[Tempcheck] Enhancing osETH Liquidity and LST Decentralization: A Proposal for a Liquidity Program on Enzyme

This Tempcheck/RFC (Request for Comments) has been curated by Moss, Ainsley To, Mona El Isa, theKIDGC, representing Avantgarde Treasury, which forms part of the Avantgarde group, encompassing Asset Management, DeFi Development (eg. for protocols like Enzyme) and DAO Governance.

TL;DR

We propose the implementation of a liquidity program service for osETH, which will be managed by Avantgarde Treasury via trustless delegation on an dedicated Enzyme vault. For further details on how trustless delegation works on Enzyme, see the documentation here and here.

The implementation would incorporate the advice of the Stakewise Liquidity Committee (SLC) as per the approved liquidity strategy in terms of selected DeFi Pools with final discretion being given to Avantgarde Treasury. This service aims to provide a passive, convenient, gas-efficient and non-custodial solution for liquidity providers (LPs) while also tackling many of the challenges that emerge from the ongoing forum discussion and in the wider LST ecosystem.

We believe that this solution offers tangible benefits for LPs and improves the effectiveness of the incentive program overall. Moreover, this initiative provides a mechanism to actively reduce the dominance of Lido and to promote a healthier balance in the LST market distribution.

MAIN CHALLENGES

From the forum discussion around the LP incentive program, it’s clear that several challenges emerge:

Managing Different LP Personas: LPs of different sizes exhibit varying behaviours, motivations, and friction points. Small and large LPs are not equally aligned with the project’s long-term goals, and managing these differences poses a significant challenge.

Negative Impact on $SWISE price: distributing SWISE tokens to liquidity providers who may not have a strong connection to StakeWise could impact the token’s price and have vicious-circle effects on the alignment of other LPs with the StakeWise protocol.

Cost Efficiency vs. Decentralisation: Striking a balance between the efficiency of distributing SWISE incentives and the goal of decentralising token ownership. It’s key to ensure that decentralised ownership is achieved without significantly increasing costs.

Monitoring & Adaptation: Continuously monitoring the impact of SWISE distribution to LPs and having contingency plans in place to adapt the strategy if it leads to increased sell pressure on SWISE is a challenge.

Excessive Concentration & Project Risks: The organic concentration of liquidity in a single pool (e.g. paired with another LST) raises concerns about counterparty project risk. Ensuring that liquidity is well distributed to mitigate risks associated with a single project or platform is an additional challenge.

RATIONALE & BENEFITS

In order to tackle the above mentioned challenges, we propose the creation of a Liquidity Program Service for passive LPs, to be run on a time-tested platform like Enzyme. The Enzyme Vault would be owned by the Stakewise DAO and the deployment to DeFi pools managed by Avantgarde Treasury via trustless vault management delegation. For further details on this concept, see our documentation here and here.

We believe this setup would offer several compelling advantages:

Convenience: Implementing a liquidity program on Enzyme would provide a significant convenience and cost savings for passive liquidity providers. LP’s can opt to hold a vault token that passively provides liquidity, accrues SWISE rewards and periodically compounds them. The convenience of using such a vault where liquidity is passively spread across the selected DeFi pools improves dramatically the ease of participating in the program.

Self-Custody for LPs: LPs would remain inhold custody of the vault shares for the duration of the program and have 24/7 transparency into the activity of the vault.

Gas savings: The aggregation of LP’s into one place means shared gas costs amongst all LP’s making it much more affordable for smaller LP’s to participate.

Better Alignment & Efficiency: More predictable collective LP behaviour leads to better monitoring for Stakewise, better strategic long term alignment and increased overall efficiency. The concerns of the immediate and systematic price erosion caused by mercenary LPs would be reduced, thus improving the effectiveness of the incentive program.

Diversification: The Liquidity deposited on the vault would be equally distributed across the selected DeFi pools, as per advice from the SLC. This balanced approach would contribute to a more stable and sustainable liquidity environment, benefiting LPs and safeguarding the protocol from corrective incentive, excessive concentration and counterparty project risks.

Possible tax advantages: Depending on each LP’s tax jurisdiction, the vault token may offer tax advantages. LP fees and rewards accumulate as appreciation and capital gains instead of immediate taxable income. This structure may reduce tax liabilities, allowing LPs to defer tax payments until they sell their vault tokens. However, LPs should consult tax professionals for jurisdiction-specific guidance to maximise these benefits and ensure compliance.

HOW IT WORKS

Based on the feedback we will receive from the Stakewise community, 1 or 2 vaults can be created. In case of 2 vaults, LPs will have the option of choosing between one vault denominated in ETH and the other in stETH. What sets the stETH vault apart is its capability to actively contribute to a more balanced staking ecosystem. This feature allows it to natively un-stake assets from the Lido contract, enhancing the overall dynamics of decentralisation of the staking landscape while aligning with the fundamental principles of the Stakewise community, as also shown by the commitment of Stakewise to the 22% self-limitation.

IMPLEMENTATION PLAN

The creation of this solution would involve the following steps:

Technical Integration
Initial scope: the native redemption from Lido is part of the work done for Diva Staking, which can be used in this case too without additional effort. For this specific use case, Avantgarde would need to integrate the price feeds for $SWISE and $osETH, provided by Redstone. This would involve some engineering work, testing, and quality assurance processes. This effort would allow the vault to execute swaps into osETH.

Possible scope extension: the initial setup does not allow the native minting of osETH, nor does it include the integration of Charm Finance’s Alpha Vaults. While these extra steps are well feasible, they would require more intensive engineering work + audit and therefore may be scheduled in the future in case this initiative receives positive feedback and sufficient AUM traction from the Stakewise community.

Education and Outreach
Develop materials and conduct outreach efforts to inform the Enzyme and the Stakewise community about the benefits of this solution. This may include webinars, tutorials, documentation and a unique white labelled page for the Stakewise community.

Launch & manage
Coordinate the launch of the solution and provide ongoing management (in close dialogue with SLC) and monitoring to address issues that may arise.

SECURITY

Security is a top priority for the Enzyme. Here’s some key considerations:

  • The protocol has been live on mainnet for about 5 years.
  • Every adapter/integration is audited by Chain Security, one of the top security firms in the space.
  • Enzyme has a large bug bounty on Immunefi.
  • In terms of protocol upgrades, Enzyme does not force users to upgrade to a new version. Users can review the upgrade features and can decide not to opt-in on a new version of the protocol.

For any other consideration regarding the use of Enzyme, here are the detailed Terms & Conditions.

FEES

While we want to remain open to community feedback on this matter, we propose implementing a flat 0.3% AUM-based fee structure, which also incorporates protocol fees. These fees on Enzyme are automatically processed through an on-chain module, accumulating for the designated vault manager. They are calculated as a percentage of the AUM on an annual basis and are accrued as an inflationary increase in vault shares that rewards the vault manager.

It is important to note that these fees are borne by LPs (Liquidity Providers). Our goal is to strike a good balance between the additional (opportunity) cost incurred and the additional value offered by this service. The advantages for the LPs include enhanced convenience and UX simplicity, time savings, lower gas cost per capita, passive reward compounding and possible tax benefits, ultimately resulting in net-positive higher rewards for all participants.

CONCLUSION

The proposed liquidity program service for osETH, managed by Avantgarde Treasury and run on a time-tested platform like Enzyme, offers a cost-efficient and flexible approach to incentivising liquidity provision. It seeks to balance the interests of the LPs with the protocol’s need to attract and retain liquidity in a cost-efficient manner. By monitoring the impact and adjusting the strategy, the proposed solution aims to maximise the benefits for all stakeholders while working towards a self-sustaining liquidity ecosystem. The built-in mechanism that reduces Lido’s dominance provides an extra element that is fully in line with the ethos and values of the community.

We invite the community to provide us with ample feedback to ensure that the final design aligns 100% with the collective goals and interests of StakeWise and becomes a useful tool for the project moving forward.

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Thanks @Moss and the wider team at Avantgarde Treasury for this Tempcheck/RFC. It is great to see quality, respected teams within DeFi looking to partner/collab with StakeWise DAO :handshake: I think this is a great initiative to help StakeWise attract and maintain LPs for its tokens.

Historically, StakeWise has focused on one main liquidity pool for its LST, however the transition towards osETH introduces three liquidity pools and that number will likely grow over time as osETH goes crosschain. Providing liquidity can often be daunting, especially when interacting with unfamiliar DEXs, and costly when trying to distribute capital across different pools - this solution solves these issues and consequently removes a lot of the barriers to entry for providing liquidity.

The cost of using the Enzyme Vault feels reasonable - LPs pay the preimum to steamline their capital deployment and allow a 3rd party (who is likely more experienced in liquidity/DeFi than the users themselves) to actively manage their allcoation for them. People pay for convinience, so I expect there to be demand for this type of product.

Having StakeWise DAO as Vault owner sounds positive, giving the DAO control over which entities have access to deploy the funds within the Vault. One area I would not be comfortable with is StakeWise DAO or the SLC actively deciding how that capital is allocated. StakeWise DAO has approved which liquidity pools it will incentivise, but it should be up to the individual LPs to be comfortable with the risks of deploying capital across each pool. As such, it should be up to a third party, such as AVG Treasury, to determine how capital is allocated, rather than StakeWise DAO/the SLC.

On that topic, I would also be careful about “the equal split of capital across osETH liquidity pools”. Each pool has very different risks/reward profiles, most notably the osETH-USDC pool. Part of the premium that LPs pay for within the Enzyme Vault should be the ‘smart’ allocation of capital across these pools. Purely as an example, but something like 80% osETH-ETH, 15% osETH-rETH and then 5% osETH-USDC (Charm Finance Vault when its available) would be more suitable.

One other risk I see here is if StakeWise has outsized exposure to Enzyme (or any third party as you rightly mentioned yourself). If the majority of StakeWise liquidity was deployed through an Enzyme Vault then I would be concerned - any issues with Enzyme/AVG and StakeWise is majorly impacted. It might be prudent to consider Vault deposit limits (as a % of StakeWise TVL/liquidity, for example) to stop this situation from arising.

The stETH Vault is an interesting idea. Lido’s liquidity has capitulated over the past several months and it certainly provides an opportunity for StakeWise to capitalise. I see no downside in giving stETH holders an easy way to swap their positions over to StakeWise. What I do not think would be worthwhile, however, is adding incentives to this sort of ‘vampire’ attack. StakeWise must be able to compete with Lido at the product level if it plans to be successful in the long term. StakeWise V3 does exactly this imo, so whilst I have no issues with the stETH vault, I would likely vote against any proposal for the DAO to add incentives there.

Questions I have:

  • One of the benefits of the solution is the ability to combine various “LP personas” to reduce SWISE sell pressure. As such, what are the plans for recycling/compounding SWISE rewards? I am just conscious that compounding rewards would often mean selling SWISE, causing sell pressure.

  • What mechanisms would be in place such that AVG Treasury can only execute strategies approved by StakeWise DAO/SLC? What are the trust assumptions that LPs place on AVG Treasury?

Views/questions are my own and not reflect those of the core team/SLC as a whole

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Thank you @Jstar for your thoughtful response.

I’d like to address some of the points and questions you raised in your reply:

Regarding the DAO as a vault owner: while we are certainly aiming for the DAO to be the vault owner, it’s important to acknowledge some challenges when using a governor contract or alike. Owning the vault through a multisig setup (we recommend at least a ⅗ configuration) would be straightforward. However, having the vault owned by a timelock and enabling the contract to control granular settings (which is especially important if the DAO wishes to make changes in the future) is a bit more complex. We are currently exploring potential solutions with Tally & Aragon, but this is still a work in progress. So, for now, the simplest approach would be to establish a dedicated multisig controlled by Stakewise for the vault ownership.

Choice of allocations and smart allocations: I completely agree with your point. Our original proposal was somewhat simplistic in this regard, and I agree that additional thought needs to be put into the distribution among pools. We will conduct additional research, and our asset management team will provide a more detailed rationale for the allocation split before launching the vault.

Outsized exposure to Enzyme: If this solution gains significant traction and becomes the primary destination for LPs in the Stakewise community, we are open to implementing a maximum percentage of LP concentration in Enzyme relative to the overall market liquidity for osETH. We can define a reasonable percentage and apply a deposit block if the TVL exceeds that threshold. The beauty of this approach is that the vault owner (Stakewise) can set and enforce this limit without relying on Avantgarde’s cooperation.

stETH denomination & vampire incentives: The growing popularity of the vampire narrative and the ease of acquiring liquidity from stETH holders rather than simple ETH are compelling reasons to continue with this approach. There is no need to introduce additional incentives, as SWISE liquidity incentives are already integrated into the program we are outlining.

Plans for recycling/compounding SWISE rewards: We can work out an arrangement between Avantgarde Treasury and Stakewise that benefits LPs without negatively impacting the project and its token. Potential approaches could involve selling SWISE tokens progressively over time, selling more during periods of price appreciation and buy pressure, or exploring advanced technical solutions like Arrakis PALM or Bond Protocol for gradual diversification with minimal or no impact on token price.

Trustless delegations: There are no trust assumptions for LPs in relation to Avantgarde Treasury, and the initiative is entirely non-custodial. The vault owner (Stakewise) can configure the vault with specific policies and permissions for the delegated manager. These permissions constitute the basis for a trustless relationship between the parties, as the manager cannot execute actions beyond the predefined and encoded guardrails. For further details on how trustless delegation works on Enzyme, see the documentation here and here.

Let us know if you have any further questions, your input is greatly valuable as we refine and develop this idea!

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