[RFC] Collateral Basket Change Proposal: Adjusting ETH+ Collateral Basket To Address Liquidity Constraints

ETHPLUS (ETH+)
1

Summary

ETH Plus (ETH+) has seen significant growth in the past year, with market growing from $15 million to $116 million since March 1st. As ETH+ grows, rETH is experiencing liquidity constraints, making it difficult for minters to access the token without higher slippage. Currently, rETH makes up 33% of the ETH+ basket, so limited rETH liquidity may hinder ETH+’s further growth. This RFC proposes two potential solutions: (a) adding cbETH to the collateral basket, and/or (b) increasing the percentage of stETH in the basket. By implementing a solution, ETH+‘s collateral basket will become more liquid, allowing it to easily be minted without liquidity constraints. New solutions introduced will be included as proposed in the reply section of the forum.

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Abstract

This RFC explores the liquidity challenges faced by rETH as ETH+ continues to expand. To mitigate these constraints, this proposal offers two potential solutions: (a) incorporating cbETH into the basket, and/or (b) increasing the allocation of stETH. Each option is evaluated based on its potential impact on liquidity, risk, and overall performance of the basket.

Problem statement

rETH’s current backing collateral for ETH+ is over $42 Million, but the largest rETH liquidity pool holds only $51 million in liquidity. It’s time to consider adjusting the collateral basket to handle ETH+’s growth. Without adjusting the collateral basket, ETH+ growth will be limited due to liquidity constraints. If this is not addressed soon, it will create significant issues for the user experience of large users, as their ability to mint large amounts of ETH+ will be deterred.

Rationale

Currently, there are two suggestions to improve the underlying liquidity in the ETH+ collateral basket. More solutions can be added in the reply section of this forum.

Solution 1: Add cbETH to the ETH+ collateral basket

By adding $cbETH to the ETH+ collateral basket, ETH+ will further its mandate to, “positively impact the Ethereum staking distribution” and “provide value to ETH+ holders through diversification”.

New ETH+ Collateral Basket

Token Allocation APY = 3.02%
rETH 25% 2.77%
Wrapped stETH 25% 3.03%
sfrxETH 25% 3.26%
cbETH 25% 3.00

Diversification:

Adding cbETH further diversifies the ETH+ collateral basket, furthering the original mandate. By diversifying, ETH+’s exposure to the risks of any particular LST (e.g., slashings or depeg) is reduced.

cbETH plugin is already available:

The plugin for cbETH has already been created which means no time will be needed to be set aside to build and audit the plugin as it already has been completed.

Solution 2: Increase exposure to stETH (wstETH) in the collateral basket

By increasing exposure to wstETH, ETH+ will gain greater exposure to the most liquid LST in DeFi. This will allow ETH+ to scale more easily as it enters its next phase of growth.

New ETH+ Collateral Basket

Token Allocation APY = 3.02%
wstETH 50% 3.03%
rETH 25% 2.77%
sfrxETH 25% 3.26%

Liquidity:

stETH (wstETH) has over $300 million in liquidity on the Ethereum blockchain paired against other ETH-pegged stable pairs. By increasing % exposure to stETH, ETH+ will gain higher exposure to the most liquid LST within its collateral basket, allowing it to scale more easily with fewer liquidity constraints. Limited Basket Adjustment:

By just increasing ETH+ basket exposure to wstETH, the community encounters minimal changes to the underlying basket. This would mitigate any potential risks of adding a new LST, especially if the community believes ETH+ is sufficiently diversified in its current state.

Risks

When considering the risks of these two LSTs, risk reports from Llama Risk will be utilized to establish key considerations for the community. The risk factors pulled from the report will be: Liquidity, Smart Contract, Dependency, and Decentralization. By using a standard and reputable research group for both, the community can more easily evaluate this decision.

Solution 1: Add cbETH to the ETH+ Collateral Basket

cbETH Risk Rating by Prisma Risk

Report last updated on October 9th, 2023

Report Here

Liquidity

“cbETH is okay on liquidity because although it ranks 2nd by LSD market share after stETH, >97% of liquidity is on Coinbase and an $18.1m on-chain swap produces a similar slippage as a $300m stETH swap.”

Additional Notes on Liquidity Risk: Since this report, cbETH has even less on-chain liquidity. At current liquidity, a swap of 1,000 ETH for cbETH could create significant slippage. For ETH+, minters can obtain cbETH directly from Coinbase at a 1:1 ratio, but the on-chain liquidity of cbETH should be noted as a potential risk to the underlying basket.

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Smart Contract Risk

“cbETH is ranked excellent in smart contracts because the contract architecture is straightforward, managed by permissioned Coinbase addresses, based on battle-tested contracts, is audited, and the contracts themselves do not handle user funds.”

Additional Thoughts on Smart Contract Risk: Though rated well on smart contract risk, it’s important to note that adding another layer of smart contract risk increases total exposure. This must always be considered when adding another LST to the basket.

Dependencies

“cbETH is ranked good in dependencies for having a reliable price feed available. A centralized service can be an advantage when managing system accounting, withdrawal processing, and unforeseen network issues (high withdrawal demand, Ethereum network issues, etc.).”

Decentralization

“cbETH is ranked poor in decentralization because it is a centralized service operated by Coinbase and users are thus exposed to counterparty risk. The User Agreement does offer assurances that users retain legal ownership of their staked ETH. Coinbase does make an effort to reduce centralization of its validators by diversifying across several software clients.”

Solution 2: Increase Exposure to stETH (wstETH) in the Collateral Basket

stETH (wstETH) Risk Rating by Prisma Risk

Report last updated on October 9th, 2023

Report Here

Liquidity

“stETH is rated excellent on liquidity for being the clear market leader with the deepest liquidity.”

Smart Contract Risk

“stETH is rated good in smart contracts for being heavily audited, having a bug bounty program, and having a long history of securing billions in TVL without major incident. The recent upgrade to V2 increases smart contract uncertainty.”

Dependencies

“stETH is rated good in dependencies for having a reliable price feed available. Dependency on Lido oracle daemons can result in disruptions that can cause incorrect reward distribution or liquidity mismanagement.”

Decentralization

“stETH is rated good in centralization for having core system controls with a DAO that has reasonable backstop measures. Multiple multisigs are employed with limited privileges for specific precautionary functions.”

  • I am in favor of solution 1
  • I am in favor of solution 2
  • I am in favor of combining these solutions
  • I am not in favor of either of these solutions and would like to explore an alternative option
0 voters
4 Likes
2

I assume combining the 2 solutions would make minting costs higher since there’s more tokens being minted. So it would be better to go with 1 solution. With 50% wstETH.

However, if ETH+ continues this trajectory, liquidity is going to be - well, challenging. Once ETH+ is a $500m token the liquidity is going to require more tokens.

Perhaps something like:

40% WstETH
25% sfrxETH
25% cbETH
10% rETH

But, until we get to 300-400m, to care for minting costs I would advocate for

50% WstETH
25% sfrxETH
25% cbETH

2 Likes
3

Thanks for putting together such an in-depth and thoughtful RFC @0xSleepy – I completely agree that ETH+ deserves special consideration given its size.

Regarding minting costs, one thing to keep in mind is that Register zaps will sometimes decide to swap directly for ETH+ instead of minting new ETH+, if it is cheaper for the user. As ETH+ grows and swap liquidity increases, the swap will start to become the better choice more and more often.

It looks like today ETH+ today costs anywhere between 2.2k to 5.7k gas to zap mint, based on the sample of 10 I looked at. That’s quite a wide range. The variance is coming from trading prior to interaction with the protocol, I believe.

(also, poll broken)

2 Likes
4

Thank you, I updated the RFC, the poll is now available.

Should gas cost be a high priority for this decision?

As this product continues to grow, more token collaterals will continually be added. Maybe the main concern should be framed around the idea of what makes ETH+ the most liquid?

It feels inevitable that more collaterals will be added. if diversifying further could help with ETH+ popularity and in turn drive up liquidity, that might need to be the priority.

I could be wrong though.

I think some mixture of diversifying into another collateral and adjusting the underlying basket may be the best route to try to keep changes from occurring due to liquidity.

2 Likes
5

Hm. Well, yes, with the current trajectory, to ensure growth we should prioritize liquidity. I voted for a combined approach.

2 Likes
6

I do not think gas should be a central concern, here. I am in favor of a combined approach.

2 Likes
7

Hey guys. Just wanted to introduce myself. I’m Westwood, Head of Community Development at Frax. Just wanted to thank you guys for supporting sfrxETH up until this point. If there’s anything you guys need from Frax in the future feel free to reach out to me (Twitter, Discord, Telegram) or any of the team on Telegram.

If you weren’t aware frxETH v2 will be launching soon with a fully decentralized validator set, native restaking, and an internal lending market so needless to say sfrxETH yields are about to get even juicier on top of frxETH adoption on Fraxtal subsidizing the monetary premium of sfrxETH. Old explainer from Sam. Just some food for thought on any future basket decisions.

Cheers!

5 Likes
8

Welcome, @Westwood! Great to have the Frax community represented here in our forum.

Thanks for the update!

3 Likes
9

Welcome ser!

Excited to have the Frax community get more involved with the ETH Plus community!

2 Likes
10

It does seem like if ETH+ continues to grow, the adjustment of rETH from 33% to 25% will not be sufficient. Does a reduction to 10% of the basket make sense? How much “time” would that buy ETH+ before the next rebalancing, if it were to continue growing at the same rate?

Are there any ways to increase the TVL of the rETH pool to avoid this issue? I’m guessing not, but hate not to ask.

Appreciate the proposal.

1 Like
11

The only way is to add incentives or explore a direct liquidity injection from ABC or Confusion Capital. The latter really hasn’t been done before so I don’t think that is viable.

Generally, we have to think that rETH currently has a $50 million capital limit for liquidity, at the scale of growth for ETH+, what percentage should rETH be to keep it from reaching this limit again.

If ETH+ is expected to reach $500 million this cycle, 10% may be best, but maybe consider reducing to that rate over time, to not concentrate the basket so quickly into 1 wstETH.

3 Likes
12

A reasonable plan. I am in support of any figures you propose.

3 Likes
13

Based on the conversation from the community, here is my recommendation for adjusting the ETH+ collateral basket.

40% wstETH
22.5% sfrxETH
22.5% rETH
15% cbETH

As the newest collateral added, cbETH will have the lowest % in the ETH+ collateral basket.

Please reply with any questions or concerns

1 Like
14

I would further decrease rETH not only because of the lowest liquidity among the 4, but also because ot the lowest yield.

2 Likes
15

Thanks for the feedback,

Is this a basket you would recommend?

40% wstETH
22.5% sfrxETH
22.5% cbETH
15% rETH

1 Like
16

Sure, that sounds like a good basket.

1 Like
17

While I appreciate the minimal reduction to sfrxETH, I wonder, why introduce a more centralized, less liquid, and less yielding LSD in cbETH? Fee is 25% and centralized. Whats the upside here?

I would like to reiterate what @Ranger said and propose:

50% wstETH
25% sfrxETH
25% rETH

2 Likes
18

Using just 3 tokens limits scaling options. As both rETH and cbETH don’t have much liquidity.
If we mean to scale for 500m+ mcap, we need both in the basket.

Doesn’t rETH have lower on-chain liquidity and a bit lower yield than cbETH? 2.99%?
I can’t find good data on sfrxETH liquidity, if high

Maybe
15% rETH
15% cbETH
40% wstETH
30% sfrxETH

If not

17.5% rETH
17.5% cbETH
40% wstETH
25% sfrxETH

However, as I said if cbETH keeps a higher apy and somewhat higher liquidity than rETH, it would be best to decrease rETH as it only had 2.64% apy and 50m liquidity. If there’s no shortcomings in what I said so far this would be the best from my current point of view. Am I missing something?

40% wstETH - high liquidity
27.5% sfrxETH - high yield
20% cbETH - higher yield than rETH
12.5% rETH - lowest yield, lowest liquidity

1 Like
19

These make more sense to me.

20

This has been great feedback, see you all in the polls!

Here is what I will be proposing as an IP

40% wstETH
22.5% sfrxETH
22.5% cbETH
15% rETH

1 Like