fuse
In the early days of the Ethereum PoS beacon chain, early arrivals developed rapidly. Centralization is one of the Devil Fruits: giving up trustlessness, decentralization, or permissionlessness pays off handsomely. The giants of the Web2 model, like Coinbase, Kraken, Binance, and others, are more than happy to lock up willing users’ funds. What options were there then? In addition to running their own nodes (a daunting task for many), these CEXs provide users with another way to participate in staking. The Lord of the Rings seems to have been granted. The woes of PoW mining pools seem destined to repeat themselves, and are repeating themselves. Greed and speed bring control.
Against this backdrop, another force is growing. A DAO (Lido DAO in this case) that seeks to bring benefits to the majority without the blatant trust assumptions of CEXs. The decentralized staking protocol Lido was launched, and its liquid staking Token stETH appeared, which was the first and currently dominant liquid staking Token. For the first time, anyone on the Ethereum network can stake less than 32 ETH while retaining control over their own funds. As far as Lido is concerned, users deposit ETH and receive stETH to enjoy the lending spree driven by the summer of DeFi. With the influx of capital, an ominous dilemma is slowly brewing in this once enlightened pursuit.
Devil fruit in the Japanese manga "One Piece"
Lido era
CEXs take your assets and then you have to trust them. And Lido gives you a self-custody receipt token (ie stETH), but where did your ETH pledged? This DAO seeking to provide staking access (i.e. the Lido DAO) becomes a black hole and becomes the only point of access. The Lido network happily accepts an unlimited amount of ETH and distributes that ETH to a select few node operators. Trust means speed. In order to onboard more users, these operators who run nodes with ETH staked by users must act quickly and be trusted as honest operators. A Devil Fruit is eaten, and power emerges - like a black hole, that power may be trapped.
Lido's validator set is full. Those Web2 centralized giants are now fighting against Lido, which is already the largest staking pool at the time of writing. In pursuit of yield, we are willing to ignore the dangers of centralization. Capital efficiency is the foundation of all systems in DeFi. Where optimization can be found, optimization will be found. The DEX (decentralized exchange) battle is a clear example. Curve and Uniswap v3 compete in the super efficient token exchange market, and end users rejoice; the concept of liquidity pool tokens makes capital active even in your wallet, earning money for holders transaction fee. Efficiency has grown over time, which is good for Lido.
Estimated validator counts in Coinbase, Lido, and Binance. Source: https://pools.invis.cloud/
It's no surprise that stETH has become a DeFi Lego. If you can replace ETH in your investment strategy with stETH (or its wrapper version wstETH), then you can passively increase your returns by a few percentage points. This increase in earnings is not the limit. The essence of Yield Farming has always been liquidity incentives. For example, the Curve protocol offers CRV Token rewards to users who deposit liquidity into the protocol's stETH-ETH pool and stake the LP Token crvSTETH they earn.
Introducing Yearn, a revenue aggregator. The vault system in the Yearn protocol packs these strange yield queues into a simple liquidity token. The protocol automatically regroups all additional liquidity rewards to the base layer. Yearn acts as a strategy building center, where the best yield strategies will attract the most capital inflows. Yearn's bot pool for Curve stETH-ETH liquidity pairings has been highly sought after since its inception. Its ycrvstETH Token is one of the most capital-efficient tokens in DeFi (Note: After the user deposits ETH or stETH into the Curve platform, the LP Token crvSTETH obtained after depositing it into the Yearn machine gun pool will get the corresponding machine gun pool Token ycrvstETH). There's a whole ecosystem of earnings in your wallet that's a lot more complicated than what I've described.
The ycrvstETH Token is the fourth most popular collateralized asset on Abracadabra Finance, one of the most popular lending platforms. This is important because it shows that the Yearn Pool Token (ie ycrvstETH) is not the end, but the base layer for higher yields and more complex strategies. This token represents the maximum benefit that a non-custodial passive token can capture. For most of DeFi's history, ycrvstETH has been the best asset in this regard.
The constant need to maximize returns has led to the expansion of Lido, the gatekeeper of liquid ETH staking. With Lido approaching 20% of all validators on the Ethereum network, further capital inflows will begin to threaten the security of the Ethereum network. There is a problem here. For now, stETH will only continue to flow into the market, as it will take several months for Ethereum validators to unlock the withdrawal function, which means that withdrawals will not be available until a hard fork after the merger. The influx of yield-chasing users cannot be stopped—as long as yields are available, yield-chasing capital will flow in, unless the consequences are immediately reflected in prices. If the Lido protocol operates 50% of the Ethereum network validators (they may rise in the short term), the returns from stETH will not decline, but in this case the value and security of the Ethereum network itself may suffer irreparable damage. So the only way forward is to channel money towards greener pastures and higher yields.
The Rise of Rocket Pool
Lido used to be a standout, but not anymore. Other Ethereum staking service providers have also emerged with their own liquid staking tokens. However, nothing is more important to the long-term health of the Ethereum ecosystem than Rocket Pool. While Lido's permissioned nodes are willing to take on all verification responsibilities, it could pose long-term risks to the network, and Rocket Pool rejects shortcuts. For Rocket Pool, there are few trust assumptions, just code and cryptoeconomic incentives. There is no speed on this path. It is impossible for Rocket Pool to onboard an unlimited amount of ETH in one day like Lido. Instead, Rocket Pool has a framework through which a decentralized set of nodes can securely support a liquid staking token network. The Rocket Pool network has more than 800 node operators, some of which are known major Ethereum players and others that are anonymous.
At the time of writing, the Rocket Pool protocol has 106,432 ETH staked, with 853 node operators. Source: https://rocketpool.net/
Creating this framework was not easy. Lido had been accepting user deposits for about a year before Rocket Pool launched. However, despite stETH's huge lead and almost complete dominance of liquidity bets, in the three months since Rocket Pool launched, massive capital inflows have pushed the protocol to the point where it dominates the Ethereum network. 1% of all validators, more than 100,000 ETH has been pledged into the Rocket Pool protocol. The reasons for the protocol’s adoption are complex, but at the current rate of adoption, Rocket Pool is likely to attract increasing inflows from its competitors. If the market is any good, though, it's that the prospect of future growth can be priced in right now. We can accelerate the development of Rocket Pool, directly benefiting the health of the ecosystem.
The 01st moment of stETH is paired with the liquidity of ETH on the Curve platform, so it is possible to compound rewards on top of this LP Token (ie crvSTETH). Most stETH use cases use the stETH-ETH pool as the base layer. The pool is currently one of the largest single holders of ETH and one of the most liquid pools in existence. What if we could create another 01 moment? The first such moment was the pair from ETH to stETH; the second such moment has come, with the potential to make gains by doubling ETH's liquidity staking exposure in this DeFi's biggest building block, the Rocket Pool double.
To understand why this is an inflection point for DeFi, let’s look at where the gains generated by ycrvstETH come from. Remember, these rewards generated by Yearn are compounded automatically. Sorted by complexity, starting with 0.5 stETH and 0.5 ETH:
The annual rate of return for 0.5 stETH is 4.5%, and the overall rate of return is 2.25% (because the underlying 0.5 ETH is not rewarded);
Curve LPs (Liquidity Providers) for stETH-ETH earn a fraction of the revenue from transaction fees;
Curve LP is rewarded with CRV+LDO Token;
Convex LP is rewarded with CVX Token.
The user's ycrvstETH yield is 4.51% APY (annual yield). However, this is after the Yearn Protocol takes a 2% management fee and a 20% earnings performance fee. Therefore, the true APY is approximately (4.51% / 0.8) + 2% = 7.63% APY. Therefore, the total reward for steps 2-4 above is 5.38% boost. This benefit is passive, but needs to be subsidized for certain protocol benefits. In a sense, this return is not sticky to the underlying token pairing. Earnings come from rewards and can be paid to any token pairing. This 5.38% is variable.
Now allow me to introduce a soon-to-be successor to Lido's powerful stETH-ETH Curve pool - the rETH-wstETH pool. rETH is Rocket Pool's liquid pledge Token (users will get rETH after staking ETH through Rocket Pool), and the Token will passively increase in value relative to ETH; wstETH is the wrapped version of Lido's stETH, and the packaged stETH is also Allow it to increase in value relative to ETH over time, just like rETH.
Above: rETH-wstETH pool on Curve, https://curve.fi/factory/89
Part of the subtlety of the original stETH-ETH pool is that the stETH token is pegged to ETH, so holders do not experience impermanent loss due to asset price deviations. This is critical because the ideal passive collateral token should carry minimal passive value risk. Since the value of wstETH and rETH grow at roughly the same rate, a Curve pool between these two tokens (ie, the rETH-wstETH pool) will inherit the benefit of this negligible impermanence loss. Additionally, the pool's novel enhancement is that there is no "cold" ETH exposure, both assets (i.e. rETH and wstETH) will gain staking exposure. Let's see how this 100% liquid staking token exposure changes the APY calculation.
0.75 rETH yields 4.3%, 0.25 wstETH yields 4.5%, and the total yield is about 4.35%;
Curve LPs (liquidity providers) of the rETH-wstETH pool receive a small portion of their revenue from transaction fees;
Curve LP will be rewarded with CRV Token;
Convex LP will be rewarded with CVX Token.
Comparing the two Curve pools, the rETH-wstETH pair yields 2.1% higher yields than the ETH-stETH pair. This alone covers 39% of the additional rewards added to the Lido stETH-ETH pool. When dealing with billions of dollars in liquidity TVL (Total Value Locked), an increase of this magnitude cannot be overstated. In the March budget, Lido had to allocate 3.25 million LDO Tokens to the Curve stETH-ETH pool for direct incentives to LPs (liquidity providers). At current rates, this equates to a monthly payout of $6.9 million. A 39% capital efficiency upgrade saves millions of dollars per month. If these liquidity schemes are added to rETH-wstETH, its efficiency will be greatly improved.
Another way to look at this is that the problem with the stETH-ETH pool is that 50% of the stETH returns must be subsidized, otherwise users are better off just holding stETH. The rETH-wstETH pool requires no subsidy, as it provides essentially the same (if not more) yield than just holding rETH or stETH. The flow of funds into ETH pledged over time will be huge, and it does not ignore this apparent increase in capital efficiency.
Looking to the future
More philosophically, we should take a lesson from DeFi veterans like MakerDAO, who abandoned the original single-collateral DAI model (i.e. initially only allowed ETH as collateral to mint and lend DAI), and instead switched to multi-collateralization. Collateral Model. This essentially eliminates the risk of a single point of failure. The same approach to risk management is long overdue in the liquid staking ecosystem. We are currently in a danger zone, with Lido having 86% of the liquid staking market share and Rocket Pool coming in second with just 4.5% market share. As shown below:
Source: https://dune.xyz/eliasimos/Eth2-Liquid-Staking
I don't want to paint the wstETH-rETH pool as a vampire attack on Lido's market share. Instead, I see this pool as the first step in a larger spatial reorganization. Reducing the ecosystem’s reliance on stETH will reduce the chance of catastrophic events such as zero-day exploits or hostile protocol takeovers. Competition is inevitable, and cooperation will bring more dynamic benefits.
Collaboration is another benefit of the wstETH-rETH pool, which is specifically for those who, like me, participate in the governance chat via Discord. DeFi runs on liquidity. Lido is willing to spend millions per month to fund the stETH-ETH pool. However, why must there be only one protocol to improve liquidity? One day in the future, a basket of staking tokens in a single liquidity pool may mean a basket of different liquidity incentives from different staking protocols. An LP Token that maximizes support for the health of the Ethereum ecosystem. This basket of pledged tokens represents the long-term security of public goods.
We have an opportunity to get a head start on something similar to the stablecoin market. Rather than competing for liquidity, we must expand the basket to allow different liquidity staking ETH derivatives to benefit from shared liquidity, thereby reducing risk across the network and continuing to divide the cost of incentivizing liquidity over time.
The ultimate purpose of staking on the Ethereum network is to ensure the security of the network. Incentivize the security of the network and encode rules to minimize attack vectors. However, the responsibility of the Ethereum community to continue to secure the Ethereum network can never be let up. The network of people running the validator nodes themselves is not just made up of Ethereum enthusiasts. As more and more value accumulates on the network, more and more individuals will try to attack it wherever possible. We must remain vigilant at all times. Unlimited expansion of the Lido network is exactly an avoidable tail risk. In fact, the safest and most capital-efficient outcome in the future is for many staking providers to compete with each other and reduce commission rates.
It’s easy to get a false sense of security when seeing $27 billion worth of ETH currently locked in an Eth2 deposit contract. But don't be fooled. The merger has not yet materialized. The vast majority of ETH is not staked. It's too early, so it's our responsibility to steer the field safely into the future. The staking dynamics that currently exist represent the early days of this space. Decisions made now will have an even bigger impact on Ethereum’s unwritten history. We call on the larger DeFi ecosystem to integrate the ycrvwstrETH Token. We call on all protocols that use the ycrvstETH Token to also allow the ycrvwstrETH Token (if secure). It will be a capital efficient future, a fair staking provider future, a secure future.