On 2021–06-23 Stakewise DAO began a farming campaign for liquidity on Uniswap v3 pairs for sETH2/ETH and sETH2/rETH2. Soon after the campaign began the price of sETH2 in ETH in the sETH2/ETH pool became between .95 and .96 ETH.
$SWISE farming incentives were targeted at the Active price, so liquidity providers (LPs) in a tight range around 1:1 sETH2:ETH were not active and thus were not incentivized with $SWISE. However, LPs whose liquidity included a price range of about .95 ETH are incentivized with $SWISE. These LPs are at risk of losing their sETH2 at a ~5% discount from their initial investment in terms of ETH (unless they obtained the sETH2 by swapping at a lower price).
This is creating a situation where the goal of the DAO to maintain a tight price range for sETH2/ETH around 1:1 is not being reinforced by the incentivization and LPs who desire to benefit from farming rewards by providing liquidity in that range without risking their sETH2 being sold at a undesirable discount cannot do so.
There is a case to be made for stakers who want an early exit to take a discount on their sETH2 to be able to exit early but I understand most of the DAO participants desire to maintain a price for sETH2 closer to 1. A small discount can help ensure willing buyers of sETH2 for stakers who do find themselves needing to exit the position early. On the other hand, a premium for sETH2 is also probable in certain market conditions where the staking queue becomes a significant factor for potential stakers (or for rETH2 holders wanting to compound their positions in smaller increments). Together, these considerations push us to desire a tighter price range around 1:1 than we are currently experiencing.
If my understanding of how Uniswap v3 pricing works is correct (all the available liquidity in a certain range needs to be converted before the price will move out of that range), at the current time given the liquidity amount and ranges in the pool (see the image above), for the price of sETH2 in the sETH2/ETH pool to reach a closer approximation of 1:1 it would be necessary for about 500 ETH to be swapped for sETH2 (plus an additional amount to offset any additional sETH2 to ETH swaps that occur) before we are back in that range. This situation could be somewhat mitigated now and in the future by making sure that incentives for LPs are aligned with the goal of keeping a tight 1:1 range. If sETH2 liquidity providers adjust their liquidity range to the Desired Range they will reduce the 500 ETH required to be swapped to a smaller amount of ETH required to be swapped for sETH2 to reach it’s approximately 1:1 range with ETH.
It might also be desirable to have some incentivization for the current active range when that diverges from 1:1 due to extraordinary market forces, so that LPs willing to engage in those transactions can benefit and the market can be more efficient for those who want to transact outside of the Desired Range.
Let’s think of incentivizing liquidity in terms of a Desired Range and the Active Range.
My idea is that the DAO should update the $SWISE incentives for sETH2/ETH LPs (and possibly also for sETH2/rETH2 LPs) to reward liquidity provided in the Desired Range.
The Desired Range would be the range near 1:1, perhaps the range of .99402-1.006 (about 1%) or the range of .98807-1.0121 (about 2%).
This would cause some LPs to tighten their ranges to the Desired Range and this would enable the price of sETH2 to return to the desired range in a shorter amount of time (both now and in the future when market forces may temporarily push it out of the desired range). Below is a screen snip of what it would potentially look like to add liquidity in the Desired Range:
Additionally, if technically feasible (and what can’t tsudmi do? maybe we should call him houdini tsudmi?), perhaps we should also continue to incentivize the Active Range when it falls outside the Desired Range so that when market forces do push the price out of our Desired Range willing LPs can be rewarded for responding to those market forces.
IF we incentivize both the Desired Range and the Active Range, it would need to be determined what happens when those overlap and when they diverge, and the available $SWISE incentive would need to be prorated between the LPs providing liquidity in these ranges. However, I believe the most important part of this idea is to incentivize the Desired Range over the Active Range so that the Desired Range is best supported in the market.
I provide liquidity to the pool and currently do so in a range close to 1:1. Some of my provided liquidity was swapped from the pool at a discount rate so I stand to benefit if the price in the pool rises closer to 1 ETH per sETH2.