Aave and Oasis launch new Ethereum staking derivative

The two DeFi apps are launching a new ETH derivative for higher yields when staking Ether.

The two DeFi apps are launching a new ETH derivative for higher yields on staking Ether. But there’s a lot of pushback on the idea.

Lending platform Aave and DeFi app "Oasis" announced a new Ethereum staking View post on X on October 24. Users would be able to earn more yield on their staked ETH with the product, resulting in a simplified DeFi strategy. But concerns remain about the product’s safety and its level of centralization.

A recurring process

"Aave Interest Bearing stETH" (View post on X) is what the creators call the Ethereum derivative in a fanciful way. It bundles steps from an existing strategy into a single transaction. The strategy, titled "stETH/ETH Multiplier," is offered on Oasis, a branch of the MakerDAO protocol. The process goes like this:

Traders deposit ETH on Lido Finance and receive the familiar derivative "staked ETH." This can be lent on lending platforms like Aave, and in return, even more ETH can be borrowed. Traders can then deposit this back into Lido. A looping process that generates more and more stETH.

Instead of walking the process in separate steps, investors can now use ASTETH to handle it all in one transaction on Oasis. The potential yield is between 5% and 14%. It sounds simple at first glance, but it comes with risks.

Depegging

For stETH and similar strategies, there’s always the risk that a token loses its (quasi) parity with ETH. Unlike stablecoins, the price ratio between stETH and ETH isn’t fixed. If stETH’s price drops significantly below ETH, the derivative may no longer be redeemable 1:1 for ETH.

In June this year, the "stETH depegging" contributed to the collapse of lender Celsius, which heavily invested customer funds in the Ethereum derivative. A similar fate could befall traders who post stETH as collateral on Aave to borrow ETH. If their collateral devalues, their positions could be liquidated.

As the ongoing looping trading strategy continues, a chain reaction looms. Large amounts of ETH are lent out by investors, which can push lending rates higher and make ASTETH positions unprofitable. If that happens, traders are likely to liquidate their positions and the price of stETH could drift further away from its peg, amplifying the effect described above.

Centralization

The depegging risk has diminished since the Ethereum Merge, as the depegging of Ethereum Staking Rewards became more tangible with the shift in consensus mechanism. Finally, when traders release their staked ETH after the Shanghai upgrade, a stETH price deviating from its peg becomes even less likely.

Recently, Lido has been a particularly relevant player in the Ethereum centralization discussion. The platform remains the largest Ethereum staking provider with over 30% share, according to analytics firm Messari. Its share among all liquid staking providers is a whopping 68%, according to Dune Analytics.

From Oasis’s example of the new derivative, it’s clear that Lido’s stETH is being used more and more as collateral for several DeFi strategies. MakerDAO founder Rune Christensen even explains in his blog entry "Endgame" how stETH could become the protocol’s base collateral.

For a thriving and safe DeFi ecosystem, a bit more competition among providers would certainly be healthier. Danny Ryan, a researcher at the Ethereum Foundation, agrees. In his report "The Risks of LSD" he writes: "Liquid staking derivatives (LSD) like Lido tend toward cartelization and bring substantial risks to Ethereum in terms of promised capital."

Staking seems less about securing the network and more about fueling the DeFi ecosystem. But at what cost?