TL;DR Launching diversified 10+ LST 'basket' value-accruing $LSTETH token with opportunistic flexible weights and an internal ETH pool dedicated to LST peg arbitrage. More blocks exposure=more rewards/MEV. More (DVT) NOs=less slashing risk. Leading LSTs max capped, rebalances skewed->small DVT networks->+decentralisation. Appreciating basket NAV/token value reflects auto-harvesting of intrinsic yield on staked ETH (including MEV), plus gains from peg arbitrage and (multi-chain/layer) extrinsic yields, including cross-staking yields. Safety Fund and internal staking/withdrawal queue management ensures near instant mint/redeem. Pledge/hedgeable=(composable). Pristine collateral for borrowing & stables minting
Proposed New PowerBasket: $LSTETH
$LSTETH by PowerPool is a diversified 'basket' token containing a mix of Liquid Staking Tokens (LSTs) representing pools of staked ETH managed by various pool operators (LSPs), curated, arbitrage-traded, and auto-rebalanced/harvested for both intrinsic and extrinsic yield by PowerPool’s PowerAgent Automation Network.
Migration of Ethereum to POS has created a massive staked ETH financing market as ever more decentralised Validators need to finance (and earn/share yields) on increasing valuable (in fiat terms) 32 ETH validator stakes. Liquid Staking Tokens (LSTs) have emerged to fill this need, with no fewer than 25 planned for launch in the run-up to the Shanghai hard fork. Rather than investing in just a few LSTs, a broadly-diversified basket of ~10 LSTs would spread the smart contract/multi-sig risk, have a higher probability of capturing randomised staking rewards/MEV, and also a lower exposure to slashing risk from broader exposure to Node Operators (NOs) and an active skew towards DVT-enabled NOs.
A basket of LSTs with opportunisitic flexible weightings can also generate arbitrage gains and maintain a steady position in the staking and withdrawal queues of many LSTs. Although back-testing with pre-merge no-withdrawals distortions show exaggerated arbitrage gains, the plethora of LSTs spreading across DEXes and L2 layers should provide steady arbitrage gains to basket NAV in addition to intrinsic yields and MEV captured.
The underlying LSTs in the basket can all also generate extrinsic yield from ‘farming’ via DEX LPing and borrow/lending sites to generate optimised yields. PowerAgent automation permits gas-efficient optimisation across various farming options potentially across various L2s. PowerAgent automation facilitates both continuous arbitrage and auto-harvesting/farming additional extrinsic yield on underlying LST tokens, including some LSP providers’ internal LST vaults, external DEX LPs and borrowing/lending protocols.
A PowerBasket of many ETH LSTs with floating weights will also improve and ensure investors’ stake-redeem ETH liquidity by 1.) incorporating a DAO-defined size ETH Safety Fund (included in NAV) to buffer ETH mints & redemptions up to maximum single daily withdrawal limits set by the DAO. 2.) virtually ‘pooling’ DEX LST/ETH liquidity across ALL the whitelisted LSTs in the basket, and 3.) maintaining arbitage-related daily positions in the staking and redemption queues of whitelisted LSTs to continuously manage Safety Fund buffers to match minting and redemption activity.
The proportion of the ETH Safety Fund within the $LSTETH basket will be set, and periodically reviewed by the DAO in the light of returns being generated by arbitrage, and the daily ebb and flow of mints and redemptions to be supported. There will also be a periodically-reviewed maximum cap (100 ETH?) on single day withdrawals to protect the liquidity of the Safety Fund and small depositors. In Phase 2, the Safety Fund (augmented by arbitrage gains) would also re-insure existing slashing insurance schemes operated by LSPs.
An diversified PowerBasket of whitelisted LST/Ds should provide combined gross and net (of fees) yields well in excess of the HODL ETH benchmark, via a single, tax-efficient and religious-compliant (halal) value-accruing $LSTETH token representing the NAV of the basket. The DAO-managed $LSTETH token should become a lower risk, higher yield, highly-liquid, token broadly held as a very low volatility (in ETH terms) real-yield bearing form of pristine collateral. The diversified, higher yield/lower risk (re-insured) $LSTETH basket token is highly composable (LSDFi) and could in turn be LPed, lent, farmed and/or pledged to mint stablecoins for payments. ******
Migration of Ethereum to POS has created a massive ETH financing market as ever more Validators need to re-finance (and begin sharing earned rewards) on increasing valuable (in fiat terms) 32 ETH Validator stakes. Liquid Staking Tokens/Derivatives (LST/Ds) have emerged to fill this need, but PowerPool believes that investing in any given single LST/D does not optimise risk/return for most investors compared to the proposed actively-managed PowerBasket solution leveraging (and ensuring fees for) the PowerAgent automation network.
Over 25 staked ETH LSTs are currently launched or under development. Assuming that post-Shanghai the amount of staked ETH rises from 13 to about 30% (35 million ETH) by the end of 2023, even if only 50% of staked ETH is via LSTs (as opposed to direct staking), there will still be over $1.0 billion of TVL per each of 25 LST protocols, more than enough to support many LST protocols at scale.
Absent an active decentralisation bias in the Ethereum Community, normal power law distribution would imply that the leading LST would eventually reach ~60% of the market, leaving a long tail of much smaller LSTs. But this would imply unacceptable concentration of control over Validators. Ethereum.org has warned that no LST/Operator should be allowed a market share over 25% of Validators. PowerPool believes that the Ethereum Community should and will support an actively-managed 10+ LST/D diversified basket with maximum caps on the share of any given LST/D as means of combating ever-present power law centralisation tendencies in the LST market.
LST/D protocols are always vulnerable to hacks, which can lead to loss of some or all of the ETH they control. Every LST/D poses independent, non-correlated smart contract risk, and pre-universal DVT, some may also pose higher slashing risk. Investing in a broadly-diversified PowerBasket spreads ETH staking across a basket of 10+ different LST/Ds effectively reduces investor smart contract risk to acceptable levels, even before applying insurance, which may or may not be available for all LST protocols in the early days.
Broad diversification across many LST/Ds via a basket also increases intrinsic yield because Validator rewards and associated MEV is granted at random, like a lottery. Investing via a broadly-diversified basket of 10+ LST/Ds not only spreads smart contract risk, but also potentially improve odds of rewards accruing to any given investor, rather like buying more lottery tickets to improve the odds of winning.
The intrinsic yield on LST/Ds collectively will vary with the total amount of ETH staked globally. The percentage staked is currently around 13% (16 million ETH), but that is expected to rise steadily towards ~50% over the next few years. Even with much higher proportions of ETH staked, gross (of fees) LST/D intrinsic yields are expected to be ~5% nominal, and a higher ~7% real in ETH terms, given that the total amount of ETH is expected to be deflationary at about 2% per year. If the intrinsic yields fall dramatically in future due to staking exceeding 50% of ETH, some stakers will be tempted to unstake and pledge their ETH in other ways, increasing the intrinsic yield on remaining staked ETH until a new balance is reached between LST/D and other DeFi yields on ETH. Therefore, gross intrinsic rates of return on a diversified basket of LST/Ds could become an important reference interest rate for the ETH economy.
By August 2023, LSD protocols accounted for 43.7% of the total 26.4 million ETH staked. Post-Shapella, LSD staking surged, causing long entry queues while exit queues remained minimal. The top 8 LSDs yielded an average of 4.4% APY since January 2022, with Frax leading. However, yields are expected to decrease as more ETH is staked.