Title: Staking ETH
The following is a proposal to invest 10,000 ETH from PCV into stETH (represents ~4% of PCV).
Lido allows users to stake ETH on the Ethereum beacon chain to earn daily rewards. The stETH is a token that represents staked ether using Lido and is pegged 1:1 to the ETH. Its value is the result of initial deposit plus staking rewards less penalties. The daily staking rewards are paid in stETH.
The main purpose of this initial investment into stETH is earning yield to grow PCV, which can help FEI Protocol to protect the peg and drive FEI utility and adoption.
Deploying a portion of PCV in a yield-bearing asset like stETH will provide PCV with another source of value appreciation, while remaining long in ETH and will strengthen our positioning in the stable coin business.
Liquid staking protocols, such as Lido, allow users to earn staking rewards without locking assets or maintaining staking infrastructure. Users of these protocols can deposit tokens and receive tradable liquid tokens in return. With Lido, users receive rewards (subject to penalties, if any happen) in the form of increased/decreased stETH balance in their wallets.
ETH2 staking rewards are appealing as the yields are interesting and reasonably predictable. From the available options for Fei Protocol to participate in ETH 2.0 staking, stETH has the following benefits: liquidity, low technical requirements for implementation, competitive fee structure, community governance, and increasingly, proven stability.
Lido has established itself as the third largest ETH depositor to the Beacon chain, only behind the centralized exchanges, Kraken and Binance.
The current APR after Lido’s fees in stETH is 5.9%, with ETH2 validator rewards currently sitting at 6.4%.
There are two reasons for the returns difference between stETH and the ETH 2.0 validator rewards: 10% profit fee charged by LIDO (used to reward validators, LDO governance token holders and an “insurance” fund) and the time needed to launch validators to obtain ETH2 rewards vs. ETH locked up for stETH in Lido.
Lido’s APR will grow as the rate of active stakers on Lido becomes higher, but will not exceed Ethereum’s APR due to the profit fee.
The scenario analysis below assumes a 12.5% reduction stETH APR compared to ETH2 staking APR (the range of discount has fluctuated roughly between 10% and 15%), a 99% own validator uptime and a 95% average validator uptime in the network. The current ETH staked is 4.76% of total supply.
|Scenario for ETH staking||ETH Staked as % of total supply 1 year from now||ETH 2 staking return 1 year from now||stETH rewards in the first year (assuming linear decrease from today)||stETH Effective APR||stETH reward per day in the first year|
Assuming the current stETH return of 5.9% APR, the investment would yield approximately 1.6 stETH per day starting from Day 1.
The table below follow the risk analysis model outlined in the PCV guidelines:
Smart Contract Risk: C-
Lido is a new protocol launched in December/2020 that is dependent on ETH 2.0, a technology under development. To mitigate the Lido smart contract risks, it has been successfully audited 4 times - by Quantstamp, Sigma Prime, and MixBytes (see Audits). No high risk or critical issues were found. The protocol is also covered by an extensive bug bounty program.
Counterparty Risk: C-
Lido is a DAO responsible for managing protocol parameters, node operators, oracle members, defining the profit fee and more. The Lido network of Ethereum node operators consists of 9 great staking providers with outstanding track records and it relies on a set of oracles to report staking rewards to the smart contracts.
ETH 2.0 validators can lose up to 100% of staked funds if they fail to validate transactions. To minimise this risk, Lido stakes across multiple professional and reputable node operators with heterogeneous setups. As an additional mitigation, Lido works with Unslashed Finance to protect stakers against slashing, covering for a 5% slashing penalty on more than 400,000 ETH until June 22nd. To date, no slashings have been incurred.
DAO key management risk
Ether staked via the Lido DAO is held across multiple accounts backed by a multisig threshold scheme to minimise custody risk. If signatories across a certain threshold lose their key shares, get hacked or go rogue, funds risk becoming locked.
To mitigate this risk, well respected signatories were chosen across the DeFi ecosystem. More info on Withdrawal key generation event. Lido plans to move over to a fully non-custodial solution in the near future.
Liquidity Risk: C
It is not possible to unstake ETH with Lido until transactions are enabled on ETH 2.0. The transfers and smart contracts are scheduled at ETH 2.0 Phase 2. Once these features are deployed, the Lido DAO will upgrade Lido to allow the users to burn stETH tokens in exchange for ether.
Until that happens, stETH is a more risky asset. In the short-term, the stETH can be sold in the market if needed. However there is a risk of insufficient Curve liquidity when selling portions of the stETH investment. Currently the stETH/ETH Curve pool holds 76% of stETH total supply and has 382,840 stETH and 355,596 ETH, and swapping back the 10,000 stETH from the PCV to ETH using Curve would incur a 24 ETH slippage (2-3 weeks of staking rewards).
The daily average volume considering the last month is US$ 5.7 millions. The current curve pool is incentivized with CRV and LDO tokens rewards. A change in this policy could impact liquidity provided in the pool and make it more difficult to sell the stETH before the launch of ETH 2.0.
This risk is partially mitigated as Fei Protocol is overcollateralized and may not need the resource in the short term. Also, the allocation of 10,000 ETH would represent only ~4% of PCV. This amount is appropriate for the current liquidity of stETH.
Market Risk: C
The value of stETH is built around the staking rewards associated with the Ethereum beacon chain. If ETH 2.0 fails to reach required levels of adoption or has relevant delays, significant fluctuations in the value of ETH and stETH could occur.
The price of stETH can be lower than its inherent value due to withdrawal restrictions on Lido, making arbitrage and risk-free market-making impossible. This represents the risk that stETH becomes significantly de-pegged from ETH before it is possible to redeem it 1-to-1 on Lido’s platform, should we want to withdraw before the ETH2 merge and Lido upgrade.
The stETH token supply can be greater than the demand. Before Phase 2 deployment, the only way to take profit from the stETH token is selling. In case the ETH 2.0 staking rewards have a significant drop, stakers may want to sell their tokens.
This proposal will add a new contract to the protocol: the EthLidoPCVDeposit. This PCVDeposit manages the movement between ETH and stETH. On deposit, it will choose the most advantageous between:
- Direct staking on Lido (1:1 stETH for each ETH deposited), or
- A swap in the Curve steth pool (that can potentially give more stETH than ETH on trade).
Should we need to recover the ETH invested before ETH2.0 goes live, this PCVDeposit allows us to swap stETH back to ETH, again using the Curve pool. Today, a 10,000 stETH swap to ETH on the Curve pool gives 9,987 ETH, or 13 ETH of slippage, which should be around 10 days of yield farming from stETH.
The exact steps executed by this proposal would be the following :
- Move 10,000 ETH from the EthPCVDripper (currently holding ~140,000 ETH that stay idle) to the new EthLidoPCVDeposit.
- Deposit the 10,000 ETH to stETH either by direct staking on Lido or a Curve swap, depending on what’s more advantageous at the time of execution of this proposal.
Depending on the feedback from community about this post, we would suggest a snapshot with two options to vote:
- 10,000 ETH @ LIDO stETH
- No deployment on LIDO stETH