[NIP-8] Add wstETH as a collateral asset

[NIP] Notional Improvement Proposal
1

Summary

This proposal looks to onboard wstETH, Lido’s liquid Ethereum staking solution, as a collateral asset to Notional. wstETH could be a good additional source of collateral for Notional users as it gives exposure to ETH’s staking rewards. wstETH collateral holders could thus earn ~4% on their ETH while borrowing at a fixed rate on Notional.

The main risks associated with listing wstETH as collateral are:

  • Smart contract risk
  • Liquidity risk

Considering stETH historical returns, volatility, and liquidity, we propose to onboard wstETH to Notional using the following governance parameters:

  • Exchange rate haircut: 0.72
  • Liquidation discount: 8%
  • Maximum collateral balance (in USD): 50,000,000 (22,500 wstETH)

Resources

Specification

1. Asset description and history

Overview of Lido wstETH:

stETH tokens are ERC20 tokens that represent staked ether in Lido. Tokens are minted upon deposit and burned when redeemed. stETH token balances are pegged 1:1 to the ethers that are staked by Lido. stETH is a rebasable token allowing its holders to access staked ETH returns without having to operate their own staking infrastructure. stETH token’s balances are updated daily. stETH funds remain locked and illiquid until transfers are enabled in phase 1.5 of Ethereum 2.0s’ phased launch, but the stETH tokens themselves can be exchanged for ETH on various decentralized exchanges.

stETH can always be minted 1:1 using ETH but can trade below or at the 1:1 ETH price. The stETH market price is a function of market liquidity, smart contract risk, and the implied probability of the execution of “the merge”.

wstETH is a wrapped version of stETH with a fixed balance system and uses an underlying share system to reflect your earned staking rewards. As an example, if a user wraps 100 stETH for 95 wstETH and unwraps his position 3 months later to receive 101 stETH.

Project history:

Lido’s stETH launched in December 2020. Lido currently operates as a DAO controlled by $LIDO holders.

2. How is the asset primarily used?

wstETH is currently used mostly as a passive way to access ETH staking yield with a liquid token. stETH is mostly used as collateral on lending protocols such as Aave, Maker, and Euler finance. stETH is also used on decentralized exchanges such as Curve, Uniswap, and Balancer.

Here are a few KPIs of stETH:

  • stETH Yield: 3.9%
  • stETH supply: 4.2M ETH
  • stETH locked in Aave: $2.85B
  • stETH locked in Maker: $350M
  • stETH locked in Euler: $50M
  • stETH locked in Curve: $650B
  • stETH locked in Anchor protocol: $50M
  • stETH locked in FEI: $100M

stETH is held by ~74K wallets. The top 100 wallets control ~87% of all stETH. The ownership of stETH appears to be quite decentralized.

3. Why the proposal would benefit Notional’s ecosystem?

wstETH would be a good additional source of collateral for Notional users as it gives exposure to ETH’s staking rewards. Thus wstETH collateral holders can earn 4% on their collateral. Moreover, although wstETH is essentially illiquid by design (wstETH can’t be unstaked) multiple pools such as the curve and balancer stETH/ETH pools offer liquidity to convert stETH back to ETH.

Adding wstETH as collateral would diversify Notional’s collateral base and potentially help onboard new users. This will also increase optionality for Notional borrowers when deciding against which asset they want to borrow.

stETH is already listed as a collateral asset on Aave, Euler, and Maker showing strong market demand.

4. Information regarding the organization behind the project and team members.

Lido’s DAO is the primary organization behind stETH. $LIDO holders currently govern the DAO and the protocol through an on-chain governance process. It is also worth noting that Lido’s core contracts are mostly immutable.

5. Security audits & information regarding past hacks or major bugs.

Lido underwent multiple security audits from Sigma Prime, Quantstamp, and MixBytes. Source: GitHub - lidofinance/audits

No critical bugs have come to our attention. It is our assessment that Lido’s stETH smart contracts are low risk.

6. Overview of market data & notable risks

Centralized Exchange listings: FTX

Decentralized exchange pools: Curve, Balancer, Uniswap v3

Metrics:

  • Market Cap: $8.5B (4.2M ETH),
  • 24h Volume (last 30 day average) : $38M
  • Volatility (annualized): 97%

Liquidity risk

The key risk the protocol will be undertaking by listing wstETH is liquidity risk as all stETH redemptions have to go through a DEX. This means that if liquidity dries up in the largest stETH/ETH pools such as the Curve and Balancer pools there could be a major price discrepancy between wstETH and the underlying assets it holds. This risk could materialize if large stETH redemptions occur and could potentially lead to liquidation losses on Notional.

This risk can be partly mitigated by capping the amount of wstETH allowed as collateral on Notional using the Maximum Collateral Balance. Moreover, we can monitor this risk by looking at the risky collateral to stETH liquidity ratio on the deepnote dashboard. stETH deposits in multiple protocols (Aave, Anchor, Maker) can also be tracked on this dedicated Dune dashboard.

Historically the stETH/ETH exchange rate has been relatively stable even under stressed market conditions. As an example, during the UST depeg in early May of 2022, the stETH/ETH exchange rate varied between 0.95 and 1 for a maximum drawdown of approximately 5%.

7. Overview of the token emission schedule

There is no planned emission schedule as wstETH is not a governance token but a claim on staked ETH inside Lido’s contracts.

Source: How Lido Works

8. Community KPIs

  • $stETH holders: 74K addresses
  • Twitter followers: 83K
  • Github activity: significantly high

Minimum requirements for consideration checklist

  • The asset is an ERC-20 token: YES link
  • The asset has been traded for at least 6 months: YES link
  • A chainlink oracle for the asset exists: YES link
  • At least two audits have been conducted: YES link
  • The monthly trading volume of the asset has been above $25m for each of the past 2 months: YES link
  • The token is held by more than 2,500 unique wallets: YES link
  • The current float (circulating supply/max supply) is above 20%: YES link

As a reference: Commonwealth

Proposed risk parameters

We propose to use a liquidation discount of 8%, slightly above the 6% ETH liquidation discount. This higher liquidation discount aims to cover additional liquidation expenses related to the unwrapping and trading of stETH. It also accounts for potential higher slippage when trading out of stETH.

We propose an exchange rate haircut of 0.72 which is lower than the 0.78 ETH exchange rate haircut. Once again this lower haircut is justified by wstETH’s higher volatility compared to ETH and its associated liquidity and smart contract risks. A 0.72 exchange rate haircut implies a 150% USDC/wstETH minimum collateral ratio.

We suggest setting the initial maximum collateral balance to 22,500 wstETH or roughly $50M.

Benchmarking with other protocols:

Link to original discussion
Link to Snapshot vote