In Part 1 of our discussion about staking your ETH, Pete and I discussed Proof of Stake (POS), how it works, and where the rewards come from when you stake your ETH. Part 2 focused on liquid staking derivatives, or LSDs. We broke down the differences between solo staking and staking via various providers like Lido, Coinbase, Frax, and Rocket Pool. But will ETH locked up in staking contracts ever be unlocked?
Many speculate a high chance of the unlock coming this year, possibly by Spring. On a recent Ethereum Core developer call, they decided to push the unlock date further up the roadmap. As it currently stands, the unlock will now be part of the next big Ethereum update known as the Shanghai upgrade.
The Great “Unlock”
The big question is, “What will happen to the ETH when the unlock occurs?” Some speculate that people who have staked ETH are going to unlock it immediately and sell. However, others counter that people bullish enough sign away their ETH indefinitely with no guaranteed promise that they’d ever be able to unlock it, may not be quick to sell their stacks.
In addition, it’s also important to consider that there are Lido validators who have been accruing rewards this entire time, and now have more than 32 ETH. Node operators who have 35+ ETH are certainly going to want to do different things with that accrued value. There’s a good chance liquid staking providers may sell accrued rewards to pay bills. This will likely put a downward market pressure on the price of ETH for a while.
On the other hand, Lido has also said that if they have a bunch of validators that each have, say 35 ETH, they wanna sweep all that up and start new validators – something they can’t do currently. This could lead to higher APRs as more validators come online with the same number of ETH.
De-Risking Staking
Right now there’s a significant risk to staking ETH because you’re essentially waiting on the hard fork to happen. However, once withdrawals have been enabled for a period of time and has been working successfully, the risk level goes way down.
We may see staking explode during this period and see a far higher percentage of the overall ETH getting staked in Proof of Stake networks (80-90%). A more conservative estimate would be around 60%. In contrast, currently only around 14% of ETH is staked – so this would be a huge deal.
But even with 14% of ETH becoming unlocked, would that flood the market and cause a price dump? Supporters of ETH will point to the merge and how speculation about possible glitches or problems was rampant. In the end, the process ended up going smoothly!
Post-Unlock Staking Rewards
So if 60-90% of all the ETH in existence were to get staked, then what happens to the staking rewards? What’s the yield going to be on staking your ETH?
Pete thinks it’s very possible that it ends up being a 1%, maybe even 0.5%. But if it’s easy enough, isn’t 1% better than 0%? On the other hand, if Lido is indeed able to sweep up all the validators with extra ETH (which isn’t currently possible) and start new validators, they would actually be able to then pay higher APRs.
We may also see the discounts we’ve been seeing on LSDs disappear when the unlock happens – as long as the providers make good on their claims and withdrawals are easy to initiate. We’ll start seeing stETH and cbETH and all these LSDs go back to peg, and that risk premium will disappear.
So overall, the yield from staking ETH might shrink. But that doesn’t mean ETH yield is going away! In fact, one theory heading into the next bull market is that ETH and LSDs will take center stage as some of the biggest sources of yield in all of DeFi.
Ethereum’s “Risk-Free” Rate
Ethereum now offers its own sort of risk-free rate with no upfront investment costs, sort of like how T-bills are the risk-free rate in fiat since it’s paid by the government that issues the money. And while this risk-free rate might be low, any revenue generated is enough to build on top of. For example, in the lending markets Compound pays out 0.09% APY for supplying ETH but also incentivizes that by paying an additional 0.13% APY in COMP token.
With decentralized exchanges like Curve, the base APY comes from fees charged on swaps. Curve incentivizes it with CRV, and Convex incentivizes it with CVX. The frxETH pool only pays a base rate of 0.055% APY but incentivizes it with FXS, which brings the pool’s APY up to over 8% from the base APY. And this is during the bear market where these tokens are down in the dumps! Imagine the APY once these tokens are doubling, tripling, 10x-ing…
In the last bull market, stable coin farming was all the rage because of the introduction of pegged pairs. When the price of all the tokens in a pool are pegged to one another, the volatility risk goes away. For example, Curve’s 3pool is made up of USDC, Tether and DAI – they all equal $1. As a result, investors don’t have to worry about their principal fluctuating when depositing stable coins into the 3pool.
The same thing is now happening with ETH and LSDs. Although the rate for solo staking ETH might go down to a couple percent, more and more swaps are happening between ETH and cbETH, ETH and frxETH, etc. And if you’re holding ETH, you might as well drop it into one of these pools because the LSDs are technically pegged to the price of ETH!
Our prediction? Yields around 20% for pegged ETH pools. That’s going to be the norm during the next bull market. Furthermore, it will drive demand for ETH which is in short supply right now – especially as most of it gets staked and issuance might go deflationary.
Another way to play the rise of staking and LSDs might be to invest in the tokens offered by the providers themselves, although it’s still difficult to assign value to these at the moment.
Betting On Predictions
So let’s say these crazy theories of 80-90% of ETH being staked are true, and that liquid staking becomes the foundation for all of DeFi. How does one place a bet on that being right?
The truth is, it’s harder than you might think. For example, just buying stETH doesn’t actually place that bet. You’re only getting the staking award, which is the supposed “risk-free” rate.
LIDO, RPL and FXS allow you to place that bet on your theory being correct. Lido token is only a governance token and doesn’t benefit directly from the increase in TVL.
Rocket Pool incentivizes staking RPL because they need people to run mini pools, so the proceeds for the pool actually accrue to RPL holders.
Frax’s ETH staking implementation doesn’t currently charge any fees, but it’s theorized they will someday, and that value will flow to FXS holders.
You could purchase Coinbase stock, but that’s also very diluted with everything else that they have going on.
Conclusions
Staking is what the Ethereum network wants you to do with your ETH. It’s helping to secure the network and is setting up ETH for a major supply shock going into the next bull market.
