Trading the Lido Staking Rate
IPOR Protocol’s epoch-by-epoch Lido Staking Rate Index and the stETH Stake Rate Swap serve a wide range of participants in Ethereum’s fledging financial ecosystem.
Key takeaways:
- With the Ethereum staking rate becoming the de-facto risk-free rate and Lido’s stETH dominating liquid staking tokens (and DeFi), IPOR is bringing transparency and powerful trading instruments to the liquid staking derivatives market.
- The staking rate is an important risk factor to hedge and a tradable quantity, comprising volatile Execution Layer and Consensus Layer rewards.
- In the coming weeks, IPOR will enable a wide range of users to trade 28, 60, and 90-day swaps referencing the newly introduced Lido Staking Rate Index.
- IPOR’s Stake Rate Swap allows for hedging, speculation, and even relative value trading of staking rates.
The successful transition of Ethereum to Proof-of-Stake (PoS) allowed holders of ETH to earn yield for securing the network and paved the way for the ETH staking rate to become the “risk-free” rate benchmark for ETH in DeFi. The innovation of liquid staking has been a significant driver of growth for the Liquid Staking Derivatives (LSD) market in DeFi.
The barrier to entry to staking has been reduced significantly (less than 32 ETH needed to participate in staking pools), while the liquid staking token (LST) construct has allowed for a new level of capital efficiency.
LSTs are essentially a “claim” on the ETH supplied to staking pools and can also be used as collateral in DeFi, thus enabling a whole universe of new use cases and trading strategies.
Listening to the market pulse and the IPORian and broader DeFi community requests, IPOR is delivering on a roadmap to bring transparency and powerful trading instruments to the LSD market.
This is manifested with the milestone introduction of an epoch-by-epoch Lido Staking Rate Index and the stETH Stake Rate Swap (SRS).
In the remainder of this article, we briefly introduce Lido on Ethereum and discuss the drivers of the Ethereum (and by extension Lido) Staking rate. We argue that the staking rate is both an important risk factor to hedge and a tradable quantity and provide specific examples of how hedgers and speculators can use the soon-to-be-launched IPOR stETH SRS.
🔷 Lido
Capitalizing on its first-mover advantage, the longevity dividend, and the virtuous cycle of TVL growth driving collateral eligibility across DeFi for stETH (Lido’s LST), Lido has maintained the lion’s share of the LSD market on Ethereum.
In its current version, the protocol offers staking services backed by a “curated list” of 37 validators (entities) and controls almost 78% of the LSD market in Ethereum. Lido is charging 10% fees on the staking rewards earned, part of which is paid to the validator set, while the rest is used to build reserves for an insurance fund (e.g. to cover losses in the unlikely case of a generalized slashing event).
Lido’s critics have been alluding to centralization concerns due to the permissioned nature of validator “whitelisting,” as well as Lido’s dominance on Ethereum. The project team and community are working towards further decentralization and the permissionless listing of validators.
🔷 What is Driving Ethereum Staking APRs?
The ETH staking yield comprises Consensus Layer (CL) and Execution Layer (EL) rewards. The yield from CL rewards has an inverse relationship with the ETH staking ratio (the percentage of ETH that is staked). Currently, at around 23%, the ETH staking ratio remains a lot lower compared to other PoS networks (typically in the 40–70% range in major PoS networks) and is likely set to increase over time.
In other words, the CL component of the staking yield is most probably on a structural downward trend until it reaches some kind of equilibrium level.
A generalized slashing event poses one of the main tail risks to staking yield.
Lido’s validator onboarding process, along with the additional assurances of the recovery fund, should reduce the risk and impact of such an event significantly. Notwithstanding, severe slashing shall not be completely ruled out.
On the other hand, the execution layer (EL) related yield (gas/tips to validators and MEV-related rewards) is increasing with network activity. It is, therefore, a more volatile yield source. In the current market environment, network activity remains subdued and exhibits spikes typically related to some major event (broad-based de-risking following stablecoin depegs or core DeFi protocol exploits, memecoin-related activity, big NFT mints, etc).
One could argue that as Ethereum becomes more established as a global settlement layer and state machine, EL rewards, albeit consistently more volatile than CL, might eventually settle at a higher level. The pick-up in gas costs and staking yield in recent weeks on the back of improved market sentiment and activity could be an appetizer for the staking yield dynamics of the next bull market. The evolution of the ecosystem landscape with respect to rollups and other scalability solutions will also be an essential factor in the years ahead.
All in all, the medium-term trajectory of staking yield will be a tug-of-war between network activity and an increasing staking ratio.
Assuming that the staking ratio reaches an equilibrium level over the next market cycle, the role of EL rewards as a driver of staking yield (and thence its volatility) is set to increase eventually.
🔷 IPOR Staking Rate Swap (SRS)
In the coming weeks, IPOR will enable users to trade 28, 60, and 90-day swaps referencing the newly introduced Lido Staking Rate Index.
The index will be calculated on an epoch-by-epoch basis (6.4-minute intervals) and serve as a reliable intraday estimate of the Lido staking APR (published daily around 12:00 UTC).
To learn why a real-time rate was necessary for a fair IPOR swap market, have a look at IPOR Labs Head of Product Lukasz Muzyka’s piece on the subject:
🔷 How to Trade the Staking Rate?
🔸 Hedging
Holders of stETH that are expecting the structural downward trend of the CL reward component of staking yield to prevail, Ethereum validators, and issuers of stablecoins collateralized by stETH are natural receivers (receive fixed) of the Lido Staking Rate using the SRS.
The same applies to more sophisticated traders who use so-called leveraged staking strategies. The IPOR SRS will offer peace of mind to these Ethereum ecosystem participants, allowing them to lock in their staking APR.
🔸 Tactical Trading & Speculation
Traders might want to position opportunistically for an increase in the staking yield (entering pay fixed positions) ahead of an anticipated market event that could lead to increased gas fees on the network or if they are simply speculating that EL rewards can pick up following prolonged periods of subdued activity.
Alternatively, tactical traders might enhance their yield by receiving fixed against spikes in gas and staking yield if they consider these temporary. (e.g. would you have faded the PEPE frenzy-induced spike in yield?).
Finally, introducing a spot ETH ETF is expected to revive the interest in TradFi product wrappers, providing access to ETH and staking yield. The SRS is set to become an essential tool for yield enhancement strategies.
🔸 Relative Value Trading
Relative value (RV) trades are an elegant way of expressing views on DeFi or Ethereum-specific market events in a cost-efficient and/or non-directional manner. The introduction of different maturities of swaps will enable curve trades, while cross-market RV trading shall become possible with the roll-out of more SRS markets.
The volatility that the MEV component of validator rewards exhibits, magnified by the pseudorandom selection of block validators, is expected to remain a source of attractive tactical cross-market opportunities.
IPOR remains committed to delivering on its mission to support transparency, better price discovery, and effective risk management for DeFi. The introduction of similar solutions and products for other leading LSD protocols will be rolled out in the coming months following the necessary DAO governance votes.
Thanks for reading. If you want to learn more about IPOR’s Stake Rate Swaps, consider this recently published piece by IPOR Labs’ Co-founder and CEO Darren Camas:
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