[stETH] Collateral Onboarding Risk Evaluation

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

The content included in this evaluation was primarily prepared by Irina Katunina, Eugene Pschenichniy, Victor Suzdalev, Vasily Shapovalov, and Nikolai Abelyashev of the LidoDAO team and community. We carefully reviewed the provided data, as well as adding additional information around certain risk factors and making independent risk parameter recommendations.

Summary Proposed Risk Parameters

Stability Fee: 4%
Liquidation Ratio: 160%
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

Protocol Summary

The Lido’s Ethereum liquid staking protocol, using the Ethereum beacon chain, allows users to earn staking rewards on the beacon chain without locking their liquidity or maintaining staking infrastructure.

Lido allows users to deposit ETH and receive stETH. The deposited ETH is then pooled and staked with node operators selected by the Lido DAO. stETH represents the user’s staked ETH balance of the beacon chain along with staking rewards accrued or penalties inflicted on validators in the beacon chain. When transactions are enabled on the beacon chain, stETH can be redeemed for unstaked ETH and accumulated rewards. The stETH token is a liquid alternative for the staked ether: it could be transferred, traded, or used in DeFi applications.

stETH is very good collateral for people who are long Ethereum, as it lets them at once margin long ETH and compounds it with staking rewards. Staking rewards alone can pay off stability fee if it’s sufficiently low.

stETH is a rebasable token and integration of this asset requires a custom Gem Join contract. An easier and less risky way is to integrate wstETH, a trustless fixed-balance wrapper (https://docs.lido.fi/contracts/wsteth), and use the standard Gem Join contract.

Governance

Lido DAO governs a set of liquid staking protocols with Lido on Ethereum among them. The Lido DAO decides on Lido’s key parameters (e.g., fees) and executes Lido upgrades. The Lido DAO members govern Lido to ensure its efficiency and stability.

To have a vote in the Lido DAO, one must hold its governance token, LDO. LDO voting weight is proportional to the amount of LDO a voter stakes in the voting contract. The more LDO locked in a user’s voting contract, the greater the decision-making power the voter gets. The exact mechanism of LDO voting can be upgraded just like the other DAO applications.

Founding and Funding

Lido launched in December 2020.

The Lido DAO consists of, amongst others, Semantic VC, ParaFi Capital, Libertus Capital, Terra, Bitscale Capital, StakeFish, StakingFacilities, Chorus, P2P Capital and KR1, Stani Kulechov of Aave, Banteg of Yearn, Will Harborne of Deversifi, Julien Bouteloup of Stake Capital and Kain Warwick of Synthetix.

The Lido treasury has been recently diversified and DAO members now include Paradigm, Three Arrows Capital, DeFiance Capital, Jump Trading, Alameda Research, iFinex, Dragonfly Capital, Delphi Digital, Robot Ventures, Coinbase Ventures, Digital Currency Group, The LAO and angels.

The stETH token is a tokenized version of staked ether. When a user sends ether into the Lido liquid staking smart contract, the user receives the corresponding amount of stETH tokens. The stETH token represents Lido user’s deposits and the corresponding staking rewards and slashing penalties. The protocol applies a 10% fee (this can be changed by the DAO) on staking rewards that are split between node operators, the DAO, and a slashing insurance fund.

Metrics and Analysis

stETH has been steadily growing in circulation supply since its inception on December 19th, 2020 and currently stands at 456,449 stETH ($1.29B). The issuance of stETH can be tracked using the chart below:

Source: Nansen

Trading volume on CEX & non-custodial venues

stETH is available for trading on a growing number of exchanges including Curve, 1Inch, Uniswap and SushiSwap. No current top-tier CEX listings.

stETH trading volume on exchanges can be tracked using live chart below (toggle off aggregators in the legend to get base numbers):

The absolute majority of trading volume (around 96%) is on Curve.

stETH trading volume is small compared to available stETH’s liquidity, and is not indicative of it (see below and article https://blog.lido.fi/concerning-steth-liquidity/)

It should be noticed that trading volume of the pool does not include the amount of ETH and stETH has being sold while adding/removing liquidity in order to keep the pool balanced as the pool’s protocol implies adding and removing ETH/stETH pair in the proportion reflecting the pool balance and performing exchanges for the unbalanced part.

For example, during last month pool’s addings and withdrawals brought $43m daily and total daily trading volume was $49.5m (8 times higher compared to $6.2m only exchanges volume).

Token Ownership Distribution

The current stETH supply stands at 456,449 stETH tokens ( worth $1.294 billion) in circulation between 7,172 unique holders for an average of 63.64 stETH per holder.

The supply of stETH tracks the number of ETH deposited into the Lido contract. The total supply of stETH can be tracked via the token contract address.

The actual holders distribution should be described taking into consideration ****that there are stETH holders of first, second and third orders.

  • first order holders are those who directly hold stETH or wstETH tokens

Source: Etherscan

Source: Etherscan

76% of stETH belongs to the Curve LP (0xdc24316b9ae028f1497c275eb9192a3ea0f67022) representing the amount of stETH added to the pool in exchange of PL tokens steCRV.

  • second order holders are those who hold steCRV representing the LP share and have an option to withdraw stETH from the pool

Source: Etherscan

  • third order holders are those who had staked their steCRV for steCRV gauge or tokens of other protocols integrated with Curve pool (Convex, Yearn, Enzym)

Source: Etherscan

Notable stETH/steCRV include:

Total Addresses: 7,172

Source: Coinmarketcap

Unique depositors: 5,615

Source: Dune Analytics

Token Contract Overview

Sourse: Etherscan

Supply Schedule / Inflation

stETH is minted by stacking ETH with Lido 1 to 1. stETH total supply is based on Lido user’s deposits and the corresponding beacon chain staking rewards and slashing penalties (see Tokemonics). APR is ~1-10%, the current value is 5.9%.

Currently, the total stETH supply is 456,449 stETH tokens which represent 8.5% of all staked ETH.

Tokens on Exchanges

76% of stETH is allocated on Curve.fi now:

Liquidity locked into curve

ETH: 329,435 (48.56%)

stETH: 348,941 (51,44%)

ETH+stETH: 678,376

USD total: $1,925,992,574

Curve liquidity providers earn a 0.02% fee from each trade including stETH and ETH being sold while adding/removing liquidity in order to keep the pool balanced. Over time, this income accrues to liquidity providers. In addition, steCRV tokens can be staked for additional CRV and LDO rewards.

Source: Coinmarketcap, calculation

Defi Presence / Integrations

The stETH:ETH pair is the biggest pool on Curve with over $1.76b in liquidity, which makes stETH one of the most liquid tokens in crypto. You need to trade 175000 ETH to stETH or vice versa (more than $200m) to move the price 2%. The reason for that is that the pool is incentivized. There are CRV rewards and LDO rewards that people who are providing liquidity for a stETH:ETH pool can receive by staking their LP shares in the Curve gauge. Lido is incentivizing the pool by monthly governance decisions: e.g. this month 0.375% of total LDO supply, which amounts to $9m or over 3500 ETH at the time of writing, was allocated to the gauge.

stETH is very good collateral for people who are long Ethereum, as it lets them at once margin long ETH and compounds it with staking rewards. Staking rewards alone can pay off stability fee if it’s sufficiently low.

Drawbacks:

  • The absolute majority of liquidity (76%) and trading volume (96%) is allocated on Curve.fi so the existing price feed relies on one liquidity pool.
  • stETH is a rebaseable token that requires a custom GemJoin contract for integration. wstETH is a trustless fixed-balance wrapper that is easier and less risky to integrate (using the standard GemJoin contract).

DeFi integrations

Exchanges: Curve, 1inch, UniSwap v2, Uniswap v3, SushiSwap;

Cover: Unslashed, Nexus;

Lending & borrowing: ARCx, Inverse Finance’s Anchor

Yield Farming: Yearn, Harvest Finance, Convex;

Wallets: MetaMask, TrustWallet, Argent, ImToken;

Portfolio managing: Zerion, Zapper;

Downside Risk

The observed period is 6 month and as it is evident that stETH tends to have the same frequency and severity of negative pullbacks as ETH. Three lowest drops took place on May (19th, 12st, 23d) due to overall market conditions.

Source: Coinmarketcap, calculation

Despite that stETH token is still quite novel and there is no such vast historical data compared to ETH, stETH holds the ETH peg 1:1 (at the latest crypto drop peg dropped to 0.99 only).

The lowest drop in price in comparison to ETH was on 24th March (0.95764). Normalized daily volatility (stETH to ETH) varies from 0.95% (30d) to 1.77% (90d).

Normalized daily volatility (stETH to ETH):

Source: Coingecko, calculation

Despite relatively low historical volatility, there is some risk of a larger price discount developing. Because it is not possible to redeem stETH for ETH until the merge upgrade (expected in 2022), users must rely on market liquidity to get back from stETH to ETH. Currently there is very deep liquidity in the Curve stETH/ETH pool supported by ongoing LDO and CRV incentives.

A decrease in overall stETH liquidity incentives would lead to less depth and greater slippage for sales, so this is partly dependent on Lido DAO governance decisions to continue incentives. As stETH gets accepted at more lending platforms (there are also applications pending with Compound and Aave, and a lending pool on Rari Capital Fuse), there’s a higher likelihood of forced selling (due to liquidations) which could cause the price to trade at a discount.

We can use implied yield to maturity as a simple heuristic to understand how large the discount could get due to short term selling impacts. The ETH2 merge is expected in 2022, leaving roughly a year until users will be able to redeem their stETH for ETH. Any price discount implies additional yield to maturity. If the price were to trade at a 5% discount to full value for example, buyers would earn an additional 5.26% yield. This can be generalized as:

supplemental yield = (1 / ( 1 - discount) ) ^ expected time to maturity

If we assume a 25% yield will be more than enough to activate buyers in even the most stressed market conditions, the price discount shouldn’t exceed 20% per year until the expected maturity date. In practice this means risk of price discount should decrease over time as the expected merge date draws closer, but is also impacted by any unexpected development delays.

Volatility

The data details the hourly volatility of stETH over 90 days and all period passed since the token was launched (~6months) scaled up the data to a yearly volatility.

The same indicators for the pair stETH:ETH indicate the low volatility toward ETH.

Risk Premium to Debt Exposure

Summary of Notable Risks

  • Smart contract/technical risks: Lido faces smart contract risks. To mitigate these, Lido has been audited multiple times - by Quantstamp, Sigma Prime, and MixBytes (see Audits), with no critical issues found.
  • Counterparty risks: Lido is a DAO. Decisions in the Lido DAO are made through proposals and votes - community members manage protocol parameters, node operators, oracle members, and more. The Lido staking infrastructure for stETH consists of 9 node operators, with a focus on decentralization. Lido relies on a set of oracles to report staking rewards to the smart contracts. Their maximum possible impact is limited by the recent upgrade (limit oracles report change by 10% APR increase in stake and 5% decrease in stake), and the operators of oracles are all well-known entities: Stakefish, Certus One, Chorus, Staking Facilities, and P2P. Read further in Lido documentation.
  • Staking risks: stETH faces staking risks, specifically validator risks including slashing and hostage risks. To mitigate these, Lido works only with best-in-class validators with a track record of success. In addition to this, staked ETH with Lido is protected from slashing using the Unslashed Finance insurance protocol. At the time of writing, Lido is covered for ~20000 ETH slashing until June 22nd. To date, no slashings have been incurred.
  • Withdrawal risks: To mitigate withdrawal risks, Lido staking went live on December 18th through a withdrawal key ceremony. Chorus One, Staking Facilities, Certus One, Argent, Banteg (yearn.finance), Alex Svanevik (Nansen), Anton Bukov (1inch), Michael Egorov (Curve/Nucypher), Rune Christensen (MakerDAO), Will Harborne (DeversiFi), and Mustafa Al-Bassam (LazyLedger) came together over a four-day event to generate threshold signatures for Lido’s withdrawal keys in a secure environment on air-gapped machines. Lido plans to move over to a fully non-custodial solution in the near future.
  • Price feed risk: stETH is not traded on CEXs yet and thus the oracle has to use the Curve pool price and ETH price feed to determine the current price.
  • Liquidity Risk: Until Eth2 merge upgrade takes place (expected in 2022), it will not be possible to redeem stETH for ETH. This creates potential for price discounts on stETH if many users want to sell at once. Lending protocol liquidations could increase this risk as large quantities of stETH may be sold all at once to satisfy a debt. The risk of price discounts decreases as expected ETH2 merge gets closer.

Proposed Risk Parameters

Stability Fee: 4%
Liquidation Ratio: 160%
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

We propose a relatively low initial debt ceiling to limit risk from the new Curve oracle, with the expectation of raising this in the near future through the parameter proposal group process. This limits risk from use of a new oracle type. stETH inherits all of ETH’s market risk factors so it is appropriate to set stETH stability fee at least as high as a corresponding ETH vault. The stability fee rate can also be adjusted through the parameter proposal group process to mirror changes in the ETH-A vault stability fee.

The initial proposed liquidation ratio is somewhat higher than the ETH-A vault, which is intended to allow for competitively low stability fees even if Maker gains large lending exposure. The liquidation ratio can be lowered to match ETH-A in the future based on liquidity conditions and usage.

We used the model from the Collateral Risk Assessment Guide here. A link to our model specification with inputs and outputs can be found here.

The content included in this evaluation was primarily prepared by Irina Katunina, Eugene Pschenichniy, Victor Suzdalev, Vasily Shapovalov, and Nikolai Abelyashev of the LidoDAO team and community. We carefully reviewed the provided data, as well as adding additional information around certain risk factors and making independent risk parameter recommendations. Their original work can be found here.

Lead Reviewer: @monet-supply

Disclosure: Reviewer holds LDO tokens (governance token of LidoDAO, the manager of stETH) under vesting. Details here.

Sources:

21 Likes

Thanks @monet-supply, think this is a fantastic write-up, and has my support.

Think the $5M debt ceiling will fill fast (esp since stETH hasn’t been onboarding many places yet)

3 Likes

While stETH remains a non-custodial solution, it depends on the competence and honesty of six of those eleven entities you mentioned. This is an all-or-nothing risk since either everything migrates smoothly to the non-custodial solution or these entities take/lose all the staked ETH.

I am quite happy to keep the DC low for this reason.

1 Like

We need to support Vaults all the way or not at all.

At a 5M debt ceiling it would at MOST generate 200k in net contributions per annum through stability fees.

After factoring in costs for maintaining oracles, opportunity ect this would be unprofitable.

Coinsidering we just went through a process to kill unprofitable vaults it seems extremely counter intuitive to launch new vaults that are by design unprofitable.

4 Likes

Lido Team is working on transfer to fully non-custodial solution, will provide announce soon.

2 Likes

Yes, I am optimistic about this but I think the DC should remain below 5M until that solution is audited, launched and survives in the wild for a period that the Risk CU is happy with.

1 Like

I would disagree with this. While I understand your point that we are offboarding unprofitable ilks I don’t think that means we need to rush when onboarding new ones.

5 million is, I think, a good introductory DC so that we can see how customers use the vaults and can always be adjusted if demand is there and we think it is safe.

1 Like

The great update is here!
Withdrawal credential rotation has happened as planned:

3 Likes