Introduction
StakeWise is a liquid ETH 2.0 staking solution, which uses a novel two-token approach which allows for efficient compounding of rewards. We believe that StakeWise is a strong option for investing the mutuals’ ETH for the foreseeable future.
Rationale
The mutual is holding significant amounts of ETH which should be used to generate a return. Currently only 20% of the ETH is being staked, with another active proposal to allocate 10% to Maple. We believe we can invest another 20% in an ETH staking solution while still being able to eventually balance our currency mismatch situation (too heavy in ETH, not enough stables compared to active covers) and hold cash equivalents to pay out claims.
Of the larger liquid staking solutions that are available, we already invest significantly with Lido on the one hand, and Rocket Pool, while promising, is being held up by an oracle issue.The third obvious option to consider is StakeWise. We’ve spent countless hours with their team to get comfortable with the counterparty risk, their diligence, approach to risk and codebase.
Currently, StakeWise is the best liquid staking alternative for us to stake ETH. Liquidity is one of their primary concerns, hence they’re investing in maximizing pool liquidity. They have impressive uptime and server stability. The two-token system allows for efficient compounding.
The core Nexus Mutual team is also in the late stages on a cover deal with StakeWise, to protect them against slashing, downtime and revenue loss on validators. There will be some residual correlation risk, in terms of server exposure, geographic and client diversity between the proposed investment and the slashing cover, as well as the existing Lido investment.
We believe that an investment into StakeWise aligns our interests and allows for a more fruitful partnership going forward.
Proposal
The mutual should use 10% of the assets in the capital pool to stake ETH in the StakeWise liquid staking pools.
Amount & Duration
At the time of writing, the mutual has 153,446 ETH. This proposal is to use 15,344 ETH for staking in StakeWise. The duration will be perpetual until the mandate of the mutual changes, claims need to be paid out in excess of our cash equivalent positions, the yield no longer justifies the risk, or the members decide to make a change for any reason.
Technical
To do so, the ETH will first need to go into an Enzyme vault (the same as the Maple proposal) and then be deposited into StakeWise. This will involve the same fee structure as Maple, meaning the yield will be impacted by a material amount.
However, given the current developer focus on getting Nexus Mutual V2 to audit and complexity of the oracle work required by Chainlink, we think it’s worthwhile to use Enzyme for this immediately. In the future, we can remove these assets from Enzyme to save on fees, or negotiate a lower fee structure. However, given the effort that Enzyme has put into making this work, it seems fair and reasonable to stay with the same fee structure for now and focus on moving faster to get investments live.
Implementation
The Enzyme vault will be created for the Maple proposal and for this, presuming both pass. The governance vote for this proposal will action the transfer of ETH from our capital pool to the Enzyme vault. The Enzyme team will then facilitate the staking.
Rewards
StakeWise is currently generating a 4% APY on staked ETH, after fees (charged at 10% of the return).
The cost of using Enzyme will be the same as for Maple:
- Fixed fees = 0.25%
- Performance fee estimate = 0.5% * 4% = 0.02%
Total fee = 0.27%
Net yield = 3.73% APY
Assuming the rewards remain the same, after converting the initial 15,344 ETH into sETH2, we will generate 3.73% = 572 rETH2, which can also be re-staked at regular intervals to compound our returns efficiently to earn more than 3.73%. Our expectation is that in the short term, as further ETH is staked in the Beacon chain, this yield might decrease. In contrast, post-merge, as demand for using the Beacon chain increases, this return is likely to increase back above the current level.
Uniswap LP Possibility (Not part of Proposal)
There is also the possibility for us to become a liquidity provider in the sETH2/ETH Uniswap v3 pool, and earn a fee in return for this service. There’s a reasonable argument, in my opinion, that this is worth doing with some portion of the tokens. By doing so, we’ll be able to enhance our yield, support the growth of the protocol and provide better liquidity for others. This suggestion is not part of the proposal, but we wanted to open the discussion on this topic.
Risks
Intrinsic to the investment
Liquid ETH staking solutions are relatively lower risk compared to investing in DeFi protocols which tend to come with significant market, liquidity and currency risk. StakeWise has a few notable risks:
- Depeg risk
- Slashing / downtime
- Smart contract risk
Following the well-known depeg on stETH from ETH, it’s worth considering what a prolonged depeg might mean for us. With our liquidity needs it’s possible that we could be forced to sell any staked ETH token below peg. This is because depeg events are more likely to coincide with hacks and exploits that become systemic (Terra was not this, but had similar wide reaching consequences), and this contagion leads to panic, forced selling and staked ETH depeg events.
We shouldn’t assume that all selling of staked ETH products will happen at peg, which is why an accurate oracle is particularly important.
Secondly, there is the risk of penalties or slashing events on the Ethereum network, downtime and other similar events which can lead to revenue loss and loss of capital. StakeWise has not experienced this to date and given the quality of their setup, diversification and internal controls for managing these events, we believe this risk is acceptable.
Finally, the other big risk is smart contract risk. Liquid solutions always rely on relatively broad smart contracts, meaning more attack vectors. A possible exploit could be a way to access the pool and drain all ETH in the exit / entry mechanism, or a way to mint staked ETH tokens and crash the market, or some other attack that we haven’t thought of yet.
StakeWise found a bug in Rocket Pool last year, and privately disclosed it to their team. To us, this is strong proof that the StakeWise team is technically competent and takes security and ecosystem sustainability seriously. You can find their last five audits here.
Despite this, smart contract risk is very real, hard to quantify and needs to be actively managed. The addition of the Enzyme protocol into the process also adds material smart contract exposure. Ultimately, we believe that the risk is acceptable and we will be compensated fairly pre and post-merge.
Nexus-specific
The biggest risks to Nexus are:
- Investment losses prevent us from paying out claims
- Trust is lost, preventing cover buys and growth
These are the two mortal risks which we have to avoid when making investments from the capital pool. Therefore, we have to be particularly cautious, far more than a hedge fund, who can justify losses as long as the expected value was reasonable. That logic doesn’t apply to Nexus Mutual where preventing capital loss is the biggest priority.
Staking ETH is a relatively low risk investment, it’s long-term and involves little to no management. These characteristics make it the ideal choice for a risk-sharing protocol.
Sizing is also critical, which is why we’re only recommending a 10% position in StakeWise. Even in the worst case scenario where the entire position is lost, it should make little to no difference to our ability to pay out claims even under black swan scenarios.
At the proposed size, Nexus is poised to become 20% of the StakeWise TVL. While this is a significant amount, we feel that the quality of the product and team justify this size of investment.
Governance
This post is the start of the governance process. This will stay live for at least 5 days before a governance vote is created. Voting will take place on-chain as a full-member vote, meaning that any NXM holder can vote, with 1 NXM representing 1 vote.
