking protocol.

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This allows a whole ecosystem of Niche staking businesses to compete with large providers more node operators, the more node operators we have, the more decentralized ethereum is.

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Being a node operator is not as hard as you think.

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Okay, so execution reward, smoothing, so execution rewards, so the ones that come from, like transaction fees and potentially Mev, are extremely variable. This is because Brock proposes are chosen at random.

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So at this time, if you have like one, validator you'll receive approximately five proposals per year um on average, but you could get two or you could get 10..

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So this variability hits small node operators hard but harder actually hard the hardest um as a decentralized staking protocol There's an opportunity to provide a reward, smoothing pool that participants pull their proposals to achieve a consistent return, rather than this highly variable return.

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So a smoothing pool actually levels a playing field, the small node operators. They can kind of compete with the larger node operators.

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This is a particularly interesting when you think about Mev Mev. You can have on average you can, you can earn. You know a decent amount from Mev, but every now and again there'll be one of these Lottery blocks. The highest block, I, think that's recorded, was 100 East block um that doesn't happen very often, uh but that hence why it's a lottery block. But if you do get one of those blocks, then this is what the smoothing pool helps with.

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So I'm Darren Langley um I'm from rocketball. You can catch me on Twitter and that's me. Thank you very much.

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Hi, my name is Benjamin with rubicon.finance I wanted to ask I understand, rocket, pull nodes are collateralized with RPL. How do you protect against a tail rest scenario where, if the price of RPL eth is is dropping.

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Average collateralization of the network uh starts to fall and how can the protocol like uh become robust uh in light of basically, uh you know relying on RPL youth price to guarantee security.

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So, in actual fact, uh so, RPL is used as a backstop. So the the first thing that they we so with a with a rocket pool node uh the node operator supplies 16 each and the liquid stakers Supply 16 Heath, um and then the node operator also supplies to marpl like it's minimum of 10. So it's about 1.68 um and uh but the eth is hit first, so if they, if they get slashed or um if, if they.

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If they're an absolutely terrible node operator and then essentially their ether, it gets hit first and then RPO is used as a backstop, because you can actually lose a little bit more than 16 in, like a like the worst worst case scenario: yeah, okay,.

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Multi-Part question: okay, so first part: um how hard is it to run a rocket pool? Node like you need to know Unix, or can you just run a script and it installs everything? Second part: okay,.

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Many nodes: can you run on one powerful, PC.

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Right, cool, okay, good question, uh so running a rocket pool. No, you do need to know probably a little bit about um Unix. Maybe you can run it on different things. We don't necessarily support Windows, um but you can run it on on then a Linux box. You do need to know a little bit about Linux. uh Speeding up a rocketball node is I. Think pretty much four commands um in your and it's four commands and you've you've spun up a validating node, um so we've made it we've streamlined the process. uh We have.

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This thing called a smart note stack and it streamlines the process of actually spinning up a node. We connect everything up for you. We handle upgrades for you, it's it's really easy.

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um The other question, the other part of that question was all right. That's right! All right! That's yeah! That's! That is a hard question to answer so terminology wise, a node is like the box, that's running it and then you have validators. So you can have a lot now, whether now, whether you, whether that's a good idea or not, is is another is another matter.

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So what you would tend to do is you probably want to distribute across multiple nodes um if you had a lot, um but you can run a lot um different clients, different consensus, clients and different execution. Clients have different performance profiles, um but you know yeah. You can run a lot on I, don't think we've I, don't think we've um we haven't modeled it, uh but it is it didn't like the hundreds yeah it depending on it also depends on the box. If it's a powerful machine, then you can do that. Yeah.

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Yeah all right awesome. Thank you very much guys.