The story of how staking is being decentralized on Ethereum and how the neverending search for yield is making this shift profitable. From CeXs to Lido to Rocket Pool— the time is now to champion the first basket of liquid staking tokens.
In the early embers of the beacon chain, the quick thrived. Centralization is one of the devil fruits— give up on trustlessness, decentralization, or permisionlessness, and bountiful rewards are to be had. Titans of the web2 model— companies such as Coinbase, Kraken, Binance— were more than happy to take willing users’ funds to be locked away. What choice was there? Short of running your own node, a daunting task for many, the CeXs provided a way in. The rings of power had been granted, it appeared. The ailments of mining pools seemed bound to repeat, were repeating. Greed and speed drew power.
In the background, another force grew. A DAO that sought to bring yield to the many without the overt trust assumptions of the CeXs. Lido was formed and the stETH token emerged— the first and current dominant liquid staking token. For the first time, anyone on the Ethereum network could stake with less than 32 ETH and retain custody over their funds. Deposit ETH → receive stETH → rejoice in the DeFi summer powered lending spree. Capital poured in, and where once was an enlightened pursuit, a sinister catch-22 slowly brewed.
How can they onboard everyone? The CeXs took your crypto and you had to trust them. Lido gave you a receipt token for self-custody— but where does the ETH go? The DAO that sought to give access became a black hole as the only point of access. The Lido network is willing to accept an infinite amount of ETH happily to be distributed amongst the select few chosen operators. Trust meant speed. To onboard everyone, the people who actually run the nodes with everyone’s ETH had to move quickly and be trusted as honest operators. A devil fruit was eaten and power emerged— and just as with a black hole, this power may be trapped.
The Lido validator set has become engorged. The centralized behemoths of web2 are now sparring mates to Lido, who sits atop the throne as the largest staking pool at the time of writing. In pursuit of yield, we were willing to ignore the perils of centralization. Capital efficiency underlies all the systems in DeFi. Where there can be optimizations, optimizations are found. The DEX wars are a clear example. Curve and Uniswap v3 compete in ultra-efficient swaps while end-users rejoice. The concept of liquidity pool tokens has enabled capital to be active even in your wallet, earning the holder trading fees. Efficiency has trended up with time, to Lido’s benefit.
It comes as no surprise then that stETH has become entrenched as a DeFi Lego. If you are able to replace ETH in your strategy with stETH (or wstETH), then you’ve increased yield by several percent, passively. This increase in yield is not the limit. The nature of yield farming has been in liquidity incentives. For example, Curve provides CRV tokens to those who deposit liquidity into the stETH-ETH pool and stake the curve-LP token. The complexity has increased from cold ETH, to cold stETH, to active liquidity pairing stETH-ETH, now to curve-LP tokens generating extra yield.
Enter Yearn, the yield aggregator. Yearn’s vault system takes this strange cohort of yield and packages it into a simple, liquid token. It autocompounds all the extra liquidity incentives right back into the base layer. Yearn acts as a strategy building hub where the best strategies will attract the most capital inflows. Since its inception, the Yearn vault for the Curve stETH-ETH liquidity pairing has been extremely sought after. Its token, ycrvstETH, is one of the most capital efficient tokens in DeFi. Sitting in your wallet is an entire ecosystem of yield more complex than that which I have described.
The ycrvstETH token is the fourth most popular collateral asset on Abracadabra Finance, one of the most popular lending platforms. This is important since it shows the Yearn vault token is not the end, but the base layer for even more yield and further complicated strategies. The token represents the most yield that can be squeezed into an unmanaged, passive token. For most of DeFi history, ycrvstETH was the best asset in this regard.
The unceasing demand for maximizing yield has led to a bloated Lido, the gatekeeper to liquid ETH staking. Further inflows will begin to threaten the health of the network as Lido creeps up towards 20% of all validators on the network. Herein lies a problem. Currently, stETH only flows in. Withdrawals will not be unlocked for many months— until the hardfork following the merge. The torrent of yield seekers cannot be deterred — where yield can be had, yield-seeking inflows of capital will follow unless the consequences are can be immediately priced in. The rewards on stETH will not go down if Lido operates 50% of the network (they’d probably go up in the short term), but the value and security of the network itself could be irreparably harmed in this scenario. Thus, the only way forward is to redirect the flow to greener pastures and higher yields.
Lido was alone. It no longer is. Other Ethereum staking providers have emerged with their own liquid staking tokens. None, however, are more important to the long-term health of the Ethereum ecosystem than Rocket Pool. Whereas Lido’s permissioned nodes are willing to assume all validation duties at potential long-term risk to the network, Rocket Pool rejects shortcuts. There is almost no trust, only code, and crypto-economic incentives. There is no speed in this path. Rocket Pool cannot onboard an infinite amount of ETH in a day like Lido. There is, instead, a framework by which a decentralized set of nodes can safely back a liquid staking token network. The Rocket Pool network has over 800 node operators, some known major Ethereum players, others as anon as their addresses.
Creating this framework was hard. Lido was accepting deposits around a year before Rocket Pool. Yet, despite a massive head start and despite near-total liquid staking domination by stETH, the three months since Rocket Pool’s launch have demonstrated vast inflows of capital pushing the protocol to 1% of all network validators and 100k ETH staked. In other words, the baby has begun to crawl and crawled directly into the cockpit of a Rocket. The reasons for the adoption are complicated, but at the current rate of adoption, Rocket Pool stands a good chance of attracting an ever-larger share of inflows from its competitors. If the markets are useful for anything though, it’s that the promise of future growth can be priced in at the moment. We can supercharge the growth of Rocket Pool to the direct benefit of the ecosystem’s health.
The 0→1 moment for stETH was the Curve liquidity pairing with ETH so that rewards could be compounded on top of the LP token. The majority of stETH’s implementations use this stETH-ETH pool as the base layer. This pool is currently one of the single largest holders of ETH and deepest liquidity pools in existence. What if we could create another 0→1 moment? The first was going from ETH to the staked ETH pair. The second moment is here, the liquid staking token basket— potentially doubling yield by doubling the liquid staked ETH exposure at the very core of DeFi’s biggest building block.
To see why this is a turning point in DeFi, let’s take a look at where the yield in ycrvstETH is coming from. Keep in mind that rewards are automatically compounded. In order of complexity, starting with 0.5 stETH and 0.5 ETH:
The user’s ycrvstETH yield is 4.51% APY. However, this is after a flat 2% management fee and 20% of yield performance fee is taken on behalf of Yearn. The true APY therefore is approximately (4.51% / 0.8) + 2% = 7.63% APY. Thus, the incentives from steps 2-4 sum to a 5.38% boost. This yield is passive, but requires subsidization on behalf of some protocol’s interests. In one sense, this yield is not sticky to the underlying token pairing. The yields come from incentives that could be paid out to any token pairing. This 5.38% is transmutable and based on mechanisms such as bribes through the Votium protocol.
Allow me now to introduce you to the pool that I believe will be the successor to Lido’s formidable stETH-ETH Curve pool, despite the massive ecosystem already assembled. Introducing the rETH-wstETH pool. The rETH token is Rocket Pool’s liquid staked ETH token that passively increases in value against ETH. The other token (wstETH) is the wrapped version of Lido’s stETH. Wrapping the token allows it to also increase in value against ETH over time, as rETH does.
Part of the genius in the original stETH-ETH pool was that the stETH token was pegged to ETH, so holders experienced no impermanent loss from diverging asset prices. This is crucial, as the ideal passive collateral token should carry minimal passive value risks. Since wstETH and rETH increase in value at roughly the same rate, the Curve pool between the two will inherit this benefit of negligible impermanent loss. Further, the novel advancement is that this pool has no ‘cold’ ETH exposure. Both assets will earn staking exposure. Let’s take a look at how 100% staked ETH exposure changes the APY calculation.
Comparing just the Curve pools, the rETH-wstETH pairing offers 2.1% higher yield. This alone covers 39% of the additional incentives added onto the Lido stETH-ETH pool. An increase of this size cannot be overstated when dealing with liquidity TVLs in the billions USD. In their March budget, Lido had to allocate 3.25 million LDO tokens toward direct incentives and bribes for their Curve stETH-ETH pool. At current rates, this is a $6.9 million USD monthly expenditure. A 39% capital efficiency upgrade is a saving worth millions every month. Liquidity initiatives will be vastly more efficient if added onto the rETH-wstETH.
Another way of looking at this is that the stETH-ETH pool faces the problem of having to subsidize 50% stETH yield, otherwise users would be better off just holding stETH. The rETH-wstETH pool requires no subsidy since it offers essentially the same yield, if not more, than holding just rETH or stETH. The flow of capital into ETH staking as time progresses will be vast and it will not ignore such obvious improvements in capital efficiency.
More philosophically, we ought to take a lesson from the page of DeFi veterans like MakerDAO who abandoned the original single collateral DAI model, allowing only ETH as collateral, for a diverse portfolio of collaterals. Principally, this eliminated the risk of a single point of failure. This same approach to risk management is long overdue in the liquid staking ecosystem. We are currently in dangerous territory, with Lido sitting at 86% market share while Rocket Pool sits in second with just 4.5%. I do not want to portray the wstETH-rETH pool as a vampire attack on Lido’s market share. Instead, I argue that this pool is step one in a greater realignment in the space. Reducing the ecosystem’s reliance on stETH will mitigate the chance of something catastrophic such as a zero day or hostile protocol take over. Competition was inevitable and cooperation will lead to greener yields.
Cooperation is another benefit to the wstETH-rETH pool that is specific to those who sit in Discord governance chats like me. DeFi runs on liquidity. Lido is willing to spend millions every month to subsidize the stETH-ETH pool. However, why must only one protocol contribute to liquidity? A basket of staking tokens in a single liquidity pool may one day mean a basket of different liquidity incentives from various staking protocols. A single LP token that maximally supports the health of the Ethereum ecosystem. This basket represents a public good in long-term security.
We have a chance to front-run an outcome like that which befell the stablecoin market. Instead of competing with each other for liquidity we must expand the basket and allow different staked ETH derivatives to benefit from shared liquidity, thereby reducing the risk for the whole network and continuously dividing the costs of incentivizing liquidity long-term. To those holding veCRV or vlCVX, we ask you to consider supporting this pool as it grows. Follow the example led by Rocket Pool friendly, DeFi whale, Tetranode as he ushers us into the first great Rocket Pool LP rush. His generous voting power will bring 0.56% of the daily CRV issuance towards this LP starting March 10th. Based on the Curve YFI-ETH pool, our Curve rETH-wstETH should launch with the ability to provide 15% APR on a $20 mil TVL. At the time of writing, the TVL is only ~600k USD, yes— this is crazy stupid good alpha. This rush will be a stress test on the protocol. However, with 40% higher base incentives from 100% staking yields, guaranteed rewards of ~8k USD/day from CRV emissions towards LPs, and zero impermanent loss the era of Rocket Pool is here and it is profitable.
Staking on the Ethereum network is ultimately about securing the network. The security of the network is incentivized and rules are coded to minimize attack vectors. Yet, the Ethereum community’s responsibility for continuously securing the network can never be abandoned. The “layer zero” human network that runs the validators themselves is not comprised solely of Ethereum enthusiasts. As more and more value accrues to the network, more and more individuals will attempt to exploit it, wherever possible. Gradually, if necessary, or immediately if possible, these attacks will be theorized and plotted. We must be ever on our guard. The unbridled expansion of the Lido network is a pathway towards one such tail risk that can be avoided. In fact, the most secure and most capital-efficient outcome is the future with many staking providers competing down commission rates.
It is easy to be lulled into a false sense of security when looking at the Eth2 deposit contract with a currently valued 27 billion USD worth of ETH locked. But don’t be fooled. The merge is not live. The large majority of all ETH is not staked. We are still early, and so have a responsibility to shepherd the space safely into the future. The staking dynamics that exist now are representative of the earliest moments of the universe— an unimaginably hot and dense core that is set to balloon into a great expanse. Just as small quantum fluctuations in this time led to the great diversity in the universe’s structure, the decisions made right now will have far greater impacts on ETH’s history yet unwritten. While the furnace is hot we can mend the space. I call on the greater DeFi ecosystem– integrate the ycrvwstrETH token. We can build the pipes but capital will flow along familiar channels. We call on all protocols that use the ycrvstETH token to allow, if safe to do so, the ycrvwstrETH token. This is the capital-efficient future. This is the equitable staking provider future. This is the secure future. All propagated off of the One Pool to Rule Them All in its current form, yet to expand— the rETH-wstETH curve pool.
EDIT: There’s an important nuance of minting rETH through the Rocket Pool smart contract— freshly minted rETH has a 24 hour time lock in which it cannot be traded. You cannot move any rETH if you have minted rETH in the last 5760 blocks. If you buy rETH from Uniswap or Balancer, there is no time lock. This time lock is designed to prevent abuse of the Rocket Pool commission system.
The limitations of Curve v1 include the inability to establish a non 1:1 ratio in a stable pair. Since Lido launched months before Rocket Pool, the wstETH token has a slightly higher value than rETH. To compensate, the pool is designed such that it is kept at approximately a 77/23 rETH-wstETH ratio. At this composition, at the given amplification parameter, the pool is able to liquidate 10% of its rETH supply with 1% slippage. This is a strong result, however, leads to some peculiarities. First off, the UI shows a warning to users because it thinks the pool is accidentally out of balance. This is just a graphical issue as shown below and will not lead to slippage.
Second, those who wish to deposit large sums should do so at the existing ratio of the pool or with the balanced proportion option. As the pool grows, these concerns will dwindle as it will take larger and larger single-sided deposits to create imbalances. Additionally, in the event someone does ape excessively on one side, arbitrage bots will trade the pool back into balance as per market rates. During the initial LP rush, it is possible that rETH will lose its peg if people dump wstETH into the pool for CRV rewards and the rETH supply cannot keep pace. In this case, we advise LPs to wait until the peg is restored before withdrawing or else you may experience impermanent loss.