adcv - Institutional Staking and the Role of Decentralized Liquid Protocols

Transcript

[Applause] cool hi everyone ER so my name is adcv my government name is Adrian I'm a co-founder at a company called steakhous Financial we are a crypto native consulting firm for those who aren't familiar with us and we originally actually spun out of the maker da as a group of contributors where we focused on financial reporting and and sort of asset liability management and since then we've sort of specialized in stable coins and in doing what we call sort of bringing open and transparent Finance which we believe is a better way of organizing our financial

activities and we work with a number of defi protocols I've listed a handful of the more active ones you know with maker we did a lot of stuff uh we're working a lot currently with Moro uh permissionless lending protocol and we've also been contributors to liod Da the lead liquid saking protocol on the market at the moment as a sort of Finance workstream lead for the past two years um and so what I'm going to talk about uh is sort of three quick things hopefully it's relevant to to a lot of you but I wanted to sort of explain and go into a little bit more detail of the type of advocacy work that we do when we speak to institutions as Stakehouse and I wanted to take the time to explain the

role of staking and liquid staking in the Eos system this might not be news to some of you but I also wanted to introduce a slightly different framework under which an allocator or an investor might look at this I wanted to explain the benefit of decentralized liquid staking protocols so you know I'm personally a Lio stake teth enjoyer and advocate for it but you know I think many decentralized LST Protocols are capable of similar things for institutions and finally I wanted to explain business models that are possible with decentralized liquid staking protocols from from the perspective of you know allocators regulated institutions and other types of businesses so touching briefly uh this

is a slide from a colleague of ours who runs a fund called program capital and who summarizes the role of staking within uh the ethereum as as an ethereum incentive balance mechanism system where you have sort of validators on one side and holders of eth and users of eth on the other and where staking is uh the role at the bottom which either Burns destroys or issues tokens to keep the activity in check introducing or incentivizing new validators to join new stakers to join and together to sort of secure the network and ensure that it remains out of control of any one single entity or organization the way that an allocator

such as program capital or an investor may want to choose to look at ethereum or investing in ethereum is from a total return perspective so although ethereum is not a let's say security or a financial asset you can still consider it in very similar terms and you can decompose the total return in a similar way the way that we're looking at it is sort of from a price return component and you can do a decomposition of price return into change in earnings which we consider the change in say last 12 months of fees the change in the multiple which is the valuation that the market gives to the e to the fee earning potential over the last 12 months and the change in Supply so the net issuance or destruction of tokens that are

available and we have a June dashboard so all of our work I think pretty much all of our work happens on June analytics so it's all sort of Open Source and queriable we're huge fans of the company and you can access a June dashboard that shows this decomposition in real time uh if you access that link but what I wanted to focus on was on the what we call a work yield which or staking issuance so this staking issuance is on net at the moment dilutive to eth Holders so even if eth is a quote unquote deflationary token stakers are technically earning faster than holders so the work yield component is dilutive to Holders who only have access to the price

return and within that framework of staking there are different ways of doing this activity decentralized liquid staking Protocols are essentially software layers that intermediate between the holder of eth and the sticker and the node operators or validators at the bottom The crucial aspect is that decentralized liquid staking protocols don't control the governance of the node operators so they're separate from them and they don't take custody of the withdrawal keys or the funds and this is beneficial because when you stick with a centralized provider such as coinbase or figment or what have you you concentrate both of those things even if in some instances you may not you may still have custody of things like the withdrawal key for example the benefit of this is

that it keeps the staking activities distributed across the network instead of concentrating them in one and this is valuable from an allocator perspective because for ethereum to have any value at all on the long run the its validation activities should take place over as many entities as possible now the state of the market is in this following grath also derived from a June analytics dashboard so Hill Dobby on June analytics has a famous graph where he charts all of the different entities that participate in staking but if you look a little bit closer you can you can sort of categorize them into centralized or decentralized and at the moment there's slightly more centralized staking

activity taking place than what we would call decentralized and this is a shame and this is something that we're sort of very Advocate about changing by advocating for the use of decentralized liquid staking protocols to do it because even if for example Lio which is is the largest block on the graph with approximately 26 or 27% market share today Lio actually represents uh 37 if I remember correctly node operators behind and these node operators don't have control over the single block and the effect of this if you look at the right hand side of the graph is actually quite positive so one way of measuring concentration in a network is through the hhi or H hin I can never pronounce this the hendal hhi index which takes

the squares of the market shares and uses it as a sort of metric to see how concentrated a market really is and this is taken from a work by eth researchers one of their earlier working papers where they measured the hhi index of ethereum as a whole and contrasted it on different scenarios where the scenario in the dark blue line is what that index is if you consider Lio as separate entities which means that the more people use d centralized liquid staking protocols the lower the concentration of the market because the stake gets distributed to more node operators and the other benefit of

liquid sticking protocols is obviously their liquidity so one feature of sticking is that it locks up eth away so of on the beacon chain deposit contract and it makes it unusable until you withdraw or unstake but the user benefit of liquid staking protocols is that they allow this collateral to be tokenized and to circulate and to be reused and for this reuse to be useful it has to be liquid and so what we do here for example is we measure liquidity in a slightly atypical way relative to defi defi tends to think of liquidity in terms of tvl but we look at uh we try to look at it from a more trafy angle and uh measure it in terms of orderbook depth so to put together this uh chart

again on on on June analytics uh we basically query aggregator apis such as 1 in or AOS and we measure the amount of Ste of lighter stick teeth that you could trade at any given level of price impact so on the colors you see a price impact of 1 5 10 all the way to 200 this is in bips so this is a price impact all the way up to 2% and it shows you the level at which you can trade effectively so you could trade hundreds of millions of dollars up to 2% price impact and this is a good measure of how liquid actually a a token or collateral could be now this collateral efficiency

enables a lot of different use cases in institution in sort of regulated Finance in trafi you know there's asset support for custody so when someone for example holds Stak teeth at coinbase Prime the the asset provider the custodian can take a fee on that the native minting is another opportunity so metamask portfolio for example example is provides uh access to the service and clips a fee for users who stake or on stake it as a trading pair the collateral efficiency of a trading pair that provides work yield is greater than a trading pair that doesn't so when you trade eth and you're holding eth for that trading it earns no work yield but

if you hold an LST such as stake eth or r e then it does and that provides opportunities for exchanges for example to benefit so you know okx and derit and other exchanges have begun listing these lsts on their platforms and generating substantial amounts of trading revenue from it and then as collateral is some you know some of the more interesting applications emerge so once you stake with an LST you're able to borrow against it and this provides yeah similar to like a Lombard loan that would be in trafi and you know the way a CDP in in defi terms and finally structur products so we're seeing the emergence of regulated fund structures that offer directional exposure to

ethereum's Total return but are able to use the liquidity of the underlying assets to offer for example a covered coal strategy and to allow people to take more complex directional bets and these are all sort of trafi business models that are typical in sort of regular Finance but that lsts allow and this is a good thing because in the background the lsts are helping secure the decentralization of these ethereum Network so some real case studies are emerging so one of the two of the more notable ones I think are hash note and taus Taurus a Swiss company based in Geneva is a regulated custodian that serves 16 private banks in the Swiss

market and they recently announced uh enabling custody and Native minting possibilities for their customers so taus as a sort of middleware integrator will allow access to stake teeth from the perspective of a bank customer of tawus enabling it on their platform or hash note for example which is uh yeah they do lots of things but among the products that they offer are regulated fund structures and some of them include uh regulated Cayman Islands fund that holds long stake Dee and so that offers regular investors the opportunity to invest with Fiat and gain access to e Total return price return plus the work yield

and then the final uh sort of major business model that's emerging is obviously ETFs and etps where there are obviously some etps on the market in particular in Switzerland that are emerging that offer staking to their holders they typically stake with centralized providers because they it's easier for them the they have a sort of first they're a first touch Business Development touch point so their custodian will typically have a relationship with a staking provider and offer to stake the eth and you see this with some of the ETF applications in the US that are changing their prospectus applications to say that hey we want to stake the E the E that we put in the ETF perhaps one day and if they do we can look at coin shares uh the AE I think

the ticker is it has hundreds of millions of Franks in in assets under custody which is a great achievement and they stake part of it and one of the ways that they use the staking return is to offer zero management fees zero headline management fees on the fund however there's obviously a compromise because one of the things that ETFs and etps have to be able to offer is redemption guarantees so they're they have to be able to offer liquidity both going in and going out and when you have native staking the IL liquidity means that there is a compromise that you have to find essentially a balance and so you're restricted and these figures that I'm putting up are inferred only from public information but from their headline return which is a net APR of 1.25% you can only in infer that up to

40% is actually staked whereas if an ETP or an ETF held stake teth or re or what have you they would be able to offer the full clip the full 3.2% uh and that's it really I think I wanted to sort of quickly talk about the the the different institutional business models and use cases explain a little bit the state of the staking market and I wanted to leave as much time as possible for sort of questions so all of of these case studies and background is derived from sort of work and contact that Stakehouse has had with regulated institutions and with trafi and all of this we do from like an advocacy perspective we don't do investment advice or other but we you know ad we

believe in decentralized finance and we advocate for it quite uh yeah vividly yeah so I think that was that was the most of it and I have a few appendix slides I anticipate uh the character of some of the questions so I'm happy to to open the floor do we have any questions for Adrien all right we have a question over there how do you think theid Market is impacting this and how do you see that forward what have or theid Market itself so reaking is a new emergence on the staking Market it's the idea that uh

actively validated service so ethereum is in principle an actively validated service this is sort of jargon for a computer network that needs Security in order to provide value of some kind and one way that uh networks have typically tried to bootstrap in the past is through simply becoming a layer one right so when you look at Solana or Ripple or what have you and Cosmos all of these are actively validated services and they're at a at a stage where where in order to get the level of security that they need to be credibly neutral they need to incentivize aggressively enough validators and enough holders of the token to come on with reaking the principle is that you can shortcircuit

this and reuse existing networks that have a strong level of security and use that existing security to validate new actively validated services so there are a lot of question marks on this at the moment namely because there are no actively validated services on the market yet yet this is still an in development uh you know phenomenon ER and this is this may change the landscape let's say in the long run outside of like points and the stuff which I I'll get to but outside of the points you can imagine that a Staker who is providing security to another actively validated service which is you might make the analogy to a form of Leverage or rehypothecation even if you

know some people don't like the word and this might provide an additional source of yield so we would put this in the in the return framework we would put this as an additional source of work yield and you know this work yield is not riskless it comes with risk right like staking is a risk plus activity you have the risk of losing part of the stick and the same applies to resticking r large you risk a little bit more to gain a little bit more return right nothing is for free and so I think this has the potential to change the landscape slightly my personal view is that it's not in the long run it's not going to make a huge huge deal because the incremental returns are likely not going to be very large so this graph is a

little bit complicated again it's a graph on available on June analytics on our which you can access on our uh steakhous june. Stakehouse and we're charting in blue the return that you get from the execution layer and the consensus layer so that provides a total staking APR and then on top what we've tried to do is estimate what the long run potential of reaking yields could be in the future and the way that we've estimated this is we've taken the total amount of sequencer profits on on layer twos which are an example of a service that is analogous to an to a future actively validated service and we've taken 20% of those profits and we suggest that that 20% is sort of the upper level of the

type of reaking yield that somebody could earn and when you divide that by the amount of East that is being quote unquote restak on igen Laya you get between you get 0.75 plus or minus 0.25% as a sort of long run estimate and I think this is probably a little bit aggressive but it's probably in the right ballpark ER the thing with the points is that to launch a lot of these Protocols are aggressively issuing new tokens this is a very typical go to market strategy for uh defi protocols a lot of the time uh the cost is wildly underestimated so protocols end up spending hundreds of millions of dollars to acquire customers who then leave immediately so it's often

not very well calibrated and the thing with points that's interesting and new is that it's less than a token so it's like an airline mile it's like a maybe you will be able to redeem this for some amount of value in the future and the protocols that are issuing these points can then calibrate how much exactly they want to spend the graph on the top is uh the implied reaking APR from tokenized igen layer points as measured by the price of K so K from kelp Dow is so this is yeah crypto we like to leave you know we had a financial crisis with like cdio squares in like 2008 but in crypto you can go up to CDO a million so now there's you know

price return work yield extra work yield points that are a promise for future X tokenized and that's helpful actually because it lets you see what the market expectation for reaking yield is and it's about 40% which is a lot and I'm not suggesting anything Financial device or anything like it but this is just this graph just shows the different range of we're trying to triangulate hey what's the expected level of reaking return in the future the market thinks it's 40% I personally think it's closer to 0.75 uh the truth is maybe somewhere in the middle

[Music] trains to be% what about the risk of the dis right so every time you restake right you are adding risks and how do you necessarily quantify you know cost right because it's not all just pure profit right it's in the case of okay make 75s but how many BS like you know risk Premia are you paying like you were paying for

insurance yeah and I haven't seen anyone really talk about this I think like when we talk about like the use cases for abs people kind of get a little of like oh could be used for that it can us for that it can used for that but in the absence of being able to quantify the risk it's also difficult to ascertain whether these things are like viable from a bus actually doing because you could very well find that uh the risk is so high that a protocol actually needs to pay people to say more than the value that that protocol can generate through

whatever service it sells or whatever yeah I completely agree there's we're actually releasing this evening uh if you follow our Twitter you'll get a uh first dibs on a report that we wrote that looks into exactly this Point uh the way that we extend the total return model is with work yield and then for reaking and you could probably extend that to some degree to regular staking we we have this concept of loss given default so there's actually two important points that you mentioned one is a LG given default which the more you restake the more you put at risk because you have one piece of say one e collateral and if you restake it to more protocols you are putting that at risk

from more vectors and those vectors are you know they they may or may not have correlated risks they may or may not be functional or sustainable in the long term and you may experience slashing so we see a work yield yeah no one knows what these slashing conditions are because they're completely fugazi at the moment but the way that we conceptualize the Lost given default is a sort of inverted Parabola where the more you restick to eventually you reach a point where it diminishes given the realistic risks right and so there'll be a point like you're you're likely not not going to be able to restake to a 100 different protocols right the other thing is on the sustainability of the business model so coming back a little bit to the core Prospect to the core value proposition

of reaking which is that you can bootstrap a secured service without going through the capital intensive effort of making a brand new layer one but if you can't afford the payments you can't afford the security and a lot of these lrts or reaking providers are you I think we will come to yeah we have like a I should have put this on the slides I knew this was going to go into recking I wanted to talk about about institutional sticking I knew it was going to go into recking ER we have a simulation of what so we we propose two terms one is like UND secured and the other one is over secured and I think it's extremely likely that we're going to see abss

wildly overc committing to a level of security that's well well beyond their needs and well beyond their affordability and that'll do in the best of cases is drive that stake out and elsewhere to look for yield because they'll see that they're generating tiny amounts of yield because these things can be conceptualized kind of as businesses and the reaking component is you can think of it kind of like senior debt like the reaking layer comes on top and clips a fee in order to provide the security but if you can't afford the debt payments you really have to start measuring the avss from a the perspective of like a a depth service coverage ratio like you would for a regular business business and the businesses that are unders secured and pay too little and where maybe the

resticking fees are very high probably aren't secure enough and incur a higher risk of slashing so I think managing these becomes way more complex like staking is already complex enough as it is ABS is mental like it's not only hypothetical at this stage but it's also extremely difficult to underwrite from a holder perspective I think I went overtime yeah all right all right sorry thank you so much follow the Stak house Twitter if you want to read the report on reaking and yeah uh happy to chat about it later also [Applause]