An Update on the Fundamentals of Staked ETH Tokens, Liquidity & sETH2
The recent liquidity crisis in the staked ETH market has unfortunately also affected StakeWise. In this blogpost, we will address the main concerns & questions the community has voiced over the past 48 hours and will share the team’s vision for StakeWise’s liquidity strategy going forward.
Short recap on staked ETH token fundamentals
First, let’s recap what the concept of “liquid” staking actually means. It describes a service that mints a token to represent some asset you have staked (read: locked in a Proof of Stake validator) through its platform. This token representation of one’s locked capital allows token holders to:
i) instantly transfer (and sell) whatever they have previously staked to other people,
ii) use staked capital as collateral for various trading purposes, and
iii) receive ETH from validators by exchanging tokens for ETH at a 1:1 ratio whenever withdrawals become possible.
It is this fact that locked capital can suddenly be freely transferred and used in exchange that makes staking “liquid”, and boy has this concept grown on people.
Since the advent of staking on Ethereum, liquid staking protocols have accumulated nearly 5 million ETH in deposits, minting close to 5 million staked ETH tokens of various flavours. Such tokens are now traded for tens of millions of dollars in volume per day and used as collateral in lending protocols and options trading. Naturally, there exists a market where staked ETH tokens are priced against ETH and other currencies, with a myriad of parameters like the depth of liquidity, direction of flows, and choice of AMM design influencing their market price.
Therefore, each token has 2 key values for stakers to watch: its underlying value, ie how much each token can be exchanged for ETH in the validators, and its market value, ie how much each token can be exchanged for ETH on the market. The difference between the two is what’s commonly known as the “discount”.
Current sETH2 price & trading conditions
Whereas historically sETH2 holders enjoyed only a tiny discount (the average market price of sETH2 over the past 6 months is 0.9967 ETH per sETH2, ie only a 0.33% discount), recent market volatility has taken the price of sETH2 to 0.9623, ie a 3.77% discount. There are several reasons for it (mostly stETH trading at a discount, ETH crashing, and liquidity providers pulling liquidity), but the ultimate result is that now sETH2 is trading in line with other staking derivatives available on the market.
How does this discount affect different sETH2 token holders? We can differentiate between 3 buckets of holders:
1. Token holders that plan to keep the token until withdrawals from staking.
Such users are not affected by the discount, because they ultimately rely on the underlying value of the token, which is 1:1 with ETH.
If this is you, rest assured that the market price of sETH2 has no bearing on how much ETH you can exchange your sETH2 for upon withdrawal. New users entering the protocol (and old stakers increasing their positions) even benefit from the discount, because they can obtain every 1 dollar of ETH for 96.5 cents thanks to the discount.
2. Token holders that want to swap the token for ETH before withdrawals are possible.
Such users are naturally affected by the discount because swapping early requires them to accept the market price, which is below 1 ETH for an asset that will be exchangeable into 1 ETH after the Merge. Still, sETH2 holders enjoy one the highest prices for their staked ETH token compared to the rest of the market (for reference, stETH has a 5.61% discount, while rETH has a 2.3% discount).
3. Token holders that are providing liquidity in the Uniswap sETH2 / ETH pool
Such users are also affected because they are willing to both buy and sell sETH2 at a discount when providing liquidity at the current price. While this is fine if sETH2 is trading sideways (ie not increasing or decreasing in price), LPs suffer if the price of sETH2 suddenly increases, especially if they provide liquidity in a tight range. This phenomenon is known as impermanent loss, which in case of sETH2 will become permanent once withdrawals are enabled and the price of sETH2 stabilizes around 1 ETH. Please read on to understand these risks further.
To sum it up, the discount for sETH2 does not affect those users & LPs who plan to hold the token until ETH can be withdrawn from the validators, yet concerns those who would like an early exit or to continue LPing with old capital by repositioning into a lower range.
As it stands, both sETH2 & rETH2 tokens are fully backed by ETH in the validators in a 1:1 ratio. The team can confirm that StakeWise or its node operators have not experienced slashing events to date, which means that all the deposits & rewards remain intact and the staked ETH tokens are fully backed. We are also looking into independent solutions that could affirm as much on-chain and will keep the community posted about the progress.
Considerations for new capital allocators & existing LPs
Before the recent decline in sETH2 price, the token was trading on Uniswap V3 in a narrow range close to 1:1 with ETH, helped by numerous people adding liquidity to earn farming rewards. However, after the price decline, many of such LPs experience being “out of range” ie market price not being within the range they chose to provide liquidity in, at which point all of their LP position has been converted to sETH2. This is what it looks like:
While such LPs are not currently participating in farming the rewards any more, they still earn rETH2 from the total amount of sETH2 they provide on Uniswap. The rewards accumulating to this position can be collected on the Farms page:
With the new sETH2 price, the range in which LPs would maximize their rewards (albeit at the expense of higher risk of IL) is 0.95887 to 0.96464 ETH per sETH2, with an all-in APR currently sitting at 112%. However, adding liquidity in the new range has several nuances that both the potential new and veteran LPs must consider:
- Veteran LPs who are currently out of range would be worse off selling sETH2 for ETH at the new price in order to continue providing liquidity in the new farming range. That’s because they would need to convert a big chunk of the sETH2 they acquired at 99 cents on the dollar into ETH at a price of around 95 cents on the dollar, ie take an immediate 4% capital loss on the ETH side of the new position. Unless LPs expect to earn back this 4% through farming incentives & trading fees during their time as LP, we do not recommend swapping from their sETH2 into ETH at the current price to add into a new farming range. Keeping liquidity out of range or removing liquidity to put sETH2 to work elsewhere outside of Uniswap, however, is perfectly safe.
- People who haven’t previously provided liquidity in StakeWise’s Uni pool and those who are willing to deploy fresh capital have a few opportunities available in StakeWise farms. First, they must make sure they learn about the specifics of LPing on Uniswap V3 and StakeWise’s method of farming rewards distribution. Second, they must ensure that the acquisition price of sETH2 they deposit is in line with the current market price, in order not to incur a loss from selling sETH2 at a discount when LPing. As long as they’re comfortable with the opportunities & risks, they can provide liquidity to farms SWISE rewards — the most profitable range to do this now is 0.95887 to 0.96464 ETH per sETH2. PS. for those reading this months down the line — the range is subject to change, so pop into our Discord for an update.
It is also important to set the expectations straight — according to the team’s best thinking at this time, the price of sETH2 is likely to be driven by the discount on stETH in the next few months, because the two staked ETH tokens have a very similar risk profile & profitability. The discounts on both tokens will depend on the market conditions, which right now are far from ideal.
The dynamics one could expect is that a rising ETH price is likely to attract more liquidity and create more demand for discounted staked ETH tokens, helping close the discount. In such a scenario, LPs at the current price should beware of getting out of range (i.e. having their whole LP position converted into ETH), while veteran LPs may get back into range based on the price of sETH2 recovering closer to 1.
Conversely, a declining ETH price is likely to exacerbate the discount due to liquidations of borrowers with stETH collateral and flight to a more liquid asset (ETH) amid market turmoil. In this scenario, LPs at the current price should beware of getting out of range (i.e. having their whole position converted into sETH2), while veteran LPs would be further advised not to convert their existing sETH2 positions into ETH at the market price in order to avoid capital losses.
Team’s position on SWISE incentives going forward
In the next couple of weeks, the team will advertise the APR available in the sETH2/ETH pool in order to make the best of the SWISE rewards allocated to the pool for the current month. However, there is a concern that solidifying the price at the current levels (you know how efficient Uni v3 is) will not only slow down sETH2 from closing the discount if ETH rallies, but might also be detrimental to further TVL growth for as long as new deposits are routed via Uniswap. Therefore, the team is preparing to make several suggestions on the StakeWise forum about how to tackle growth, liquidity and sETH2 price all at once. In the meantime, we encourage the community to also think about this challenge and share their thoughts on the forum or in Discord. We’ll get through this together.