Executive Summary
The rise of liquid staking has reshaped the Ethereum supply composition and the dynamics of ETH emission, with a notable presence of Lido driving these dynamics.
We are witnessing an upward trend in the adoption of stETH, especially when contrasted with ETH, which has experienced a stagnation in demand.
stETH has taken over from ETH as the preferred asset on lending platforms. This shift is mainly propelled by the appeal of leveraged stETH positions, which seem to offer more attractive yields compared to providing liquidity through stETH-ETH pairs on decentralized exchanges.
📊 View all charts covered in this report in The Week On-chain Dashboard. Liquid Staking on the Rise
Since the introduction of the Proof of Stake consensus mechanism to the Ethereum network, a new phenomenon has emerged: Liquid staking.
In essence, liquid staking projects enable individuals to delegate their ETH to the project’s node operators, who in turn stake the ETH on their behalf. In return, the individuals receive a representation of their staked ETH known as Liquid Staking Derivatives (LSDs) or Liquid Staking Tokens (LSTs).
In the context of these new developments, the composition of the circulating ETH supply has changed. Currently, 23% of the ETH supply is staked, with 32% of that being staked via the largest liquid staking service provider, Lido. This also means that 7% of the ETH supply is being replaced by Lido’s staking derivative, stETH. This shift is showing a rising tendency.
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Usually, staked ETH serves as security for validators and is locked up. However, liquid staking derivatives allow users to reuse their staked ETH, for example in DeFi protocols, while still receiving staking rewards. These derivatives are backed by the equivalent amount of staked ETH, and can be redeemed through the liquid staking platform at any time.
This appealing feature of liquid staking is the driving force behind the current trend of increased staking through liquid staking providers, with Lido currently dominating the field with an 86% market share. We therefore continue this analysis by evaluating Lido's staking derivatives stETH and its wrapped version, wstETH.
stETH's Impact on ETH Supply
Since the merge, the issuance of newly created ETH is solely generated from the rewards paid out to validators.
As Lido owns 32% of the staking pool, they subsequently receive 32% of the validator's rewards, and consequently, 32% of the newly created ETH is distributed into the ETH economy via Lido. To understand the impact this might have for the ETH supply, we should take a closer inspection at Lido's reward mechanisms. Lido's reward structure consists of three layers:
🟠 Consensus Layer Rewards in the form of rewards paid on top of the staked ETH account for the largest portion of the protocol rewards at 68.8%
🔴 MEV rewards are a form of extra fee for being included in a certain position within a block and are the second largest at 28.4%.
🔵 Priority Fees paid for transacting on the network constitute the remaining 3.72% of rewards.
The gross annual percentage rate for Lido is determined by the overall consensus layer APR and the execution layer APR, which are based on the rewards received by Lido validators in relation to the total pooled Ether. As of writing, the total Protocol APR is 4.07%.
Lido charges a 10% fee on staking rewards with the fee split between both the node operators and the protocol's treasury. This applies to both execution layer rewards and consensus layer rewards.
When considering Lido's consensus layer reward distribution in terms of the 32% of the newly created ETH, we observe a different emission dynamic compared to what was envisioned by the Ethereum protocol. Unlike solo stakers who receive all validator rewards, and hence newly created ETH, Lido only distributes 1.6% of the newly created ETH to node operators (assuming they are not holders of stETH). Another 1.6% goes into the Lido Treasury, whilst 28.8% is distributed to stETH holders.
Furthermore, Lido compounds the rewards earned by validators, by restaking the rewards earned from Priority Fees and MEV. Currently, around 104k ETH has been restaked, which contributes to a compounding effect of 1.24% of the Protocol APR.Lido's compounding strategy offsets parts of the ETH emission through the Consensus Layer Rewards. While 3.2% of the rewards are distributed as described above, an additional 0.95% of the total rewards are locked away in the staking pool. In total, this amounts to Lido receiving a total of 221k in newly created ETH (see previous chart), whilst 105k ETH is locked again in the staking pool, resulting in net emission of 116k ETH.
stETH's Impact on ETH Demand
Lido mints stETH for every ETH staked with its node operators, as well as for the rewards received from staking activities. All stETH holders receive an automatic update of their the account based on the rewards they are eligible to making stETH a yield-bearing version of ETH. Due to the attractiveness stETHs yield-bearing properties compared to ETH, there are beliefs circulating that stETH could replace ETH as Ethereum's reserve currency.
To determine if Lido's stETH is tapping into the demand for ETH, we examine the recent adoption of both ETH and its wrapped version, WETH, in comparison to stETH and its wrapped version, wstETH. By comparing the trends using a 30D-SMA, we observe that the number of new addresses using ETH + WETH has stalled since the Terra Luna Collapse in May 2022, whilst demand for stETH + wstETH has increased by 142% during the same period.
When observing the transfer volume, a similar trend can be noted with both ETH + WETH, experiencing an increase in volume ranging from $6B to $10B on average throughout 2022. However, this volume flattened out at the beginning of 2023.
Conversely, stETH reached a peak volume in the spring of 2022 and remained relatively stable for the rest of the year. However, in 2023, it gained momentum again, jumping from $127M, to a range of $450M - $880M.
stETH's Impact on DeFi
When comparing the usage of ETH and stETH in DeFi, we shall primarily focus on the wrapped alternatives of both tokens as proxy for demand due to their support in the majority of DeFi applications.
Since the beginning of 2022, a significant increase in the supply of the wstETH can be observed, with an additional 3M+ tokens issued. This suggests a growing preference amongst users to hold wstETH instead of stETH.
However, it is worth noting that only 70.5% of the wstETH supply is held in smart contracts. The large number of individual wstETH holders can be attributed to tax regulations. With the automatic balance updates of stETH being seen as taxable income, users may prefer to hold the wrapped version that only increases in value without increasing the number of tokens.
In comparison, wETH supply has decreased by 62% within the same period, indicating a lack of demand for the wrapped version of ETH. This provides confluence with the observation of reduced usage of wETH in smart contracts.
When analyzing the breakdown of stETH supply into its token holders, whilst taking into account that wstETH replaces 74% of the stETH supply, we can observe that Lido's staking derivative has found significant adoption within Aave's lending protocol. Approximately 14.4% of the stETH and 25.3% of the wstETH supply are utilized in Aave.
Of note, only a small percentage of Lido's staking derivative is being used on decentralized exchanges (DEX). Among the DEXes, Curve holds the highest amount of stETH liquidity, which represents a mere 1.4% of the total stETH supply.
This is a concerning number, considering that stETH and wstETH are traded primarily on DEXes. In this context, we reiterate the points raised in the previous Week on Chain 27 regarding the receeding liquidity of stETH.
As depicted in the charts below, Curve, the largest trading venue for stETH, has experienced a 90.2% decrease in stETH reserves for the top three stETH pools since May 2022.
Concurrently, Aave has experienced an influx of Lido's staked ETH, with an increase of approximately 53.6%. The stETH reserves have been evenly divided between the two versions of Aave. This transition is likely be driven by the fact that leveraged stETH positions offer more attractive yields compared to providing liquidity for stETH on DEXes.
The shift from DEXes to lending platforms like Aave has reduced liquidity for stETH, which potentially poses risks in terms of stETH depegging as well as the creation of bad debt on Aave. This is because the liquidity available on DEXes may not be sufficient for the liquidation of these loans.
Summary and Conclusion
The rise of liquid staking has brought about significant changes in the composition of the Ethereum (ETH) supply and the dynamics of newly created ETH. Lido, a major player in the staking pool, has altered the flow of new ETH entering the economy through its restaking strategy.
Furthermore, a portion of the newly minted ETH is distributed to sETH holders, who may exhibit different characteristics and behavior patterns compared to validators. Which leads to the assumption that a notable portion of the newly minted ETH from Lido is being directed towards DeFi applications
This shift has also seen stETH replace ETH in Aave, presumably due to leveraged stETH positions offering higher yields than providing liquidity with stETH-ETH pairs on decentralized exchanges. This development carries the potential risk of stETH losing its peg to the underlying asset and could also lead to challenges related to handling bad debt on Aave.
Disclaimer: This report does not provide any investment advice. All data is provided for information and educational purposes only. No investment decision shall be based on the information provided here and you are solely responsible for your own investment decisions.
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