Maximizing ETH Yield While Mitigating LST Risks: A Case Study on (ETHPLUS) ETH+
This article was originally published on July 9, 2023, in collaboration with Reserve Protocol.
The DeFi market offers various opportunities to generate yield on ETH, but as the industry evolves, security remains a top concern. Most notably, depeg events have underscored the risks associated with liquid staking tokens (LSTs) and their impact on asset safety.
To navigate these risks, solutions that balance yield generation with robust safeguards are essential. One such solution is RTokens, like ETH+.
ETH+, built on the Reserve Protocol, is composed of an index of liquid staking tokens (LSTs) and is designed to provide both high yields and enhanced safety through overcollateralization. This structure makes it a compelling choice for ETH yield generation while helping mitigate risks associated with individual LSTs.
But what happens when an LST depegs? And how does it affect RTokens backed by LSTs?
In this case study, we examine how ETH+ would have responded to the stETH depeg event in June 2022.
Primer on (ETHPLUS) ETH+
ETH+ is an interest-bearing "RToken" backed by a 50/50 split of Lido’s wstETH and RocketPool’s rETH. "RTokens" are assets composed of baskets of ERC20 tokens – often yield-bearing– that can be created permissionlessly on the Reserve Protocol.
Each RToken has its own governance, determined by the Reserve Rights ($RSR) tokens staked to it. When $RSR is staked to ETH+, it becomes eth+RSR, granting holders yields from the underlying basket and voting rights over ETH+. Additionally, the eth+RSR acts as first loss capital, helping to protect against collateral defaults.
Since its inception, ETH+ has witnessed a steady increase in ETH+RSR stakers, indicating healthy signs of adoption. However, the rate at which ETH+ gets minted has surpassed the pace of ETH+RSR staker growth. Presently, RSR stakers contribute approximately 3% of overcollateralization for ETH+.
To put things in perspective, the FDIC provides about 1.3% coverage on deposits socialized across all member banks. Similarly, the Maker DAO Surplus Buffer provides 1.7% coverage across all stakeholders.
In terms of yield, holding ETH+ offers holders 3.75% APY –as it’s a culmination of wstETH and rETH yields–which, considering market standards for single-sided staking ETH opportunities, is quite favorable:
Lido Finance stETH: 3.7% APY
Rocket Pool rETH: 3.1% APY
Coinbase cETH: 3.4% APY
Frax Finance frxETH: 5.2% APY
Ankr aETH: 4% APY
ETH Safety: stETH depeg case study
ETH+ not only inherits yield from its underlying LSTs but also mitigates risks like depegs.
The importance of such protection became evident in June 2022 when stETH, Lido Finance’s ETH LST, experienced a depeg following the UST collapse, according to Nansen.
As a yield-bearing token, stETH is typically valued above ETH. However, between June 1st and June 7th, 2022, its price hovered around 0.98 ETH. Amid broader bear market conditions, the stETH/ETH ratio then declined further, reaching a low of 0.94 between June 9th and June 11th before rebounding to 0.96 on June 12th.
Below, we analyze how ETH+ would have responded to the stETH depeg event.
Basket Rebalancing
RTokens are built with a rebalancing mechanism that auctions off the failing collateral to roll over into emergency collateral.
In the case of an LST depeg, the RToken smart contracts would sell off the failing collateral for emergency collateral and then liquidate the RSR stakers to backfill any deficit to recapitalize at 100%.
Currently, Reserve uses Gnosis Auctions (batch auctions) via a Gnosis EasyAuctions plugin to sell off the defaulted collateral. Using the predetermined emergency collateral, people can bid on the defaulted collateral during auctions. For ETH+, the emergency capital is wETH.
For example, when wstETH depegged and the price ratio of wstETH/WETH dropped to 0.96, people could buy this defaulted collateral at a rate of 0.96 WETH per 1 stETH, which would become part of the backing collateral.
The trading taking place during auctions is modularized so that it can happen dynamically as on-chain liquidity evolves. The auction length for ETH+ is set to 10 minutes.
However, if the protocol cannot become fully collateralized by the end of the auctions, it will seize the ETH+RSR stakers’ funds and auction them to make up the difference for the remaining required wETH.
RSR-over-collateralization
RSR stakers act as the last line of defense in the case of insolvency. When Reserve protocol seizes the staked RSR, it’s sold into the market for the emergency collateral.
In the case of the stETH depeg, considering ETH+'s current RSR over-collateralization of ~3%, it would be capable of withstanding a (wstETH/ETH) price ratio decline of 0.94 –assuming favorable trade execution for RSR during the auctions.
In the event of both assets depegging (wstETH/rETH), Reserve could handle a total price ratio decline of 0.98.
To handle more severe situations –like both assets depegging– additional ETH+RSR stakers would be necessary.
Interestingly, ETH+'s composition of two different LSTs (wstETH & rETH) paradoxically mitigates the risk compared to holding a single LST. This diversification spreads the risk, as you are not solely dependent on the security of a single protocol.
Issuance and Redemption Throttles
Rtokens employ issuance and redemption throttles to prevent simultaneous cascading liquidity outflows before black swan events go in full swing.
The issuance throttle places a cap on the amount of ETH+ the contract can issue, limiting the potential for value extraction in the event of an exploit. Following a significant issuance, the issuance limit gradually "recharges" to the defined maximum.
Similarly, the redemption throttle aims to ensure that the net percentage redemption of outstanding ETH+ never surpasses an hourly limit.
The specific parameters for ETH+ are as follows:
Issuance Throttle parameters
Issuance throttle amount: 1,000 ETH+ maximum amount per hour
Issuance throttle rate: 2.5% ETH+ supply
Redemption Throttle parameters
Redemption throttle amount: 2,000 ETH+ maximum amount per hour
Redemption throttle rate: 5% ETH+ supply
These limits can be specified in terms of RToken quantities and/or as a percentage of the RToken supply.
The amount and rate of the throttle are chosen depending on which is greater when the throttle is invoked.
Closing Thoughts
For ETH+ to maintain its safety, the demand for RSR must grow alongside its market cap to ensure a stable overcollateralization rate capable of absorbing major depeg events. This requires stakeholders to align with the Reserve Protocol by holding $RSR and directing their stake toward ETH+ rather than other RTokens.
As long as demand for ETH+ RSR staking keeps pace, ETH+ can continue to offer a secure and risk-conscious way to earn passive income on ETH.