[CurveLP-stETH-ETH] Collateral Onboarding Risk Evaluation

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  1. Summary Proposed Risk Parameters
  2. Overview
  3. Metrics and Analysis
  4. Risk Parameters

Summary Proposed Risk Parameters

Stability Fee: 4.5%
Liquidation Ratio: 155%
Debt Ceiling: 5m
DC-IAM gap: 3m
DC-IAM ttl: 8h
Cut: 0.99
Step: 90 seconds
Buf: 1.30
Cusp: 0.4
Tail: 140 minutes
Chip: 0.1%
Tip: 300 DAI
Ilk.chop: 13%
Tolerance: 0.5
Ilk.hole: 3m DAI
Dust: 10.000 DAI

Overview

This assessment examines the Curve ETH/stETH LP token (steCRV) as potential Maker Vault collateral. It focuses on the Curve platform and the ETH/stETH liquidity pool. It should be noted that this assessment is not related to the onboarding of stETH as its own collateral. The @Risk-Core-Unit has already released a separate collateral onboarding risk evaluation specifically for stETH, which can be found here. The WSTETH-A vault type passed in an executive on October 26, and will be available for execution on October 28. Hence, this assessment will exclude a number, but not all, topics and metrics that were assessed in the stETH report.

Protocol Summary

Curve is a decentralized exchange (DEX) that mainly offers liquidity pools between token pairs with similar characteristics and that peg to the same value. The benefit of the Curve AMM design, compared to other AMMs that offer liquidity pools with non-pegged tokens, is more efficient token trading, with lower slippage and better capital efficiency. One example is the 3pool, which contains DAI+USDC+USDT. It should also be noted that Curve has recently introduced an additional AMM design for non-pegged tokens that offer a different set of trade-offs.

The first iteration of Curve was conceptualised in the whitepaper “StableSwap - Efficient Mechanism for Stablecoin Liquidity”, published on November 10, 2019, by Michael Egorov. The project was later launched in January 2020 as Curve Finance. In August 2020, an anonymous developer, with the handle @0xc4ad front run and deployed smart contracts for the CRV token and Curve DAO, without the knowledge of the Curve team. After initial scepticism and caution, the team and community finally acknowledged the traction and adopted the governance token, CRV, and the DAO. In January 2021, soon after the introduction of the Lido project, the ETH/stETH liquidity pool was launched on Curve.

stETH is a derivative token that represents staked ETH on the Beacon Chain. When users stake ETH through Lido, they receive newly minted stETH. The token rebases to reflect the amount of ETH staked through Lido, plus staking rewards, less penalties. stETH is a liquid alternative to staked ETH. It can be transferred, traded, and used within other DeFi protocols and applications. Once staking withdrawals are available on Ethereum, users will be able to burn their stETH, and subsequently redeem their ETH from Lido.

The ETH/stETH liquidity pool on Curve enables secondary market liquidity between stETH and ETH. By allowing ETH/stETH swaps, Curve essentially offers users a solution to unstake their ETH from Lido, before staking withdrawals are enabled on Ethereum.

Tokenomics

Users who provide liquidity to Curve pools receive liquidity provider (LP) tokens in return. LP tokens signify a user has provided liquidity to a pool and attract trading fee rewards.

Curve uses the notion of a “liquidity gauge” to measure the amount of liquidity provided by a particular user. Users can stake their LP tokens in a gauge, and in return receive CRV tokens, and sometimes other incentivised rewards, depending on which gauge is being used. The number of tokens received depend on the CRV inflation rate and the liquidity gauge weighting for a specific pool, which is voted on by the Curve DAO. The rewards can be boosted by a factor of up to 2.5x if a user decides to vote-lock their CRV tokens for a period of up to 4 years. A longer vote-lock period results in more veCRV (voting escrow CRV). veCRV allows users to participate in Curve governance. The process of providing liquidity, receiving LP tokens, and staking the LP tokens into a gauge can be executed automatically on the Curve front-end.

For the ETH/stETH pool specifically, liquidity providers collectively earn 0.02% from each trade in the pool. The fees earned are then split proportionally to the LP’s share of the pool. Liquidity providers are also able to earn both CRV tokens and LDO tokens as incentivised rewards when they stake steCRV in the ETH/stETH gauge. In addition, the stETH token earns staking rewards as per Lido staking APR.

From a user experience perspective, the steCRV adapter works like any other Maker Vault. Instead of staking steCRV in the ETH/stETH gauge, users deposit steCRV as collateral. The steCRV tokens are then automatically inserted into the LDO rewards contract, rather than staked in the ETH/stETH gauge. As a result, users will not receive CRV rewards, but will still enjoy the trading fee and LDO incentivised rewards. steCRV vault owners receive the rewards when they interact and initiate a transaction with the CropJoin adapter.

Metrics and Analysis

Total Value Locked (TVL) on Curve, Lido, and the ETH/stETH pool

At the time of writing, Curve’s total value locked (TVL) in USD terms is approximately $15.15 billion. Circa 1.418 million ETH ($5.94 billion) is being staked through Lido, which means that approximately 1.418 million stETH is currently in circulation.

The ETH/stETH liquidity pool is the largest on Curve, with $5.16 billion locked in currency reserves. The composition of the pool is currently 737,842 stETH (57.8%) and 538,668 ETH (42.2%).

The share of total stETH in the ETH/stETH pool is illustrated in the chart below. Currently, circa 52.1% of all stETH liquidity is locked in the pool. More recently, the wstETH/WETH Stable Pool on Balancer has increased in stETH liquidity. At the time of writing, the pool contains 57,624 wstETH (56.9%) and 43,593 WETH (43.1%).

stETH on Exchanges

Source: @KIV Dune Analytics

ETH/stETH Curve pool balance

ETH and stETH deposits have increased rapidly in tandem. The intended balance in the pool is 50% stETH and 50% ETH. As shown in the chart below, the amount of stETH deposits have on some occasions decoupled from the amount of ETH deposits. Recently, the amount of ETH in the pool decreased, while users continued to add more stETH. This led to the most unbalanced proportions in the ETH/stETH pool history, reaching 725,801 stETH (68%) and 341,837 ETH (32%) on September 11, 2021.

Curve ETH/stETH Balance

Source: @KIV Dune Analytics

According to Lido’s analysis, there were two reasons for the imbalance:

(i) Cyclical abuse of the Lido referral programme: The referral programme was exploited by a number of users, effectively receiving stETH referral rewards and thereafter selling it to the ETH/stETH pool. After this, Lido changed to a whitelisted approach, where only approved users were eligible to receive rewards.

(ii) Arbitrum yield farming leading to relatively more attractive ETH yields: Shortly after the public release of Arbitrum, some projects offered ETH yield farming opportunities with higher APY than the ETH/stETH incentivised rewards. This resulted in liquidity providers withdrawing ETH from the ETH/stETH pool, to allocate in other farms.

It is worth noting that before staking withdrawals are enabled on Ethereum, stETH will tend to trade at a discount to ETH in the ETH/stETH pool. By staking with Lido, you can always receive 1 stETH for 1 ETH. As a result, the higher bound of the stETH price is relatively fixed. Meanwhile, there may be ETH specific yield farming opportunities offering higher rates elsewhere. This implies that there may be a risk of stETH selling pressure within the Curve pool. As the date of the staking withdrawal implementation approaches, the potential for a stETH discount is likely to decrease. There is one key reason for this: when stETH is trading at a discount, a time-based arbitrage opportunity emerges. Arbitrageurs can buy stETH at a discount, and then after the staking withdrawal implementation, they can withdraw ETH from Lido at a 1:1 relationship, hence profiting in ETH terms. A higher stETH discount will likely lead to increased arbitrage demand until stETH trades at parity with ETH.

Token Distribution

Liquidity providers of the ETH/stETH pool can choose to either hold steCRV tokens or stake the steCRV tokens in the ETH/stETH gauge. Hence, it is worth including two separate charts to get a more holistic picture of the token distribution.

steCRV token holders

As illustrated by the pie chart below, the vast majority of steCRV tokens (98.7%) are deposited in the liquidity farming reward contract (steCRV Gauge Deposit). This may change if steCRV is accepted as vault collateral and users decide to use steCRV in Maker instead.

Source: Etherscan

steCRV + steCRV gauge holders

The pie chart below shows the distribution of the top liquidity providers of the steCRV gauge. The largest steCRV + steCRV gauge holder contract is from Convex Finance. Staking through Convex is achieved by providing liquidity to the ETH/stETH Curve pool (without staking directly into the gauge), and then staking the steCRV LP tokens through Convex. Liquidity providers are incentivized to stake through Convex as they earn additional CRV tokens on top of the native rewards from the ETH/stETH liquidity gauge.

Source: Etherscan

Historical Returns - Fees and Incentivised Rewards

Currently, the daily base vAPY (variable APY from trading fee rewards) for the ETH/stETH pool is 2.9%. Meanwhile, the annualized tAPY (token APY) is 0.07% from CRV tokens (0.17% with max boost) + 2.94% in LDO tokens. In addition, the stETH APR is currently 4.9%. However, if a user decides to only deposit stETH, the pool will reallocate the balance into both ETH and stETH, effectively reducing the stETH balance and hence the original stETH APR. It is also worth noting that the tAPY is based on the current price of the reward tokens and the reward rates. This means that the tAPY may change over time since the underlying reward tokens are subject to high volatility.

The chart below illustrates the LDO incentive reward scheme from the inception of the ETH/stETH liquidity pool up until October 2021. Lido has recently decided to diversify its LDO rewards to other protocols, such as Balancer and Sushi. At the time of writing, 43.45 million LDO tokens have been allocated to Curve. Lido has publicly stated that they are committed to incentivise the pool at least until the merge and staking withdrawals are enabled.

Source: @LidoAnalytical Dune Analytics

We believe that it is justifiable to set a higher stability fee of 4.5% initially. This is because the APY from the steCRV adapter will on average be higher than 4.5%. Lido’s commitment to incentivise liquidity until the withdrawal implementation will likely maintain rates for the foreseeable future. We also believe that other factors such as optimistic market outlook and the lack of competitive alternatives will likely maintain sufficient vault demand. However, when/if Lido decides to disable LDO incentivised rewards, the APY will likely decrease considerably.

CEX and DEX Volumes

steCRV Trading Activity

steCRV is an LP token with essentially no direct trading activity. One way to understand the liquidity of steCRV is by assessing the liquidity of stETH and ETH. Keepers can liquidate steCRV positions by withdrawing the underlying assets from the pool and selling them. stETH got listed on FTX on October 26 2021, which marks the beginning of stETH trading on large centralised exchanges. The majority of DEX stETH liquidity is currently on Curve. The chart below shows the trading volume for stETH. To get base numbers, toggle off DEX aggregators in the legend within Dune Analytics.

Source: @KIV DuneAnalytics

Downside Risk

The ETH/stETH pool works with the same pricing model as Curve stablecoin pools, where the assumption is that the two assets are roughly equal in value. Hence, the downside risk of steCRV should theoretically be the same as for ETH, with the added price discrepancies that stETH and ETH may experience.

stETH has been able to accurately hold the value of ETH, with the lowest drop in price being on March 24 (95.8% of ETH). At the time of writing, the stETH:ETH peg is 99.3%.

Source: @KIV Dune Analytics

The ETH/stETH pair is currently very liquid. The chart below shows the slippage curve for the stETH-ETH trading pair on the 1Inch DEX aggregator. Selling $1 billion worth of stETH through 1Inch would incur a -1% slippage on price.

On-chain Price Slippage - Pair: stETH-ETH

Source: Blockanalitica

DeFi Presence

Since the inception of the ETH/stETH liquidity pool on Curve in January 2021, both Curve and Lido have grown rapidly in users, liquidity, and market share. Lido has been able to capture a considerable market share in the ETH staking provider market - currently, circa 8 million ETH is being staked, and approximately 1.418 million ETH is staked with Lido. Curve was one of the first DeFi protocols to join forces with Lido. As a result, Curve has been able to attract the majority of stETH liquidity (52.1%) to the ETH/stETH liquidity pool. This essentially means that circa 9.2% of all staked ETH is locked in the ETH/stETH liquidity pool on Curve. Curve and Lido have created a symbiotic relationship, providing users with a liquid staked ETH alternative in an otherwise illiquid environment. As long as the demand for liquid staked ETH continues to rise, both Lido and Curve may continue to capture market share in the staking provider market.

However, it is not clear if the ETH/stETH Curve pool will be able to protect its market share once staking withdrawals are enabled on Ethereum. The pool might continue to exist as a staking derivative, however, one of the main use cases of the pool is to unstake ETH. If users can unstake directly on Ethereum through staking providers (including Lido), or through other exchanges, liquidity in the ETH/stETH pool may decline. For example, in January 2021, circa 88.1% of all stETH liquidity was in the ETH/stETH pool. Today, it is 52.1%. The market share may further decrease if pool incentive rewards are reduced or discontinued altogether. Nevertheless, the merge and ETH staking withdrawals will most likely not happen until Q1/Q2 2022. The subsequent effects in regards to the ETH/stETH pool can only be accurately quantified once relevant data is available, after the implementation of staking withdrawals.

Summary of Notable Risks or Red Flags

  • Market Risk: Recent events revealed that the ETH/stETH pool risks becoming unbalanced due to several market dynamics. However, the pool has rebalanced relatively well. The potential stETH discount in the ETH/stETH pool may remain or reappear on occasions until staking withdrawals are enabled on Ethereum. This is due to the relatively fixed upper bound on stETH price and the possibility of other more attractive ETH yield farms that can incentivise liquidity providers to allocate ETH elsewhere.

  • Execution risk of the Ethereum 2.0 roadmap: There is currently only an approximate planned date for the merge and staking withdrawal implementation (Q1/Q2, 2022). This date risks being delayed if some unexpected hurdle appears. If the plan is delayed, this may have implications on the stETH discount. Furthermore, in case there is a crucial bug in the withdrawal implementation that restricts or disables ETH withdrawals on the Ethereum protocol level, the ETH/stETH pool may experience a long squeeze event. Users may then decide to withdraw ETH, which would lead to significant sell pressure on stETH in the pool. This would trigger a highly unbalanced liquidity pool and drop in stETH price.

  • Competition risk: The ETH/stETH Curve pool risks losing its competitive advantage of being able to unstake ETH as more exchanges onboard stETH/ETH or stETH/USD pairs. In addition, when staking withdrawals are enabled on Ethereum, staking providers will be able to unstake themselves.

  • Smart Contract Risk on Curve and Lido: Onboarding steCRV as collateral implies an increased smart contract risk from both Curve and Lido. Both platforms have been audited. However, security vulnerabilities or errors may have unintended consequences on the steCRV-CROP adapter.

Proposed Risk Parameters

Stability Fee: 4.5%
Liquidation Ratio: 155%
Debt Ceiling: 5m
DC-IAM gap: 3m
DC-IAM ttl: 8h
Cut: 0.99
Step: 90 seconds
Buf: 1.30
Cusp: 0.4
Tail: 140 minutes
Chip: 0.1%
Tip: 300 DAI
Ilk.chop: 13%
Tolerance: 0.5
Ilk.hole: 3m DAI
Dust: 10.000 DAI

A link to our model specification with inputs and outputs can be found here.

Lead Researcher: @Sean

Sources:

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