Why is Rocket Pool crucial for the Ethereum ecosystem?
More than 100,000 ETH have been staked in the Rocket Pool protocol.Written by: jasperthefriendlyghost.eth
Compiled by: Nanfeng
In this article, we will discuss how decentralized staking on Ethereum is, and how the endless pursuit of yield is making this shift towards decentralized staking profitable. From CEXs (centralized exchanges) to Lido Finance and Rocket Pool, it is time to embrace liquid staking tokens.
The Catalyst
In the early days of the Ethereum PoS beacon chain, early adopters quickly emerged. Centralization is one of the devil's fruits: if you abandon trustlessness, decentralization, or permissionlessness, you will reap rich rewards. Web2 giants like Coinbase, Kraken, Binance, etc., were more than willing to lock up the funds of voluntary users. What options were available at that time? Apart from running your own node (which is a daunting task for many), these CEXs (centralized exchanges) provided users with another way to participate in staking. The One Ring seemed to have been granted. The flaws of PoW mining pools seemed destined to repeat themselves, and they are indeed repeating. Greed and speed brought control.
In this context, another force is rising.
A DAO (referring to Lido DAO) seeking to provide returns to the majority, without the overt trust assumptions of CEXs. The decentralized staking protocol Lido was launched, introducing its liquid staking token stETH, which is the first and currently the dominant liquid staking token. For the first time, anyone on the Ethereum network can stake less than 32 ETH while retaining control over their funds. For Lido, users deposit ETH → receive stETH → enjoy the lending frenzy driven by DeFi summer. Capital poured in, and in this once enlightening pursuit, a sinister dilemma is slowly brewing.
The Era of Lido
CEXs take your assets, and then you must trust them. Lido gives you a self-custody receipt token (i.e., stETH), but where did your staked ETH go? This DAO (i.e., Lido DAO) seeking to provide staking access has turned into a black hole, becoming the sole access point. The Lido network is happy to accept an unlimited amount of ETH, and allocate these ETH to a few selected node operators. Trust means speed. To onboard more users, these operators using users' staked ETH to run nodes must act quickly and be trusted as honest operators. One devil's fruit has been consumed, and power emerges------like a black hole, this power may become trapped. The validator set of Lido is already full. Those Web2 centralized giants are now competing with Lido, and at the time of writing, Lido is already the largest staking pool.
In pursuit of yield, we are willing to ignore the dangers posed by centralization. Capital efficiency is the foundation of all systems in DeFi. Where optimization can be made, optimization will be found. The battle of DEXs (decentralized exchanges) is a clear example. Curve and Uniswap v3 are competing in the super-efficient token exchange market, and end users are thrilled; the concept of liquidity pool tokens allows capital to remain active even in your wallet, earning trading fees for holders. Over time, efficiency has increased, which benefits Lido.
Above: Expected validator counts in Coinbase, Lido, and Binance. Source: https://pools.invis.cloud/
stETH has become a DeFi Lego block, which is not surprising. If you can replace ETH in your investment strategy with stETH (or its wrapped version wstETH), then you can passively increase your yield by several percentage points. This increase in yield is not the limit.
The essence of Yield Farming has always been liquidity incentives. For example, the Curve protocol offers CRV token rewards to users who deposit liquidity into the stETH-ETH pool and stake the earned LP token crvSTETH. Enter yield aggregator Yearn. The vault system in the Yearn protocol packages these strange yield queues into a simple liquidity token. The protocol automatically reinvests all additional liquidity rewards back into the base layer. Yearn plays the role of a strategy-building hub, where the best yield strategies attract the most capital inflow.
Since its inception, Yearn's vault for Curve stETH-ETH liquidity pairing has been highly sought after. Its ycrvstETH token is one of the most capital-efficient tokens in DeFi (Note: Users receive LP token crvSTETH after depositing ETH or stETH into the Curve platform, which can then be deposited into the Yearn vault to receive the corresponding vault token ycrvstETH). There is a complete yield ecosystem in your wallet, which is much more complex than I have described. The ycrvstETH token is the fourth most popular collateral asset on Abracadabra Finance (one of the most popular lending platforms). This is significant because it indicates that this Yearn vault token (i.e., ycrvstETH) is not the end point, but rather the base layer for higher yields and more complex strategies. This token represents the maximum yield that a non-custodial passive token can capture. Throughout most of DeFi's history, ycrvstETH has been the best asset in this regard. The constant demand for yield maximization has led to the expansion of Lido, the liquidity ETH staking gatekeeper.
As Lido approaches 20% of all validators on the Ethereum network, further capital inflows will begin to threaten the security of the Ethereum network. There is a problem. Currently, stETH will continue to flow into the market because the withdrawal function for Ethereum validators will not be unlocked until months later, specifically until a hard fork after the merge to allow withdrawals. The flood of yield-chasing users cannot be stopped------as long as yield can be obtained, yield-chasing capital will flow in, unless its consequences can be immediately reflected in the price. If the Lido protocol operates 50% of Ethereum network validators (which may rise in the short term), the returns from stETH will not decrease, but in this case, the value and security of the Ethereum network itself may suffer irreparable harm. Thus, the only way forward is to direct funds to greener pastures and higher yields.
The Rise of Rocket Pool
Lido once stood alone, but that is no longer the case. Other Ethereum staking service providers have also introduced their own liquid staking tokens. However, nothing is more important for the long-term health of the Ethereum ecosystem than Rocket Pool. While Lido's permissioned nodes are willing to take on all validation responsibilities, they may pose long-term risks to the network, whereas Rocket Pool refuses shortcuts. For Rocket Pool, there are almost no trust assumptions, only code and cryptoeconomic incentives.
There is no speed on this path. Rocket Pool cannot onboard an unlimited amount of ETH in a day like Lido. Instead, Rocket Pool has a framework through which a decentralized set of nodes can securely support a liquid staking token network. The Rocket Pool network has over 800 node operators, some of whom are well-known major Ethereum participants, while others are anonymous.
Source: https://rocketpool.net/
Creating this framework was not easy. Lido had already accepted user deposits for about a year before Rocket Pool launched. However, despite stETH having a huge lead and almost completely dominating liquid staking, in the three months since Rocket Pool's launch, significant capital inflows have pushed the protocol to account for 1% of all Ethereum network validators, with over 100,000 ETH staked in the Rocket Pool protocol. The reasons for the protocol's adoption are complex, but at the current rate of adoption, Rocket Pool is likely to attract increasing amounts of capital from its competitors. However, if the market has any utility, it is that the prospects for future growth can be reflected in the price at this moment.
We can accelerate the development of Rocket Pool, directly benefiting the health of the ecosystem. The 0→1 moment for stETH was in the liquidity pairing with ETH on the Curve platform, allowing for compounding rewards on this LP token (i.e., crvSTETH). Most stETH use cases utilize the stETH-ETH pool as a base layer. This pool is currently one of the largest single holders of ETH and one of the deepest liquidity pools in existence. What if we could create another 0→1 moment? The first such moment was the trading pair from ETH to stETH; the second such moment has arrived, potentially doubling yields by doubling ETH's liquid staking exposure in this DeFi Lego block (i.e., Rocket Pool). To understand why this is a turning point for DeFi, let’s look at where the yields generated by ycrvstETH come from. Remember, the rewards generated by Yearn are automatically compounded. In order of complexity, starting with 0.5 stETH and 0.5 ETH:
- 0.5 stETH has an annual return of 4.5%, with an overall return of 2.25% (since the underlying 0.5 ETH does not earn rewards);
- The stETH-ETH Curve LP (liquidity provider) earns a small portion of income from trading fees;
- Curve LP receives CRV+LDO token rewards;
- Convex LP receives CVX token rewards.
The user's ycrvstETH yield is 4.51% APY (annual percentage yield). However, this is after Yearn deducts a 2% management fee and a 20% performance fee on the yield. Therefore, the real APY is approximately (4.51% / 0.8) + 2% = 7.63% APY. Thus, the total rewards from steps 2-4 amount to a 5.38% boost. This yield is passive but requires subsidizing the interests of certain protocols.
In a sense, this yield is not sticky to the underlying token pairing. Yields come from rewards that can be paid to any token pairing. This 5.38% is variable. Now allow me to introduce a soon-to-be successor to Lido's powerful stETH-ETH Curve pool------ rETH-wstETH pool. rETH is Rocket Pool's liquid staking token (users receive rETH after staking ETH through Rocket Pool), which will passively increase in value relative to ETH; wstETH is the wrapped version of Lido's stETH, which also allows it to increase in value over time relative to ETH, just like rETH.
Above: The rETH-wstETH pool on Curve, https://curve.fi/factory/89
The brilliance of the original stETH-ETH pool lies in the fact that the stETH token is pegged to ETH, so holders do not experience impermanent loss due to asset price divergence. This is crucial because an ideal passive collateral token should carry minimal passive value risk. **Since wstETH and rETH increase in value at roughly the same rate, the Curve pool between these two tokens (i.e., ** rETH-wstETH pool ) will inherit the benefit of negligible impermanent loss. Additionally, the novelty of this pool lies in the absence of "cold" ETH exposure; both assets (i.e., rETH and wstETH) will gain staking exposure. Let’s see how this 100% liquid staking token exposure changes the APY calculation.
- 0.75 rETH earns 4.3%, 0.25 wstETH earns 4.5%, total yield approximately 4.35%;
- The rETH-wstETH pool's Curve LP (liquidity provider) earns a small portion of income from trading fees;
- Curve LP will receive CRV token rewards;
- Convex LP will receive CVX token rewards.
Comparing these two Curve pools, the yield of the rETH-wstETH pairing is 2.1% higher than ETH-stETH. This alone covers the additional rewards added to the Lido stETH-ETH pool by 39%. When dealing with billions of dollars in liquidity TVL (total value locked), such scale of growth cannot be overstated. In the March budget, Lido had to allocate 3.25 million LDO tokens for direct incentives to LPs (liquidity providers) in the Curve stETH-ETH pool. At the current rate, this amounts to a monthly expenditure of approximately $6.9 million. A 39% capital efficiency upgrade can save millions of dollars each month.
If these liquidity schemes are added to rETH-wstETH, their efficiency will be greatly enhanced. Another way to look at this issue is that the stETH-ETH pool faces the problem of needing to subsidize 50% of stETH yields; otherwise, users might as well just hold stETH. The rETH-wstETH pool does not need subsidies because the yields it provides are essentially the same as holding rETH or stETH alone (if not more). Over time, the inflow of funds into ETH staking will be enormous, and it will not overlook this significant improvement in capital efficiency.
Looking Ahead
More philosophically, we should learn from DeFi veterans like MakerDAO, who abandoned the initial single-collateral DAI model (which initially only allowed ETH as collateral to mint and borrow DAI) in favor of a multi-collateral model. This essentially eliminates the risk of a single point of failure. The same risk management approach should have appeared in the liquid staking ecosystem long ago. We are currently in a dangerous zone, with Lido holding 86% of the liquid staking market share, while Rocket Pool ranks second with only 4.5% market share. As shown in the figure below:
Source: https://dune.xyz/eliasimos/Eth2-Liquid-Staking
I do not want to portray the wstETH-rETH pool as a vampire attack on Lido's market share. Rather, I believe this pool is the first step in a larger space reorganization. Reducing the ecosystem's reliance on stETH will decrease the chances of catastrophic events, such as zero-day vulnerabilities or hostile protocol takeovers. Competition is inevitable, and collaboration will bring more vibrant yields. Collaboration is another benefit of the wstETH-rETH pool, specifically targeting those who, like me, participate in governance chats through Discord. DeFi runs on liquidity. Lido is willing to spend millions each month to fund the stETH-ETH pool.
However, why must there be only one protocol to enhance liquidity? One day in the future, a basket of staking tokens within a single liquidity pool may represent a basket of different liquidity incentives from various staking protocols. A LP token that maximally supports the health of the Ethereum ecosystem. This basket of staking tokens represents the long-term security of public goods. We have the opportunity to get ahead in a situation similar to the stablecoin market. Instead of competing for liquidity, we must expand the basket, allowing different liquid staking ETH derivatives to benefit from shared liquidity, thereby reducing the risk to the entire network and continuously dividing the costs of long-term incentivizing liquidity.
The ultimate goal of staking on the Ethereum network is to secure the network. Incentivizing the security of the network and encoding the rules to minimize attack vectors. However, the Ethereum community's responsibility to continuously protect the security of the Ethereum network must never wane. The interpersonal network of those running validator nodes is not solely composed of Ethereum enthusiasts. As more and more value accumulates on the network, more individuals will attempt to attack it at any possible opportunity. We must remain vigilant. The unrestricted expansion of the Lido network is a tail risk that can be avoided.
In fact, the safest and most capital-efficient outcome in the future is for many staking providers to compete and lower commission rates. When seeing that there is currently $27 billion worth of ETH locked in the Eth2 deposit contract, it is easy to develop a false sense of security. But do not be deceived. The merge has not yet been achieved. The vast majority of ETH has not been staked. It is still too early for us, and we have the responsibility to safely guide this field into the future. The current staking dynamics represent an early stage in this field. The decisions made now will have a greater impact on Ethereum's unwritten history. We call for greater integration of the ycrvwstrETH token into the broader DeFi ecosystem. We urge all protocols that have used the ycrvstETH token to also allow the use of the ycrvwstrETH token (if safe). This will be a capital-efficient future, a future for fair staking providers, and a secure future.
