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Before and after the Ethereum merger, what opportunities exist for liquid staking agreements such as Lido and StakeFi?

Before Ethereum’s highly anticipated Beacon Chain merger, there have been more and more discussions around the obvious advantages or disadvantages of liquid ETH pledge. Approximately 20% of Ethereum is mortgaged in the liquidity pool, and the proportion of mortgages through centralized cryptocurrency exchanges is even greater, so this discussion is necessary. Especially considering that exchanges or pools of funds may have a strong, quasi-commissioned impact on the future of the network. Another view is that by separating equity and block production through liquid equity options, the pledge pool and node operators may lack sufficient incentives at some point to ensure the orderly operation of the Ethereum network.

1637659374651391Source: Elias Simos, Dune Analytics; https://dune.xyz/eliasimos/Eth2-Liquid-Staking

Despite this governance debate, the current percentage of ETH pledges in the circulating supply is about 7%, which is far from the 50% or more of the first PoS L1 chains such as Polkadot, Solana, and Cosmos.

1637659374646068Source: Messari, HTTPS  : //messari.io/screener/staking-supply- (Top-5-POS) -C1C07858

However, in absolute terms, the total value of pledged Ethereum is about 34 billion U.S. dollars. In terms of market value, it ranks in the top ten among all digital assets, of which more than 7 billion U.S. dollars are in staking pools such as Lido, Stakehound, and StakeFi. From this perspective, there is actually an important network value, although the amount of pledged ETH is not a high percentage of the total supply. Anyone who is interested in the orderly operation of the Ethereum network in the next few years or its mid-term pricing dynamics should pay close attention to the dynamics of liquidity changes in the ETH pledge pool.

As Paul Simon (American pop music singer and composer) said, “You know that the closer you are to the destination, the more you slide farther away”, which may feel to some of the liquidity betting pool participants on Ethereum today Very appropriate. Unlike the discount of GBTC, the mortgaged ETH has a redemption date, which is expected to be in the first half of 2022. But like GBTC, all top ETH pledge derivatives have discounted the value of their underlying ETH in the past few weeks, and some discounts have taken longer.

So, why is there a discount between the value of ETH pledge derivatives and the value of their underlying ETH? In terms of market dynamics before and after the merger, what should holders or speculators expect? Below, we will discuss several derivative tokens, the strategies that staking pool participants have been seeking to maintain the peg, and the opportunities for traders in the pre-merger environment.

Taxiing on the highway

First, a quick review of the fundamentals of Ethereum staking. Ethereum 2.0 pledge requires the verifier to pledge 32 ETH in the official pledge contract in order to participate as a complete verifier. Once pledged, validators must meet a series of technical and operational requirements to perform blockchain functions, such as batch processing transactions and checking other validator blocks. In a process called Slashing, validators that fail to meet uptime requirements may be punished in the form of losing pledged ETH. When the validator meets these conditions, it will receive variable income on the pledged ETH as compensation. The rate of return is calculated based on the total amount of ETH pledged by all validators, and is tracked and updated through the Launchpad website .

Although many ETH holders may have the technical knowledge to start validator nodes, the punishment related to Slashing may have scared off quite a few of them, making them afraid to self-host (32 ETH at startup) The value is slightly less than $20,000). From the beginning, the exchange was a clear choice for custody and pledge, but users faced a lock-up period before the final merger. Therefore, non-exchange node operators and decentralized mortgage providers enter the market to provide users with an alternative solution, in which ETH mortgagers can: 1. Invest less than 32 ETH; 2. Maintain liquidity; 3. At the same time You can choose to mortgage their newly issued derivative tokens elsewhere in the market.

The adoption of decentralized ETH staking pools is very compelling. The following is a chart of the top providers of decentralized, liquidity collateral by token:

1637659374646920Source: Elias Simos, Dune Analytics; https://dune.xyz/eliasimos/Eth2-Liquid-Staking

Lido is a DAO that manages liquid pledge agreements. It is an undeniable winner in terms of liquid pledge market share, accounting for more than 88% of the total decentralized ETH pledge market. Stakehound and Ankr’s StakeFi (abbreviated as “Stkr” in the figure above) accounted for 7.5% of the remaining market, and these three participants represented the vast majority of decentralized ETH collateral. As the dispute with the custodian Fireblocks has not yet been resolved , Stakehound no longer has access to the encryption keys that protect more than 38,000 customers’ pledged ETH. Therefore, the company stopped its liquid pledge service in August and focused all its energy on restoring the funds locked by users. This makes Lido and Ankr’s StakeFi the largest active liquidity collateral provider in the market.

Lido and StakeFi have a lot in common in providing services. Both companies provide a Web3 method to pledge, and both companies allow users to pledge any denomination of ETH. Lido charges 10% of all staking profits, while StakeFi charges 15%. Both companies issue derivative tokens to represent the pledged ETH, and users can redeem their original pledge positions and the interest earned after the merger is completed. To ensure market liquidity, both ecosystems and their partners provide incentive-based incentives to provide liquidity to decentralized exchanges. For Lido and StakeFi, exchanges like Curve and Balancer are particularly important to ensure that ETH pledge derivatives maintain some form of peg to the value of their underlying assets. Since late May, Lido’s pledge of ETH-stETH, has shown a relatively strong price stability record.

1637659374648205Source: Elias Simos, Dune Analytics; https://dune.xyz/eliasimos/Eth2-Liquid-Staking

In other words, this road is not always “slide on the highway”, and in recent weeks, the parity of stETH to ETH has shown greater volatility. The 90-day deviation of stETH is approximately -0.48%. Although this degree of deviation is not serious, it cannot be ignored, because it means that any holder of the derivative token stETH has reduced an average of 0.48% in the past 3 months.

On the other hand, Ankr’s StakeFi ETH pledge token ankrETH has had greater deviations from the peg and price fluctuations since its inception. Like stETH, ankrETH seems to have found some ways to re-adjust to anchor in the summer. Compared with stETH, the deviation of ankrETH in the past 90 days is much higher, at -3.35%. For a brief period in September, ankrETH was trading at a higher price than ETH.

1637659374665624Source: Elias Simos, Dune Analytics; https://dune.xyz/eliasimos/Eth2-Liquid-Staking

Since the exact date of the merger of the Beacon Chain is uncertain, it is logical that ETH mortgage derivatives are traded at least temporarily at a discounted price. Even devout hoarders need mobility from time to time. Nonetheless, ETH derivatives currently represent the originally pledged ETH, plus all pledge rewards received since December 2020. AnkrETH estimates that this basic value is currently 1 ankrETH = 1.051 ETH . Lido’s stETH is a repriced token whose value reflects the pledge interest earned over time, and the exchange rate is expected to be similar. As a clear leader in market share, Lido’s huge market liquidity makes the long-term link to ETH prices more stable. That is to say, when tracking based on the net asset value (NAV) of its underlying assets (that is, the pledged ETH plus the interest earned), both Lido and StakeFi show a relatively large deviation from the peg.

The main strategy used by these fund pools to maintain the net asset value is to incentivize token holders to provide liquidity pairs to decentralized exchanges in exchange for further income. Lido rewards liquidity providers with Lido’s own governance token LDO to incentivize income farming. StakeFi relies on third parties to provide incentives to fund pool participants. One example is OnX Finance, which rewards early depositors of ankrETH with OnX governance tokens to provide liquidity. These strategies may affect the ability of the two projects to hold the link, because many holders have obtained more than 5% of the income through the governance token incentives. In many cases, when taking into account the NAV discount and the concomitant rate of return of governance tokens, holders may earn a net profit of more than 5%.

For the long-term viability of ETH-derived tokens, further providing opportunities for re-staking will be crucial. Hasu recently had a conversation with BitMEX on this issue. He said that if the pledged ETH is trustlessly managed and there are continuous re-collateralization opportunities in the market, then the adoption of ETH is actually an opportunity cost issue. He believes, “If this cost is low enough, then I believe that stETH for ETH may become the effect of U.S. government bonds on physical dollars-quasi-risk-free interest rates.” So, what can be said about the current opportunity cost? ? Is the annual rate of return attractive enough? Are derivatives productive-are there opportunities for re-collateralization? For about 35,000 ETH liquidity mortgage depositors, the answer is yes.

What will happen before the merger?

For those investors who are not too concerned about the mid-term price dynamics of ETH and are willing to hold them during the merger process in the first half of 2022, Staking derivative tokens may represent a simple alpha. Tokens like stETH and ankrETH are widely available in the market, sometimes with considerable discounts, and reflect the redemption value of 1.05 times ETH. In addition, these tokens can be profitable elsewhere in the market. Naturally, risks abound in DeFi, and ETH’s liquidity bet is no exception. If the ETH merger is further postponed, people may see a more pronounced deviation from the peg.

Once the date of the merger is determined, the demand for ETH-derived tokens may increase significantly. Especially in the days before the redemption event, one would expect any discount to convert to a premium. If the merger occurs in a continuous bull market cycle, this situation is more likely to happen. On the other hand, if any kind of large-scale risk aversion and market correction occurs before the merger, it may inhibit this dynamic. In this case, people may expect greater discounts during the sell-off, because market participants will run away from riskier bets and instead purchase stablecoins and other assets that are considered safe.

Looking at other PoS chains, it is clear that high liquidity, including the ability to exchange and redeem pledged assets, will not hinder the overall interest in pledges. Given the current interest and adoption of ETH-derived tokens so much, more adoption of ETH staking before and after the merger seems to be the most likely outcome. This is likely to lead to the last-minute panic buying of ETH liquid pledged tokens, and ultimately close the market discounts observed today. Will ETH liquid pledge tokens disappear? Time will tell us.

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