In The Weeds #7
Why you should care about Rocket Pool Atlas and why Curve wants to enter the stablecoin market.
Welcome to Decentral Park’s new research sub-newsletter: In The Weeds.
This weekly installment will focus solely on key technical developments and themes within Web3, keeping you ahead of the game on upcoming trends.
Let’s get stuck into this week’s key highlights.
1: Rocket Pool Atlas and LEB8
What is it? We all know and love Rocket Pool as the most decentralized Liquid Staking Derivative (LSD) provider within the Ethereum ecosystem, and arguably the most closely aligned with the Ethereum ethos. Though Rocket Pool’s performance, from a fundamentals standpoint, has always been overshadowed by its older brother, Lido Finance, and over the past year by the arrival of the new kid on the block, Coinbase.
To date, a major driver in Rocket Pool’s competitive advantage over the two aforementioned dominant LSD providers has been LEB16, which stands for ‘Lower ETH Bonded’ and refers to Rocket Pool’s innovative minipool node operator model.
If you’re unfamiliar with this model, Rocket Pooloffers node operators, who can deploy in a permissionless manner, the ability to deposit only 16 ETH to a validator, instead of the full 32 ETH required for a full Ethereum validator. The remainder is pooled together from liquid stakers who deposit their ETH into the Rocket Pool protocol. With the need for node operators to deposit 16 ETH of their own capital, Rocket Pool can enforce security incentives, i.e. slashing penalties, while dramatically enhancing capital efficiency for node operators.
The financial results of LEB16 minipool nodes are undeniably attractive for node operators. Current node operators running 16 ETH mini pools earn on average 16% more than solo stakers, due to the 15% commission awarded from the protocol on rewards earned for their work, i.e. commission on the additional 16 ETH deposited from liquid stakers of the protocol.
If you are a node operator or solo-staker, then I have good news for you… Rocket Pool, after intensive testing, has deemed it safe to reduce the 16 ETH requirements to 8 ETH with the introduction of LEB8. This is all without compromising the security incentives already in place.
The introduction of LEB8 is set to take place in the Atlas upgrade, scheduled for the 18th of April (less than two weeks away!). Atlas will mark the second major upgrade for Rocket Pool since launching on mainnet. Of course, LEB8 isn’t the only feature upgrade being implemented in the Atlas upgrade, we’re also looking at a solo validator conversion implementation (in line with the Shapella upgrade allowing validators to change their withdrawal credentials), and various smartnode feature upgrades, such as automatic rewards distribution, a unified Grafana dashboard, changes to Nimbus support, Lodestar support, and a new network snapshot system.
For this section of ‘In the Weeds’, I’ll be focusing solely on the LEB8 upgrade, so if you’re interested in reading more about the additional features of the Atlas upgrade I’d direct you to the Rocket Pool official Atlas guide.
Why is it important? So, back to the important stuff… Why is LEB8 such good news for node operators and solo-stakers? The answer becomes clear when looking at the financial comparison between LEB8 and LEB16. As previously mentioned, LEB16 offered rewards 16% higher than solo-staking, with the introduction of LEB8 this figure increases to 45%... yes, 45% higher than solo-staking rewards. That’s a seriously attractive offering to incentivize solo-stakers to shift over to become Rocket Pool node operators. Note, this equates to 25% better returns for minipool operators with LEB8 than LEB16.
A factor that goes hand in hand with these figures is the fact that LEB8 halves the capital-based barrier to entry for node operators. This acts as incentivization to deploy in and of itself, but when combined with the favorable financial statistics, the option of deploying a LEB8 minipool starts to get very exciting.
This is great for node operators, but for Rocket Pool, the implications could be significant. LEB8 is a genuine source of incentivization for further node operators to join the network, in addition to the existing LEB16 node operators who are incentivized to split their validators into two LEB8 minipools. The result is a huge increase in rETH capacity, 3x to be specific.
Previously capacity has been a crux for Rocket Pool. You’ll know if you’ve ever tried to mint new rETH directly from the protocol that it is almost always oversubscribed, to the frustration of potential rETH users. This is a major issue since ultimately rETH circulating supply and liquidity within the DeFi ecosystem is paramount in the utility of the LSD. What LEB8 offers is a sound path for rETH to increase this liquidity within the ecosystem, and make a name for itself amongst Lido and Coinbase by clawing in market share from its existing 5.8% level. LEB8 acts as a catalyst for Rocket Pool to compete more aggressively in this core Ethereum sub-sector.
Let’s turn our attention to the RPL token, which as a reminder must be staked by node operators to the tune of 10% of the USD value of the ETH staked in the validator. This is a key piece of information because the dynamic here is a mechanism that ties the value of RPL to the value of ETH, while still allowing it to generate a premium above ETH.
LEB8 has retained the 10-150% collateral range for RPL that was used in LEB16, meaning that node operators must stake 10-150% of their staked ETH value, in USD terms, to operate the validators on RocketPool. This is great news because it means as new node operators join the network, which we predict will be the case as a result of LEB8, there will be organic demand for the RPL token. This demand is likely not to be sustained at initial levels longer-term, but remember that the RPL collateral requirements are tied to the USD value of the ETH staked. This means that as ETH price increases, node operators must purchase and stake additional RPL to maintain the 10% minimum collateral requirements. If you believe that the price of ETH will increase over the coming 12-18 months, this implies sustainable demand for the RPL token.
Where does it go from here? The next logical step in Rocket Pool’s minipool journey is to reduce the LEB levels from 8 to 4 ETH. This is something that has been frequently referenced by the team, with the official Atlas announcement Medium post even stating: “As is a tradition at Rocket Pool, we take safety and security very seriously. So it is hoped that should 8LEBs prove successful and safe, 4LEBs may be introduced in a future upgrade not long into the future.”
If deemed safe from a technical perspective, LEB4 would compound the benefits of LEB8 from a capacity and RPL demand perspective, greatly benefiting the protocol and its ability to capture LSD provider market share. One factor that will need to be held constant should a further reduction in minipool requirements not result in a net negative for the value-capture of the RPL token will be maintaining the 10-150% collateral range requirements.
Another predicted implication of the LEB8 introduction is a reduction in RPL emissions. As it currently stands, despite offering 16% higher rewards than solo-staking, LEB16 rewards are supplemented by RPL emissions to attract node operators. Given the extent to which we deem the LEB8 offering will attract node operators, we anticipate it to be less necessary to bolt on additional incentivization, thus anticipating a reduction in the rate of RPL emissions from reward top-ups.
Conversations between the Decentral Park and Rocket Pool teams while at ETHDenver indicate that while other LSD providers (Lido, Stakewise, etc.) have been focusing on the implementation of DVT, Rocket Pool’s implementation of the technology has taken a back seat as a result of Atlas.
Nevertheless, looking ahead longer-term, once implemented, capital requirements will only further decrease. For example, four distributed nodes could form a DVT cluster within a minipool, depositing only 2 ETH each to reach the 8 ETH LEB8 requirement. Not only is this beneficial from a financial point of view, but it acts to materially bolster the decentralization and security of the Ethereum network.
Ultimately we see the introduction of LEB8 being a catalyst for Rocket Pool to finally roll its sleeves up and get to work competing with the larger players in the LSD sub-sector.
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2: Frax Finance LSD Solution
What is it? Our next deep-dive keeps us on the theme of LSD providers, but for those who haven’t been keeping up with recent developments, the protocol in focus will come as a surprise. Frax Finance is best known for its partially collateral-backed, partially algorithmically stabilized stablecoin, Frax. Frax has grown to become the sixth-largest stablecoin by market capitalization across the whole of DeFi, boasting a market capitalization of $1.05b.
In addition to its flagship stablecoin product, Frax has introduced FraxLend, a lending product, and FraxSwap, an exchange product. To this end, Frax has positioned itself as a DeFi conglomerate, with the ultimate vision of providing the ‘Holy Trinity’ of DeFi.
In true Frax fashion, Frax Finance has again expanded its product offering, this time dipping its toes into the LSD provider game with a dual-token staking model, frxETH and sfrxETH. This dual-token model is nuanced when compared to that of Lido and RocketPool, with some major advantages, but first, here’s how the model actually works.
frxETH acts as a tokenized ETH-pegged stablecoin, very much akin to Wrapped Ether. For context, Wrapped Ether has accumulated a market capitalization of ~$7b, with the primary use case being deployment across various chains, as opposed to being siloed to its original chain. Users can swap ETH for frxETH 1:1, and immediately leverage the utility benefits of the tokenized version beyond the standard ETH token.
Interestingly, wrapping ETH for frxETH is a one-way street, users are not able to unwrap frxETH once it has been deposited to the Frax protocol. This is fine for frxETH users, since they can merely take to a DEX and swap back their fxrETH for ETH at a ~1:1 rate, though it means the market capitalization of frxETH will only ever increase or stabilize. The result is that the Frax protocol can, and does, take the ETH deposited and deposit it into Ethereum validators, earning staking yield on the ETH deposited.
So who gets this staking yield?... I hear you ask. The answer is, mostly, the holders of sfrxETH, which is Frax’s yield-bearing liquid staking token. To stake in a liquid fashion with Frax, users must first purchase frxETH, or deposit ETH and mint frxETH, which they’re then able to stake in the Frax app for sfrxETH.
sfrxETH holders earn 90% of the staking rewards, while Frax Finance as a protocol receives 10%, 80% of which goes to the Frax treasury and is then redirected to holders of veFXS, and 20% of which is held in a slashing insurance fund.
What’s interesting about this dual-token model though, is the fact that there is a mismatch between the market capitalization of frxETH and sfrxETH, and thus between the ETH earning yield, and the ETH receiving yield.
Why is it important? This mismatch is a dream for holders of sfrxETH. At the time of writing, there are 128k frxETH in circulation, but only ~60%, or ~77k of this is staked. This means that 77k sfrxETH is receiving rewards for 128k ETH worth of stake. The result is that sfrxETH boasts the highest APY of any LSD. Now, the APY is 5.72%, 18.18% - higher than the next highest APY offered in the LSD market.
To no surprise, the above dynamic has resulted in sfrxETH being the fastest growing top 5 LSD from a TVL perspective over the past 30 days, and by some margin, boasting 16.75% growth, compared to the next highest of only 7.98%. Its recent growth has seen TVL boost to $246m.
Another reason why this token is particularly important is the relationship between the two tokens in this model. The value of sfrxETH appreciates over time as staking rewards are accrued, meaning users can redeem sfrxETH for more frxETH than originally deposited. This removes drawbacks associated with a rebasing token, and offers benefits from a tax perspective, given a tax event is only triggered when the sfrxETH is swapped back to frxETH, as opposed to every time the token rebates.
Further to this, rebasing tokens are unable to be used within DeFi protocols such as Uniswap, Aave, Curve, etc. without forgoing their rebase due to the token standard design.
Where does it go from here? The recent growth in sfrxETH speaks for itself, and we believe it is set to continue given the innovative dual-token architecture and its APY benefits. What’s clear though is that this growth is dependent on the ratio of frxETH to sfrxETH remaining in favor of sfrxETH holders.
Analyzing the distribution of frxETH we noticed that the frxETH/ETH pool on Curve, which acts as the primary liquidity venue for frxETH holders (remember, frxETH can’t be swapped back to ETH on the Frax protocol), currently holds 39,440 frxETH. This is due to the high APY offered, as a result of Frax Finance being the largest DAO holder of CVX, enabling it to incentivize liquidity on the pair. What’s at play here is the liquidity requirements for frxETH directly benefiting the staking APY of sfrxETH by removing locking frxETH in the Curve pool.
The result of this dynamic is that as long as Frax deems it necessary to incentivize liquidity on the frxETH/ETH Curve pool, which theoretically should be indefinite, there will be a mismatch between the market capitalizations of frxETH and sfrxETH, favoring sfrxETH from an APY perspective. Long live sfrxETH market share growth!
3: CrvUSD and LLAMM
What is it? DeFi blue-chip and OG Curve have been the go-to stableswap DEX pretty much since its launch in August 2020. Since then, it has grown to the third largest DEX by daily volumes across the whole of DeFi, behind only Uniswap and PancakeSwap, with 7-day average trading volumes of $1.02b at the time of writing. It also happens to be the largest DEX by TVL, boasting TVL of $4.79b, $810m greater than that of Uniswap!
Given the nature of the protocol as a stableswap DEX, stablecoin volumes are high on Curve, with the second most actively traded pool behind the stETH/ETH pool on Curve being 3pool, a base pool consisting of USDC, USDT, and DAI. Curve has seen this and decided it wants to capture more value than it currently is, by launching its stablecoin. The stablecoin has been dubbed crvUSD, and it is anticipated that Curve will push to have this coin either replace 3pool, or become an integral part of 3pool, and/or its successor.
As you may have guessed from the name, crvUSD will be a dollar-pegged stablecoin, that’s over-collateralized similarly to DAI or GHO and leverages a novel lending-liquidating AMM (LLAMM) design.
The stablecoin is backed by assets supplied to the Curve platform, which acts to further incentivize liquidity within the Curve protocol.
While the backing of the stablecoin has been seen before in DeFi, the LLAMM is what’s interesting to us about this stablecoin design. Essentially, as the collateral value drops, the protocol automatically converts this collateral to USD to prevent liquidation, we assume it will convert to crvUSD, though it’s possible the user will have a choice of stablecoin or even base pool. The opposite action is performed as the collateral value begins to increase.
The result is that the user will take a hit on the value of their collateral as the price approaches their liquidation price, although this is seen as favorable as prevention of liquidation, over the obvious alternative of complete loss of collateral.
While I won’t dive into the maths behind this liquidation mechanism in this write-up if you’re interested I’d urge you to visit this Curve Stablecoin Brown Bag talk to understand the mathematics, or simply check out the whitepaper released by the Curve team.
Why is it important? Being the largest stableswap DEX in DeFi, and seeing the greatest volumes in stableswaps, it makes sense for Curve to launch its own stablecoin and attempt to capture value where previously third-party stablecoin providers have done so. This is particularly true when considering that Curve has the means to funnel its users towards denominating their swaps in any asset they deem appropriate through APY incentives, including their own stablecoin.
Ultimately, crvUSD has the potential to eat into the stablecoin market share. For example, if it were to become the go-to stablecoin denomination within the Curve protocol alone, it would theoretically capture ~1.2% of the stablecoin market. While this doesn’t necessarily sound like a significant share, the implications lie primarily with the Curve protocol. Given the stablecoin volumes the protocol puts up daily, depending on how the economics behind the token itself is framed, crvUSD could become a significant revenue generator for Curve.
One consideration from this is that incentivizing crvUSD as the denomination across stableswap pools would likely result in APY incentives, and thus CRV emissions, which could diminish the attractiveness of the token in the short- to medium term. It is of course unclear as to whether Curve would opt for this incentivization route, though we deem it likely.
It’s also worth noting that crvUSD fits, along with Frax, DAI, and GHO, into a somewhat decentralized stablecoin bucket. I’ve used the word somewhat due to the backing of these stables, at least in part, by centralized stablecoins. While the landscape is far from clear for stablecoin regulation when it comes to somewhat decentralized options versus entirely centralized options, crvUSD has at least a path to complete decentralization should it opt to expel these centralized options from its collateral backing.
Where does it go from here? There is currently no visibility into the launch of crvUSD, although communications on Discord between the Decentral Park and Curve teams indicate a launch is coming soon. Take this with a grain of salt.
While we don’t believe crvUSD will grow to the size of USDC or USDT, given the nature of the token and it’s likely being confined to the Curve protocol, it still represents the significant revenue-generating potential for the Curve protocol itself.
Having said this, the LLAMM mechanism is attractive for speculators looking to gain leverage on their risk assets and could be enough of a pull to extend crvUSD market share, gain material liquidity on the protocol (beyond its already impressive liquidity base), and cement Curve’s place as the go-to stableswap DEX within the DeFi ecosystem.
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