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Following recent developments in the ETH staking ecosystem, including: - Ethereum (minority) client bug - Protocols using primary LST price (1:1) instead of market price - Introduction of @eigenlayer and restaking Decided to write a revised leveraged ETH staking risk analysis.
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Agenda: - The strategy and historical performance. - Sustainability analysis: squeezing the spread (min spread at 0.2%). - Risk analysis. - Liquid restaking strategy. - Minority vs majority client bug risks. - Managing lev-staking positions: http://ethsaver.com. - Summary.
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The strategy for boosting the ETH staking yield via lending protocols has become quite popular since the last write-up, so I'll give just a short overview of it here. Increased yield comes from leveraging the spread between ETH borrow rates and ETH staking APY. πŸ‘‡
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Before delving into the risks, it's worth mentioning that the profitability of the leveraged staking strategy has increased in the last couple of months, with the average APY being over 10% despite the recent LSTs' drop in average yield (from ~5% to 3.5%).
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The sustainability of the leveraged staking strategy has been questioned many times ever since the first additions of LSTs as collateral. One of the main concerns was that the spread between borrow rates and staking yield was going to be arbed away. https://dune.com/queries/2235238/3665104
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As it turned out, the spread has not been squeezed at all. With the max leverage for LST/ETH positions being increased across all money markets (up to 18x on Blue), the required spread got down to a minimum. Even 0.2% is now enough to perform better than simply holding an LST.
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The conclusion is that there are just enough people wanting to earn mild APY (<3%) on their vanilla ETH, alongside people longing ETH or just using it as collateral to short other assets (not interested in the supply rate), to make this strategy sustainable (long-term).
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Alongside new underlying protocols and LSTs enabling this kind of strategy, the associated risks have also evolved in the meantime. Some are fully mitigated, but there are new ones, too. Let's explore those below.
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Revised risk analysis of leveraged ETH staking strategy. 1. Borrow rate spikes. 2. LST provider (big) slashing event. 3. LST depeg & liquidation hunting. 4. SC risks. 5. Governance risks. 6. Restaking. 7. Ethereum execution client bug. Breakdown of each point.πŸ‘‡
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Borrow rate spikes. Users can end up having negative net APY in case of high ETH market utilization on the underlying lending protocol (i.e. borrow rates > staking yield). However, this needs to be severe or very long-lasting to have an impact (which depends on the leverage).
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Protocols like Compound v3 and Morpho Blue (can) avoid having huge rate spikes after hitting the optimal utilization since no collateral is lent out guaranteeing liquidity for potential liquidations. Those are thus deemed to be less risky for borrowers in this regard.
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LST depeg. LST market price represented a significant risk factor because of their use as collateral especially after the stETH/ETH Curve pool 'depeg' in 2022, *but it's not anymore*: 1. Can redeem 1:1 in a few days (withdrawals enabled). 2. Protocols now using primary rate. πŸ‘‡
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