IIP-##: Launch the Diversified Staked ETH Index (dsETH)


IIP: ###

Title: Launch the Diversified Staked ETH Index (dsETH)

Status: Proposed

Author: @allan.g, @josephknecht

Reviewer: @afromac, @MrMadila, @anthonyb.eth

Created: 2 Sept 2022


1.0 Simple Summary

The Product team would like to propose that the Index Coop launch the Diversified Staked ETH Index (dsETH), which will provide diversified exposure to the top liquid staking tokens in the Ethereum ecosystem.

2.0 Abstract

dsETH will enable token holders to access the best ETH liquid staking tokens through a single token, using a methodology that promotes decentralization and competition amongst provider protocols. dsETH will also be the first Index Coop product built on a Managed Balancer Pool, a new primitive that has been developed in partnership with Balancer.

2.1 Motivation

At time of writing, there is nearly $7.7B worth of ETH in liquid staking pools, representing almost a third of all ETH staked on the beacon chain. Lido’s stETH product commands the majority of the liquid staking market, but newer protocols like Rocket Pool and Stakewise have emerged as competitors. As a result, users seeking to stake their ETH today must consider a variety of value propositions, principles, and protocols.

With dsETH, users can instantaneously distribute their stake across the top liquid staking protocols and earn an aggregate staking return. Rather than selecting a single liquid staking token and concentrating risk, dsETH token holders benefit from its innate diversification - both at the asset and the issuing protocol layer. The dsETH methodology is also weighted towards protocols with more node operators and balanced distribution of stake, with the objective of encouraging decentralization and competition in the on-chain liquid staking market.

2.2 Rationale

ETH is the most prominent and most liquid asset in DeFi. It functions as a utility token, a medium of exchange, an interest bearing asset, and store of value (amongst other things). With a market cap of $188B and an average annual return of 194% over the last five years, there are many investors eager to grow their ETH holdings.

Staking is one of the most popular methods for earning a return on ETH and it is often referred to as the risk free rate within the Ethereum ecosystem. Approximately 11.7% of ETH circulating supply has been staked on the beacon chain in preparation for the network’s shift to proof-of-stake consensus, with deposits earning ~4.1% APR at time of writing. Dozens of different “staking-as-a-service” providers have emerged as a result, ranging from centralized entities like Coinbase and Kraken to decentralized protocols like Lido and Rocket Pool.

Within the DeFi ecosystem, protocols that offer liquid staking tokens - interest bearing tokens that represent staked ETH and its rewards - have experienced tremendous growth due to low deposit requirements and higher returns compared to centralized services. The largest decentralized protocols are also incentivized to maximize transparency and minimize trust assumptions for users, and also provide secondary market liquidity for their liquid staking tokens.

As more liquid staking protocols emerge, stakers are confronted with the decision of which one(s) to entrust with their ETH. Also, because these protocols and most of their token liquidity are native to Ethereum main net, it can be exceptionally expensive to manually deposit to multiple protocols or buy multiple tokens off secondary markets in an effort to diversify your stake. Diversified Staked ETH (dsETH) addresses both of these pain points by indexing the most prominent liquid staking tokens and bundling them up into a single ERC20 token.

dsETH delivers value to customers by…

  • enabling simple exposure to the top liquid staking tokens
  • socializing gas costs associated with maintenance and rebalancing
  • encouraging competition and decentralization in the liquid staking market

dsETH benefits the Index Coop by…

  • diversifying our ETH product offerings
  • expanding the broader category of yield products
  • deploying our first Balancer-based product

3.0 Overview

dsETH will be built on Balancer and contain Rocket Pool, Lido, and Stakewise liquid staking tokens. More specifically, dsETH will be the first managed balancer pool deployed in partnership with Balancer. Swaps will be disabled by default for the pool (though this may be revisited after the Shanghai update when staking redemptions are enabled). Rebalancing will be decentralized, with the methodology defining the appropriate weights at each rebalance interval and enabling swaps for a predefined period so that arbitrageurs can adjust constituents as needed. Circuit breaker protections will be in place whenever swaps are enabled in order to prevent unbounded losses in a black swan event.

Lido’s stETH will be wrapped in order to accommodate its rebasing nature and Stakewise’s dual token model will be abstracted into a single set token so that staking rewards will accrue to a single ERC20.

Flash Minting will also be enabled at launch, allowing users to deposit ETH or ERC20s and receive dsETH tokens in return.

3.1 Differentiation

Though there are many different liquid staking tokens in the DeFi ecosystem today, there are no on-chain offerings that index or emulate the same strategy as dsETH. This table presents the liquid staking tokens that will be present in dsETH and their respective yields:

token Issuing Protocol Protocol Fees APR (net)
stETH Lido 10% of rewards 3.90%
rETH Rocket Pool 15% of rewards 4.03%
sETH2 + rETH2 Stakewise 10% of rewards 4.13%

Because dsETH will be launched post-merge, the table below outlines potential yields for each token based on a 50% increase in staking returns.

token Issuing Protocol APR (today) APR (post-merge)
stETH Lido 3.90% 5.85%
rETH Rocket Pool 4.03% 6.05%
sETH2 + rETH2 Stakewise 4.13% 6.20%

As a result, the initial composition for dsETH will yield a 5.78% APR after accounting for the streaming fee (0.25%); again, this is using post-merge projections. This is a simple projection, and it is worth noting that a variety of factors - percentage of ETH staked, network fees, fee burn - fundamentally affect the staking rate (thus yield is subject to change over time).

3.2 Example composition

dsETH will have the following composition at launch:

  • Rocket Pool rETH: 44.11%
  • Lido (w)stETH: 29.6%
  • Stakewise sETH2/rETH2 set token: 26.3%

Staking rewards will gradually accrue to the token’s value and be realized in the form of price appreciation.

3.3 Backtest results

Backtest calculations are shown for the period 13 March 2022 to present. The former is the earliest date for which complete price history is available for all constituents. The green plot shows the price history of dsETH in USD terms, the blue plot dsETH spot price in ETH terms, and the red plot dsETH “NAV” price in ETH terms. It is important to note that the dsETH “NAV” price (red) assumes 1:1 exchangeability between the underlyings and ETH. The dsETH spot price in ETH terms (blue) can decrease due to decoupling between the underlying staked ETH tokens and ETH; an example would be the discounted exchange rate for stETH relative to ETH. Historical data on node operators were not available so we assumed a uniform allocation across the constituents.

4.0 Size of Opportunity

There is $21.8B worth of ETH staked on the beacon chain today, and $7.7B of that is from liquid staking pools. ETH staked on the beacon chain has consistently risen since the contract went live in November 2020.

It is generally expected that the amount of ETH staked will increase over time, but using present values, if dsETH is able to capture 1% of the liquid staking market, that will amount to $77m in TVL for the product.

5.0 Market & Customer Research

5.1 Target Customers

dsETH is a relevant product for all customer types that the Coop currently serves: retail, DAO treasuries, and institutions. Because ETH is a core component of almost every crypto portfolio, all of these investor types stand to gain from a low-risk staking index like dsETH.

During DAO Treasury research, an ETH yield token was the most requested non-stablecoin product, and many treasuries today are seeking to deploy their ETH productively and earn a reasonable yield. Anecdotally, Rook DAO recently implemented a similar diversified staked ETH strategy to dsETH, though in a more manual fashion.

Regardless of customer type, this product will deliver a sustainable return on ETH!

5.2 User stories

  • As a token holder, I want sustainable yield on my ETH
  • As a token holder, I want diversified exposure to liquid staking tokens
  • As a token holder, I want to distribute my stake across multiple protocols
  • As a token holder, I want to support decentralized and permissionless staking protocols
  • As a token holder, I want to support a balanced liquid staking market

5.3 Product economics

We predict monthly revenue of $5,208 and negligible rebalancing costs for a gross profit margin of effectively 100%. This is based on a $25M NAV, 0.25% streaming fee,and negligible rebalancing.

5.4 Product financial forecast

Financial forecast of monthly streaming fee revenue assuming $25M max NAV, 1 month to half max NAV, 0.25% streaming fee, and no underlying appreciation. The rebalancing is very infrequent so the costs are effectively zero and the gross profit margin 100%.

6.0 Methodology

6.1 Initial Composition & Token Inclusion Criteria

The objective of the dsETH methodology is to give token holders diversified exposure to liquid staking tokens, with a weighting that favors decentralized liquid staking protocols as measured by the number of node operators as well as distribution of stake across node operators. To begin, constituents are equally weighted before adding a Node Operator Factor, which benefits staking protocols with more active node operators.

An HHI (or Herfindahl-Hirschman Index) Factor is then added, which measures the concentration of stake and broader competition amongst active node operators within each protocol.

After applying both of these factors, dsETH will have the resulting composition:

Token Inclusion Criteria:

  • liquid staking tokens must be available on the Ethereum blockchain
  • liquid staking tokens must have a minimum of $25m secondary market liquidity on Ethereum main net
  • liquid staking tokens must have a competitive APR relative to alternatives
  • staking protocols must be audited and reviewed by security professionals to determine that security best practices have been followed
  • staking protocols must also be in operation long enough for the decentralized finance community to arrive at a consensus regarding its safety
  • staking protocols must be open source
  • staking protocols must have a bug bounty program
  • staking protocols must establish and maintain client diversity amongst node operators

Other liquid staking tokens that meet these criteria can be added to the index over time. No one liquid staking token can exceed 50% of the index.

6.2 On-Chain liquidity analysis of underlying tokens

As of 25 August 2022:

Asset Largest DEX Pool Type, Fee, Size Trade depth @1% Price Impact
sETH2 Uni v3 Concentrated, 30bps, $42m ~$34m or 20,000 ETH
rETH2* Uni v3 Concentrated, 5bps, $10m ~$1.7m or 1,000 ETH
rETH Balancer Meta-Stable, 4bps, $15m ~$1.9m or 1,100 ETH
wstETH Balancer Meta-Stable, 4bps, $240m ~$26m or 15,000 ETH

*there is additional rETH liquidity in Curve that allows it to meet the $25m secondary market liquidity inclusion criteria

6.3 Maintenance / Rebalancing frequency

Rebalancing will be performed semi-annually or every 6 months in an effort to minimize exposure to secondary market pricing for liquid staking tokens before staking redemptions are enabled by the Shanghai update. The Index Coop will be responsible for providing updated weights for the pool at the beginning of each rebalance period, and once the rebalance period begins, swaps will be temporarily enabled in order for the pool to be appropriately arbed to the updated weighting. Rebalancing parameters may be revisited after the Shanghai update, including frequency and the pool’s default swap state.

7.0 Costs

7.1 Cost to customer

Holders will pay a 0.25% streaming fee. There will be no mint fee and no redeem fee.

7.2 Cost transparency

NAV decay is an implicit cost associated with this strategy (though it is excluded from the effective yield communicated in this proposal). NAV decay due to impermanent loss is expected to be negligible due to infrequent rebalancing, but is possible if constituents do not have a 1:1 exchange rate with ETH during rebalance periods. Price impact related to rebalance trades will also contribute to NAV decay. However, dsETH holders will receive 100% of the swap fees generated during rebalancing periods, which should offset some of the implicit costs associated with the product.

7.3 Fee split

The streaming fee will go 100% to Index Coop.

Swap fees earned during rebalancing periods will go 100% to dsETH token holders.

8.0 Meta / intrinsic productivity

Token holders stand to benefit from the intrinsic productivity enabled by the underlying liquid staking tokens. There are no metagovernance rights available with this product.

9.0 Liquidity

This product will require approximately $300,000 in seed liquidity at launch in order to provide a target access cost of 1% based on the assumptions below which are subject to market conditions. It is highly likely that this product will naturally attract LPs, given that dsETH and ETH will not diverge in price quickly.

Target Access Cost % 0.25%
ETH/USD Price $1,549
Gas Price 19.47 gwei
Exchange Issuance Gas Required 890000 wei
Exchange Issuance Gas Cost $27
Total Baseline Liquidity $19,783,987
Concentration - Lower Bound -5%
Concentration - Upper Bound 1%
Total USD Required $300,604

10.0 Author Background and Commitment

The Product team is responsible for designing, developing, and deploying index products for the Index Coop, as well as managing and maintaining products post-launch.

11.0 Marketing support / distribution / partnerships

As an internally-produced product for the Index Coop, there will be a joint effort amongst Product and Growth to market, distribute, and maximize composability for this product.

Lido, Rocket Pool, and Stakewise have all signaled support for this index as well.

Revision history

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Copyright

Copyright and related rights waived via CC0.

14 Likes

Congrats on getting this posted! This is a really huge win for the Balancer and Index Coop communities and the Ethereum ecosystem at large.

8 Likes

Great stuff! I like the idea and the combo of Balancer working with Index. My question is that icETH had the rumour of eventual diversification to include RPL in its future. Does that still stand?

4 Likes

Great proposal and product! Looking forward to seeing this in action after the merge

4 Likes

Great question! There are a few limitations around using rETH within icETH today…

  1. rETH must be listed and enabled as collateral within Compound or Aave; this is due to the protocol-specific Leverage Modules that we currently have at our disposal

  2. risk parameters (LTV, Collateralization Ratio, etc) for rETH must allow for a safe leverage ratio/range comparable to stETH today

  3. replacing stETH with rETH would require that the strategy be unwound in order for the collateral asset to be swapped, and that would translate to significant NAV decay for token holders which is unfavorable; “hot swapping” the collateral asset with some flash functionality may be possible, but the risk/return would need to be clearer

  4. alternatively, we could spin up a separate, rETH-denominated product that executes the same strategy; this is an unlikely outcome though because “duplicate” products could confuse customers, but if the business case is there, we could consider it!

3 Likes

are you sure the APRs for LDO and RPL are right? I think net APR LDO is higher given its only 10% fee vs. 15%. I know the advertised RPL APR on its website is higher than the LDO APR.

Also if you are buying steth in the open market, APR should be higher given the discount

the APRs were captured at a specific point in time, but they will be updated once the proposal has been finalized ahead of the vote!

You are correct that buying stETH at a discount to ETH on the open market would lead to a marginally higher APR, but for the sake of simplicity, we’ve assumed that 1 liquid staking token = 1 ETH.

1 Like