Staked Ether Is Creating a Benchmark for the Crypto Economy, Says ARK Invest

As a seasoned investor with years of experience navigating the cryptosphere, I find myself increasingly drawn to the growing phenomenon of staked ether and its impact on the DeFi landscape. Having closely watched the evolution of this space, it’s fascinating to witness how stETH is becoming the new benchmark for collateral in decentralized finance.

Slowly but surely, staked ether (stETH) is becoming a benchmark for the entire on-chain economy.

Based on findings from ARK Invest’s recent report, it appears that Ether staked through Ethereum’s monetary policy has evolved into an exceptional kind of asset – one that shares similarities with sovereign bonds.

Lorenzo Valente, a researcher at ARK Invest, explains that the return on staking ETH functions as an indicator of activity within smart contracts and economic fluctuations in the digital asset market, similar to how the federal funds rate signals trends in traditional finance.

Comparing staked ether to sovereign bonds

Ethereum is structured so that individuals who hold Ether (ETH) can deposit their tokens within the network, thereby keeping them secured, in return for earning an income. As of now, the earnings from staked Ether are estimated to provide a 3.27% annual return, as per CoinDesk’s CESR data.

Additionally, you might come across a token known as stETH, which is associated with the Lido initiative. Ethereum stakers have the option to utilize this token within decentralized finance (DeFi) platforms.

The fact that staked ether produces a yield makes the asset comparable to sovereign bonds, which are debt securities issued by governments to finance themselves. Investors can buy up this debt and earn interest on it over time.

But staked ether differs from bonds in several crucial aspects, the report said.

In some instances, the differences are advantageous. For example, unlike governments that may fail to meet their debt repayment commitments, such as Argentina in 2020, Ethereum is incapable of defaulting on staked Ether. The network ensures users can withdraw their funds whenever they desire, and the returns continue to be issued consistently, albeit with a fluctuating interest rate based on on-chain activity. One significant risk associated with bonds is inflation. If a government overprints currency and inflation exceeds the bond yield, investors experience a loss of purchasing power.

Ether could experience inflation if network activity decreases significantly, causing the rate of ether creation to surpass the amount burned during transactions. This burning mechanism reduces the total supply of ether each time a transaction occurs. The process of ether’s inflation is more transparent due to on-chain data. For instance, over the past 30 days, the annual growth rate of ether’s supply has been approximately 0.33%. Websites like ultrasound.money provide this information as data aggregators.

However, holding staked Ether isn’t without its potential downsides. The network has the power to dissolve staked Ether, for instance, if the validators – entities where investors stake their Ether; they process transactions – encounter an operational glitch or act in a manner harmful to the network. This scenario is commonly referred to as “slashing.

Government bonds carry political and regulatory uncertainties, but they won’t vanish instantly or be destroyed by automated systems in case of mishaps.

To sum up, sovereign bonds are often attractive due to their stability and low volatility, making them seem safe investments, even similar to cash. On the other hand, Ether, a cryptocurrency, is highly volatile, having increased by 65% over the past year. Consequently, investors cannot categorize staked ether in the same low-risk group as bonds because of its volatility.

The report noted that although traditional sovereign bonds and Ethereum (ETH) share some common risk factors like inflation, changes in interest rates, and currency depreciation, the characteristics and consequences of these risks can differ greatly. Furthermore, ETH staking presents exclusive risks pertaining to network security, validator conduct, and smart contract glitches – aspects not typically encountered with traditional sovereign bonds.

Growing use in DeFi

either by establishing their own validators, or by investing through decentralized finance (DeFi) platforms like Lido (LDO) or Rocket Pool (RPL). These platforms collaborate with reputable validators and handle all the technical aspects of staking on behalf of their users.

Notably, they offer liquid staking tokens (LSTs), which are equivalent to the amount of Ether invested by users within the network. This is a significant advantage since their Ether remains secured and generating yield, yet investors can continue utilizing stETH tokens (the commonly used LST) for various other purposes – such as collateral in lending platforms.

In simple terms, the edge that stETH is offering is becoming increasingly attractive, causing it to gradually replace ETH as the preferred form of collateral in the decentralized finance (DeFi) market.

According to the report, approximately 2.7 million units of stETH are currently being used as collateral in decentralized finance (DeFi), which accounts for around 31% of the total stETH supply. This preference is largely due to the financial advantage it provides to investors, liquidity providers, and market makers by offering capital efficiency.

At the moment, approximately 1.3 million units, 598,000 units, and 420,000 units of stETH are secured within Aave V3, Spark, and MakerDao respectively. These amounts serve as collateral to facilitate the issuance of loans or stablecoins backed by crypto in these platforms.

Becoming the benchmark

As staked Ether (stETH) becomes increasingly popular among major DeFi platforms, it’s causing a gradual reshaping of the broader cryptocurrency financial landscape, according to the report’s assertion.

This is due to the fact that projects aim to demonstrate to investors that, in comparison to just holding Ether and earning returns, their investments will yield greater, risk-adjusted returns. Furthermore, reinvesting these earnings will amplify the gains.

According to the report, a closed-end fund would need to exceed the return of Ethereum (ETH) by approximately 31% over a seven-year span, without considering any potential price growth, if it aims to match the 4% yield compounded annually on ETH.

One reason why projects such as Solana (SOL) and Avalanche (AVAX), which are competing Layer 1 platforms, provide greater interest rates for token staking is to motivate investors. This is because these assets tend to be riskier and more volatile, necessitating higher returns over time to encourage long-term holding.

According to ARK Invest, the increased need for staked Ether is exerting strain on Decentralized Finance (DeFi) platforms that offer loans in stablecoin assets.

Sky (previously known as MakerDAO) boosted the interest rate on locked DAI, its native stablecoin, due to intense selling activity and a drop in supply, according to the report. Also, investors on Aave and Compound are receiving higher returns for lending stablecoins, as users prefer lending stETH and borrowing stablecoins instead of directly lending stablecoins.

To put it simply, as stETH gains a larger portion of the market, more decisions within the cryptocurrency economy will be influenced by the yield of staked Ether. Effectively, staked Ether could come to serve similar functions in crypto-economics that the Federal Reserve’s funding rate plays in the global financial system.