Background

With the Shapella upgrade coming just around the corner, I decided to run my own Ethereum PoS node some time ago as I previously wasn’t too comfortable staking to a contract that did not yet have a withdrawal function enabled. It was a fun experience purchasing and arranging a satisfactory hardware setup (up to 50% cheaper to do in S.Korea) and went to look up Rocket Pool Minipools because I had heard great feedback from my fellow degens.

Not only was I impressed with the UX of following through their docs for node setup, but I was also fascinated by the token dynamics and instantly realized that it can be an excellent reference for ongoing token design discussions. There are definitely certain design choices of $RPL that many projects can learn from when aligning their network value proposition with their token value capture mechanisms.

Before moving on to the details, I would like to emphasize that this post will not focus on deep diving into the speculation and price prediction of $RPL, but more on why I am excited to see its token dynamics playing out in the radically promising Ethereum staking industry after the Shapella upgrade. If it works as intended, I believe it will be an exemplary case for many projects trying to effectively capture their network value via token dynamics.

Brief overview of Rocket Pool

Rocket Pool’s core focus is to create a more accessible and user-friendly staking experience for Ethereum users, while also contributing to the security and decentralization of the Ethereum network.

Users who simply stake $ETH into Rocket Pool receive Rocket Pool’s liquid staking derivative token, $rETH, which represents the individual’s proportional claim to the collective $ETH pool including the rewards accrued by validators. This is because according to Rocket Pool’s node network model, ‘Minipools’ are formed by matching the $ETH pooled from these users with node operator’s $ETH to fulfill the 32 $ETH requirement to run a node on Ethereum PoS. This model helps to reduce the capital barriers to entry for running nodes, and ultimately contributes to the decentralization of the Ethereum node network. The network currently only supports 16 $ETH Minipools (as in 16 $ETH required for node operators), but will expand to support 8 $ETH Minipools after the Atlas upgrade which will come together with the mainnet Shapella upgrade.

$RPL token

When node operators want to create a Minipool utilizing Rocket Pool’s resources, they have to stake $RPL as a means to insure the $ETH delegators. As the Rocket Pool node operators are mostly individuals, it is necessary to have a safety net to ensure that even when the node operators receive penalties (via slashing, etc.), the delegated $ETH will be safe.

For this insurance, node operators have to stake and bond 10% ~ 150% of the delegated $ETH value in $RPL. The bonded $RPL is locked, and the only instance when the node operators can withdraw their tokens is when the node has exited or the $RPL collateral exceeds 150% of the delegated $ETH value. Node operators that have an insurance ratio outside the standard range of 10% ~ 150% are disincentivized by not receiving the $RPL staking rewards for the digressing portion.

In order to persistently incentivize $RPL staking, Oracle DAO activities (providing various oracle data) and to fund decentralized development, $RPL has a no-capped annual inflation of 5% that is distributed as follows:
— Node Operators staking RPL as insurance collateral (70%)
— Oracle DAO members providing various oracle data (15%)
— Protocol DAO Treasury to fund decentralised development (15%)

Takeaways from the $RPL token dynamics

Rocket Pool’s token dynamics generally focuses on reducing the circulating supply of $RPL to maximize positive price impact coming from additional utility & speculative demand. The direction itself is pretty common in that many projects with staking incentives (additional APY, governance, time lock for withdrawals, etc.) and fee based buyback & burn schemes also pursue supply shocks. However, I believe the following aspects of $RPL token dynamics makes it a meaningful reference.

Circulating supply reduction is ‘directly’ aligned with the core focus of the protocol

Rocket Pool focuses on decentralizing the Ethereum PoS node network by making node operations as hassle-free as possible. As their thesis plays out, more node operators will create more Minipools, directly leading to more $RPL staked and bonded for insurance. In my opinion, this intuitive link between the protocol’s core focus and the value capture mechanism introduces an element of ‘predictability’ to the $RPL network value. The pace of Minipool expansion is a straightforward measure to track the progress of the network, and the cumulative number of formed Minipools indicates the minimum $RPL that has to be locked to preserve node operators’ staking rewards. The fact that Rocket Pool has community-built tools to calculate these metrics and derive the bare minimum price of $RPL to sustain the current number of Minipools is an effective testimonial to this attractive characteristic.

Many DEXes have also attempted to apply a similar connection between trading volume and token value capture with their fee based buyback & burn schemes. However, I believe that these models we see today will have difficulty achieving a competitive level of predictability since volume is greatly volatile according to market conditions, and it is difficult to show the accumulative impacts of the buyback & burn schemes. This is because the buyback portion usually does not introduce significant buy pressure due to its nature of being a small margin of the total accrued fees, and the staked tokens can easily become liquid per user discretion.

Bonding design is critical to the attractiveness of $rETH

Even if the token value capture model is cleverly arranged, artificial capital requirements for protocol participation can be a major churn point for new users. In this context, Rocket Pool has made a compelling case for the requirement by directly tying the committed capital to the attractiveness of $rETH, which is a critical part of the protocol’s sustainability. Although $rETH has the advantage of minimizing dependencies on large scale node operators (which can lead to concentrated points of failure), this comes with a trade-off where delegating users have to trust non-professional node operators for validating activities. As the insurance policy is a crucial component of mitigating this trade-off, node operators are less likely to have doubts on the necessity of the $RPL staking and bonding mechanism, which can be seen from the steady increase in the number of Minipools.

Thanks to these measures, the deposit pool utilized for Minipools, where users deposit ETH to receive rETH, has been constantly filled to full capacity post-merge. This is pretty surprising since the deposit pool limit was recently (April 5th) elevated from 5,000 ETH to 18,000 ETH. The following deposit pool chart provided by Rocketscan illustrates how the pool was instantly filled up even after the significant pool expansion.

$RPL staking & bonding mechanism does not sacrifice the scalability of Minipools

Rocket Pool denominating the $RPL bonding requirements in $ETH is not only logical (since it insures a portion of delegated $ETH) but is also beneficial for the long term scalability of the project. As $ETH is the denominator, $RPL bonding requirements dynamically adjust to $ETH and $RPL price changes, which means that the burden of bonding does not linearly increase with the appreciation of $RPL value. Although $ETH price appreciation can certainly increase the capital burden of node operators, the percentage requirement of bonding can always be modified by the community if $ETH price skyrockets.

Along with this, the 10% floor and 150% ceiling standard of delegated $ETH value, which determines the eligibility of $RPL staking rewards, encourages new and existing node operators to spin up additional Minipools. Without the ceiling, node operators who had deposited $RPL in the early stages (when $RPL/$ETH price was significantly lower) will be capable of gaining disproportionately high rewards, significantly diluting the staking rewards directed to later participants. This would have discouraged all user types from creating new Minipools since existing users would already be receiving maximum benefits without any further action, while new users will be getting smaller returns. The floor obviously prevents the delegated $ETH from being under insured, and together they assure a balanced staking and bonding ratio for Minipools.

Interesting Implications of $RPL/$ETH Volatility

Based on my analysis, I wanted to see whether $RPL price activity was showing any differences compared to other competitive protocols, namely Lido. As everyone will be well aware of, there are multiple complex factors that influence price action and thus it is very difficult to derive a causal relationship between token dynamics and token price action. However, there was one interesting implication I wanted to share. The following is a comparative chart visualizing the data I played around with.

As you can see, the charts provide a holistic view of the changes in cumulative number of Minipools (and staked $ETH on Lido as a comparative measure), and the price of $RPL & $LDO each denominated in $ETH. I denominated the price in $ETH because it incorporates general market delta, while being more relevant with Rocket Pool’s token design.

Even from the visuals, it was pretty obvious that $RPL volatility was significantly lower than that of $LDO. This was opposite to the well known tendency of token networks with larger market caps having generally less volatility, and as of writing, the fully diluted market cap of $RPL and $LDO is $0.870B and 2.397B respectively. To derive the actual volatility, I calculated the historical volatility (thank you Investopedia!) of the two and the results were very interesting.

According to the historical volatility analysis, $RPL had significantly lower volatility with 0.038 (vs $LDO’s 0.053), which implies an alluring narrative when combined with the takeaways I emphasized in the previous section. Although it is difficult, if not impossible, to deterministically derive any causal relationship between the token dynamics and the lower volatility at the moment, I believe that this could be a good starting point to observe whether the logically thorough token dynamics of Rocket Pool contributes to the ‘predictability’ of its network value.

Remaining Challenges and Closing Thoughts

Rocket Pool obviously has its own challenges. As many have pointed out, the no-cap inflation of $RPL can become a powerful burden as the network expands. 5% of the supply in the future will be exponentially more than that of today, and the sell pressure can become excessive if the pace of Minipool expansion lags behind. The Rocket Pool community will have to continuously monitor the trade-off between having sufficient incentives for $RPL stakers/runway for protocol development, and the sell pressure this inflation could impose.

Nevertheless, I believe Rocket Pool has made attractive design choices at this stage. With large scale updates coming up following the Shapella upgrade, I will be keenly following how their token dynamics play out after withdrawals are enabled and as their network scales further.

Please feel free to DM me on Twitter (@0xwhykay) if you have any questions or comments!

Thank you SB (@subinium) for providing valuable feedback on the article!

Disclosure: Hashed has established, maintained, and enforced strict internal policies and procedures designed to identify and effectively manage conflicts of interest related to its investment activities. This content is provided for informational purposes only, and should not be relied upon as legal, business, investment, or tax advice. Furthermore, references to any securities or digital assets are for illustrative purposes only and do not constitute an investment recommendation or offer to provide investment advisory services.