[PASSED] Adding wstETH as a new collateral on Vesta

Hey Vesta Community,

This proposal aims to add Lido’s wrapped stETH (wstETH) as a new collateral type on Vesta. wstETH is created by depositing stETH into the stETH wrapper in Lido. Wrapping stETH creates a DeFi-compatible version of the stETH token, allowing for easier integrations with DeFi protocols. This would provide ETH stakers with an opportunity to not only leverage their staked ETH position but also earn original daily rewards generated by stETH. Furthermore, Vesta would benefit from the increased diversity of supported assets and attracting wstETH holders for TVL growth.

Motivation

  1. Deep liquidity: The current total supply and market cap of wstETH on Arbitrum is nearly 30K and $60M. Also, there are more than 24K wstETH holders on Arbitrum.
  2. Diversification: Adding wstETH as collateral will enhance the diversity of assets supported by Vesta, and increase the popularity and volume of VST.
  3. Easy to operate: wstETH can be easily bridged to Arbitrum via the official Arbitrum bridge.
  4. Enhanced utility: Currently, wstETH on Arbitrum is mostly used in yield farming pools on Curve and Balancer. Lending as collateral to mint VST would be a new and attractive usage. Therefore, it will not be hard to gather TVL at the early stage.

Lido’s wrapped stETH

The link to the main project Github repo for Lido Finance:

The verified wstETH contract:
0x5979d7b546e38e414f7e9822514be443a4800529

The age of the token on Arbitrum:

  • 5 months (October 2022)

The number of transactions in token contracts to date: 935,986

Token supply: 29,827.05

Market cap: $59,840,525.06

The chart below shows the total wstETH bridged to Arbitrum since its launch on Arbitrum.

Proposed Parameters

  • Collateral Type: wstETH
  • Minimum Collateral Ratio: 150%
  • Debt Ceiling:
    • Initial: we may start the pool with 600K of the mint cap (roughly 1% of the current market cap)
    • Scaling: we aim to scale the mint cap with the growth of the wstETH market cap on Arbitrum
  • Liquidation Penalty: 15%
  • Vesta Reference Rate: using βcollateral = 0.75%
  • Oracle: Chainlink or similar decentralized oracle network. There’re live Chainlink wstETH/stETH rate feeds for Arbitrum.

Risk Assessment

Smart contract risk

Lido has been audited multiple times with no critical issues found. There is also an independent audit by MixBytes for wstETH token with only 5 warnings and all have been fixed or acknowledged by Lido’s team.

Counterparty risk

Holders of the token on Arbitrum: 24,553

The decentralization level of the governance of the protocol that issues this token:

Lido is managed by the Lido DAO, which governs all Lido governance and network decisions. For example, the decision of bridging wstETH to Arbitrum is made by LDO holders by voting on Snapshot. For security, Emergency Brakes multi-sigs have been set up on Arbitrum. Also, a portion of the ETH staked via the Lido DAO is held across multiple accounts backed by a multi-signature threshold scheme to minimize custody risk.

Upgrade of token contract:

Lido is going to present V2 upgrade as Shanghai edges closer, but there is no proof that the token contract will be upgraded.

Market risk

wstETH is subject to price volatility, but its high relationship with ETH and our 150% of liquidation ratio and 600K of starting mint cap should provide adequate protection against market fluctuations.

The depth of liquidity on this token: wstETH is mainly based on the ETH staked ($10.5B) and stETH wrapped ($2.7B) on Lido.

Oracle: we’ll make use of a reliable and decentralized oracle network like Chainlink to ensure accurate and tamper-proof price feeds for wstETH.

Token Volatility: Volatility is obviously close to ETH as the two are highly linked, the 30D Volatility is 0.62 for wstETH and 0.58 for ETH according to Messari.

Future emission schedule: wstETH can be minted infinitely as long as stETH is wrapped in Lido, but limited by the staked ETH amount.

Timeline

This poll/discussion period will be live for seven days and if passed, the official voting will commence immediately and will take place over three days.

It is a sensible and strategic move to add wstETH as collateral on Vesta. Our protocol would benefit from the diversity and increased usage in the Arbitrum ecosystem. Furthermore, the new collateral to mint VST would draw more wstETH to be bridged to Arbitrum. We welcome feedback and discussion from the Vesta community before moving forward with the implementation of wstETH as collateral.

6 Likes

Fully support adding LSDs as backing for VST!

2 Likes

100% in favor of this. Hopefully other LSDs like Rocket Pool can be added once they establish better liquidity on Arbitrum.

1 Like

ok nice good awesome masth

1 Like

Absolutely in favor. Shanghai not far away now.

1 Like

As discussed by the community there appears to be strong demand to add wstETH as a collateral asset on Vesta.

Following the risk assessment posted by @plpmtech, we’ll provide additional information that will help draw a more complete picture of wstETH’s risk profile, and provide our assessment of the suggested parameters.

In this risk assessment we will provide detailed information about market risk along with our assessment of the following parameters: Liquidation Ratio, Debt Ceiling, Liquidation Penalty, Vesta Reference Rate.

Risk Assessment

Market Risk

The token has been trading on Arbitrum for a relatively short time period (5 months). We’ll use the historical data from the last year for its Ethereum counterpart to give more depth to this analysis.

Volatility

Let’s analyze the maximum drawdowns, the 1 hour volatility and 24 hour volatility of wstETH. All of these values are based on Chainlink historical price data.

Asset price volatility - Last month

1 hour volatility 1 day volatility
wstETH 0.63% 3.27%

Asset price volatility - Last Year

1 hour volatility 1 day volatility
wstETH 0.56% 4.26%

Maximum drawdowns - Last year

1 hour maximum drawdown 1 day maximum drawdown
wstETH -9.46% -28.01%

Liquidity

wstETH total DEX liquidity on Arbitrum has been ranging between 35M and 55M over the last 30 days.

Liquidity is distributed on 174 pools split across the following DEXes:

  • Balancer V2: $18.75M
  • Curve: $15M
  • Camelot: $8.95M
  • Uniswap V3: $260k

As a conservative measure, we can simulate the expected slippage conditional on a decrease of 30% of wstETH’s on-chain liquidity over the next 30 days:

Trade size Actual Slippage (%) Adjusted Slippage (%)*
$100K wstETH -0.1% -0.14%
$500K wstETH -0.15% -0.21%
$1M wstETH -0.21% -0.3%
$2M wstETH -0.37% -0.52%
$5M wstETH -0.84% -1.2%

* Conditional on 30% decrease in liquidity and assuming the same liquidity distribution profile

It is worth noting that wstETH on Arbitrum can’t be claimed for stETH, contrary to its counterpart on Ethereum. Thus, wstETH liquidity is strictly limited to liquidity of the token itself. Although a mitigating factor is Arbitrum’s wstETH price is usually kept in line with mainnet by market markets.

image

Centralization

wstETH total supply on Arbitrum as of April 6, 2023 is standing at 32k wstETH ($66.7M).

The holder base is well diversified and centralization risk is relatively low given how distributed wstETH is on mainnet and on Arbitrum.

Proposed Parameters

Over the following section, we’ll review the parameters as proposed by @plpmtech

  • Minimum collateral ratio: 150%
  • VST Mint cap: 600K VST
  • Liquidation bonus: 15%
  • Vesta reference rate: 3.0%

Mint cap

It is our assessment that setting the Mint cap at 600K VST is appropriate given the current wstETH on chain liquidity and would allow stability pool depositors to swap wstETH for stables without incurring too much slippage.

Let’s suppose a worst case scenario where one user would mint the whole 600K VST against wstETH and be liquidated. Under that scenario, the stability pool depositors would receive wstETH in exchange for their VST. Stability pool depositors could then exchange wstETH for USDC at 0.15% slippage given the current on-chain liquidity. Even if wstETH on-chain liquidity decreases by 30% over the coming weeks, slippage to execute a 600K trade would be about 0.21%. Stability pool depositors would then swap USDC to VST in order to profit from the liquidation.

In most cases, only part of the 600K would get liquidated as wstETH depositors will mint VST at different collateralization levels.

600K VST represents about 9% of the current VST supply. If the mint cap is reached due to strong market demand, we could reassess wstETH on-chain liquidity and volatility profile to increase the cap.

Liquidation Penalty

It is our assessment that the proposed Liquidation penalty of 15% is likely to compensate stability pool depositors sufficiently to cover wstETH liquidation costs.

A stability pool depositor will incur the following costs when liquidating wstETH for VST:

  • Slippage selling wstETH for USDC and USDC for VST.
    • As mentioned previously the slippage cost of selling wstETH for VST is sub 1% for a trade size of $600K which implies the whole mint cap would have to be liquidated at once.
  • Gas costs
    • We estimate the gas liquidation cost at 0% assuming the gas compensation will cover this cost. The only gas cost the liquidator will have to pay is gas to swap wstETH for VST.
  • Oracle price skew
    • Based on historical data, the price skew between the Oracle price and the market price can be as large as 1.6%. This means that in a worst case situation a liquidator would have lost 1.6% of the 15% liquidation bonus due to the Oracle price skew.

This means that, based on historical data and looking at comparatives assets, a stability pool depositor should expect to profit for wstETH liquidations assuming the stability pool depositors convert wstETH for VST as soon as an account is liquidated. Based on the historical maximum drawdowns of wstETH and similar assets the liquidator is expected to have a sufficient buffer to profit from liquidations.

If the stability pool is not sufficiently large for wstETH then the VST staking module would execute the liquidation.

We think the proposed liquidation penalty of 15% is adequate for the time being.

Collateral Ratio

The minimum collateral ratio protects the protocol against large decreases in collateral asset prices. We think the proposed parameter of a 150% minimum collateral ratio is appropriate at the current time given wstETH and similar asset historical volatility profiles.

The proposed 150% minimum collateral ratio and the 15% liquidation penalty imply that the protocol has an additional 35% buffer. This buffer would protect the protocol in a situation where the wstETH price would decrease rapidly before liquidations can occur

To avoid the creation of bad debt, the protocol should set its minimum collateral ratio at a point where it covers for the 15% liquidation penalty and also protects the protocol against a large decrease in the collateral asset price.

Given a 150% collateral ratio and 15% liquidation discount, the buffer left for covering the asset price drawdown until a liquidation is executed is:

(1 / (150% - 15%)) - 1 = -26%

The worst maximum 1 hour drawdown of wstETH in the last year was -9.46%. This is well within the -26% price decline the buffer would have protected the protocol against.

It is our assessment that the proposed parameter of 150% minimum collateral ratio for wstETH is likely to protect the protocol against a large decrease in the wstETH collateral price even if no liquidation occurs for at least 1 hour.

We think the minimum collateral ratio for wstETH could be potentially lowered following the Shanghai update as it will make stETH redeemable for ETH on Mainnet. The ability to redeem stETH will make the volatility profile of wstETH even more similar to ETH as it will mitigate wstETH liquidity risk. The additional risks of holding wstETH compared to ETH post Shanghai will be mainly slashing risk and smart contract risk.

Vesta Reference Rate

In order to properly evaluate the suggested Vesta Reference Rate, we can compare wstETH liquidity and volatility profile against other assets that are already onboarded on Vesta.

We think the proposed Vesta reference rate of 3.0% is very conservative as an initial parameter and could be lowered in the future especially post Shanghai update.

Conclusions & Next Steps

Our analysis demonstrates that current parameters are conservative enough to safely list wstETH as a collateral asset on Vesta. As per our measurements, the current mint cap, collateral factor and liquidation discount are conservative.

We could reassess parameters in the following months if needed as we gather more information about the actual wstETH utilization on Vesta.

References

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