The Importance of Native Reward-Bearing Tokens

Types of Tokens

Rebase vs. Reward-Bearing Tokens

- Rebase Tokens

A rebase, or rebasing, token is a cryptocurrency designed with an algorithmically adjustable supply to help stabilize its price. The supply of a rebase token may experience high volatility, yet its price often remains stable, contingent on the price of the asset it is designed to track.

stETH, for example, consists of a ‘transferable rebasing utility token’ that represents a proportion of the total ETH staked through Lido. stETH balances are updated daily to reflect the staking yield [1]. As a result, holders of these liquid staking rebase tokens receive rewards in new tokens, while the exchange rate remains the same.

However, sometimes rebase tokens face challenges when it comes to integrating smoothly with other DeFi protocols, due to constantly changing supply metrics. This lack of DeFi composability can limit their adoption and application in other protocols, including lending, borrowing and yield platforms.

- Reward-Bearing Tokens

A reward-bearing token represents a cryptocurrency whose value increases over time through a dynamic exchange rate, despite its amount remaining constant.

Liquid staking reward-bearing tokens accrue staking rewards, reflected on an increasing exchange rate. In Ankr’s case, users receive ankrETH, a reward-bearing token, for staking ETH. These ankrETH tokens follow a 1:1 ratio with users’ staked assets. When stakers redeem the position, they receive back the original staked assets, in addition to the accumulated staking rewards [2].

Reward-bearing stablecoins are backed by overcollateralized reward-bearing assets, such as LSTs or LRTs, whose staking rewards are distributed to the stablecoin holders. These tokens achieve peg stability by locking the collateral in smart contracts, which dynamically adjust collateral ratios and manage the issuance and redemption of the stablecoin based on prevailing market conditions [3].

Native vs. Non-Native Tokens

- Native Tokens

Native tokens represent assets that are intrinsic to a blockchain’s infrastructure or are directly created by smart contracts on the blockchain itself without external intervention. These tokens are closely tied to the core functionalities and security of the blockchain [4]. *For this research, native tokens were considered to be all the tokens that can be natively minted on a specific blockchain, in addition to gas tokens.

Characteristics:

1. Integration at the blockchain level: Native assets are deeply integrated into the blockchain’s architecture. For Ethereum, for instance, ETH is the prime example, as it’s minted with each block’s creation and used for transaction fees and network operations.

2. Direct Minting: A distinctive feature of native assets is that they can be minted directly on the blockchain. USDC is a good example, as it’s minted directly by Circle on various blockchains including Ethereum and Solana. As a result, it’s considered a native asset to multiple blockchains.

3. Liquidity and Transferability: Native assets typically experience higher liquidity on their ‘home’ blockchain, facilitating DeFi composability, integrations in other protocols and adoption.

4. Cross-chain Limitations and Solutions: Native tokens face some limitations when it comes to moving across different blockchains, mainly due to incompatible standards. In order to solve this issue, some third-parties may create a wrapped version or equivalent of the token that complies with the destination blockchain’s standards.

- Non-Native Tokens

Non-Native tokens include any asset that must be either wrapped or validated by a third party before they can interact with the blockchain. These tokens are not inherently integrated into a blockchain’s architecture like native tokens. Instead, non-native assets, often referred to as wrapped tokens, exist on the blockchain but need an additional layer of validation or conversion to operate within that blockchain environment. Examples of these include wBTC and wMATIC, which have been wrapped into a standard token format, such as ERC20 on Ethereum.

Characteristics:

• Cross-Blockchain Functionality: Wrapped tokens can be used within ecosystems of other blockchains, thereby increasing interoperability among different networks.

• Third-Party Involvement: The creation and management of these tokens involve third-parties, responsible for handling the wrapping process, maintaining the necessary reserves and ensuring that the tokens on the blockchain accurately represent the original assets.

• Cross-chain Liquidity and Functionality: Users are able to leverage the strengths of a multitude of blockchains, without the need of transferring assets between wallets or exchanges directly. The liquidity of non-native tokens is spread across the blockchains supported.

• Example of a use case: Bitcoin doesn’t natively exist on the Ethereum blockchain. In order to use bitcoin on Ethereum’s ecosystem, it must be first wrapped into wBTC.

Importance of Native Yield-Bearing Assets

Most Layer 2s still do not provide any yield on assets. While ETH staked on Layer 1s can yield approximately 4% APY, bridging liquid ETH to Layer 2s currently yields nothing on many chains. The same is true for stablecoins, which do not generate returns on the majority of either Layer 2s or Layer 1s [5].

However, some Layer 2 solutions have recently emerged to provide users with native yield generation on their ETH and stablecoin holdings directly on the network. This represents a significant development as it offers a source of passive income without requiring involvement in separate staking or yield farming protocols [6].

Benefits of offering Native Yield-Bearing Assets

• Increased Network Security and Participation: Native Liquid Staking Reward-Bearing Tokens provide staking rewards to users, who are incentivized to retain their assets for longer periods of time in a specific network. Thus, it significantly increases security and stability mostly in POS chains.

• Enhanced User Engagement and Loyalty: By receiving rewards for holding or using certain assets, users are more likely to remain engaged with the network. This can increase user retention and deepen loyalty to the blockchain or its projects, as stakeholders benefit directly from the ecosystem's growth and success.

• Economic Stability and Growth: Reward-bearing assets can help stabilize the economy of a blockchain by providing consistent returns to holders, which can mitigate market volatility. Additionally, these rewards can encourage more transactions and interactions within the ecosystem, fostering further economic activity and growth.

• DeFi Composability and Ecosystem Development: Reward-bearing tokens are particularly attractive to be used as collateral within the DeFi ecosystem. Rewards can also incentivize liquidity provision, critical for the efficient operation of trading platforms and other DeFi platforms on the blockchain.

Capital Efficiency

Reward-bearing assets are designed to maximize the utility of capital. Holders are not only able to earn passive income through yields - often derived from staking or lending activities - but also benefit from the potential appreciation in the asset's value (in the case of LSTs and LRTs).

This dual benefit streamlines capital allocation by allowing investors to derive multiple types of returns from a single position. Additionally, the ability to use these assets in various DeFi protocols without needing to liquidate them adds a layer of flexibility. This means that capital can remain productive in one form while still being used as collateral or for liquidity provision in other DeFi platforms.

zkLink Nova, for instance, plans to incorporate an ERC-20 Token Aggregation mechanism, where native Layer 2 assets from multiple chains can be deposited into zkLink and traded with each other with interoperability. This feature allows for additional capital efficiency among many DeFi applications and creates a variety of use cases. The token aggregation mechanism would be also applied to reward-bearing tokens, such as LRTs and LSTs, significantly increasing earning opportunities on zkLink Nova [7].

Reduced Liquidity Fragmentation

One of the critical challenges in DeFi is liquidity fragmentation, where capital is spread across multiple LSTs, LRTs, and stablecoins within the same network. Native reward-bearing assets address this issue by incentivizing users to retain these specific tokens for extended periods. The longer holding periods are usually encouraged through mechanisms such as higher yield rates for longer staking terms. It’s also easier for the chain to incentivize users to hold, trade, or even set up pools against their native reward-bearing tokens, for instance, through a points mechanism.

Specific Cases

- Blast

Blast is an EVM-based optimistic rollup offering native yield to depositors. The yield on Blast is generated from ETH staking and RWA protocols. This yield is automatically distributed to Blast users from these decentralized protocols. While the default interest rate on other L2s remains at 0%, Blast offers 4% for ETH and 5% for stablecoins.

According to l2Beat and as of May 20th, Blast has a total TVL of approximately $2.7B, from which $355M come from USDB (Blast’s native yield-bearing stablecoin) and around $2B from WETH. Please note that, within the network, WETH and ETH are most of the times used interchangeably. The only difference is that ETH’s contracts have disabled yield by default, while WETH and USDB have automatic yield for both EOAs and smart contracts. According to Blast’s documentation, however, ‘ETH itself, not WETH stETH or other ERC-20 token, is natively rebasing on the L2’.

By holding ETH or WETH on Blast, users get Lido’s yield plus blast points. As a result, this could be one of the reasons behind Blast achieving 4th place among Layer 2s with the highest TVL.

Figure 1 – Blast TVL Breakdown

Figure 2 – Blast TVL Breakdown

- Mantle

Mantle network is an EVM-compatible chain with modular architecture, that combines an optimistic rollup with various data availability solutions. As reported by l2Beat on May 20th, Mantle's TVL stands at around $1.13B, of which $377M are attributed to Mantle Staked Ether (mETH) – a reward-bearing liquid staking token. Users are able to stake ETH on mainnet and receive mETH directly on Mantle Network, to start exploring the ecosystem, while consistently earning rewards simply by holding the token. In these particular cases, users are no longer incentivized to hold ETH, because it doesn’t generate any internal yield.

Figure 3 – Mantle TVL Breakdown

Figure 4 – Mantle TVL Breakdown

- Swell L2

Swell L2 is a restaked rollup built on the Polygon CDK, using EigenDA and the Polygon AggLayer in addition to AltLayer, Chainlink, and Redstone.

As of May 20th, Swell L2 had already secured $1.4B in pre-deposits, potentially making it the fifth-largest L2, behind Arbitrum, Optimism, Base and Blast. Swell decided to use its liquid restaking token, rswETH, as the native gas token of the chain. This enables users to accrue 4x Pearls and EigenLayer points, in addition to participating in Swell L2 airdrops.

- Fraxtal

Fraxtal is a rollup equivalent to EVM that uses the OP stack for its smart contract platform and execution environment. According to l2Beat, Frax’s yield-bearing stablecoin, Staked Frax (sFRAX), has a TVL of about $6M. Staked FRAX (sFRAX) is an ERC4626 staking vault that allocates a portion of the Frax Protocol yield to stakers on a weekly basis, with payments made in FRAX stablecoins. The sFRAX token represents proportional deposits in the vault and can be exchanged for FRAX stablecoins at any time at the proportional rate.

Frax also launched frxETH, a token pegged to and with a similar amount of circulation as ETH. However, frxETH on its own does not accrue any yield. In order to solve this issue, Frax revealed sfrxETH to share the staking yield from Frax ETH Validators with token holders. Users can convert frxETH to sfrxETH at any time by depositing it into the sfrxETH vault, enabling them to earn staking yields on their frxETH. As validators accumulate staking yields over time, an equivalent quantity of frxETH is created and added to the vault. This process allows users to withdraw more frxETH than they initially deposited when they redeem their sfrxETH. According to the previous sources, sfrxETH has a TVL of approximately $9.19M.

Figure 5 – Fraxtal TVL Breakdown

Figure 6 – Fraxtal TVL Breakdown

Conclusion

Native reward-bearing assets are of the utmost importance for L2s because they address fundamental challenges such as scaling, capital efficiency, and liquidity. By incentivizing long-term holding and active participation, these assets directly contribute to the robustness and maturity of L2 ecosystems.

It's also important to note that the Market Capitalization to TVL ratio of any L2 is significantly higher than the same ratio for issuers of reward-bearing assets, such as Liquid Staking or Liquid Restaking protocols. For instance, the ratios for Optimism [13.27], Mantle [22.29], and Manta [9.83] are at least 80 times higher than those for Lido [0.06], RocketPool [0.11], or Ether. fi [0.1]*. This indicates that it is much easier for a chain to increase its Market Capitalization relative to the same growth in TVL compared to a Liquid Restaking or Liquid Staking protocol.

*these ratios were calculated based on CoinMarketCap and CoinGecko data.

References

[1] - https://blog.lido.fi/steth-the-mechanics-of-steth/ [2] - https://www.ankr.com/docs/switch/overview/ [3] - https://www.gate.io/learn/articles/lst-backed-stablecoins-a-new-frontier-in-defi-innovation-and-opportunity/2200 [4] - https://lifi.substack.com/p/what-is-this-asset-lifi-explains [5] - https://mantanetwork.medium.com/new-paradigm-the-real-l2-that-helps-you-earn-more-yield-than-a-multisig-2f445ab4dc47 [6] - https://www.kucoin.com/learn/crypto/top-crypto-projects-in-blast-layer-2-network [7] - https://blog.zk.link/token-merge-unifying-aggregated-assets-from-ethereum-ethereum-layer-2s-on-zklink-nova-ade9cf3811fb