Token Economics of Ethereum 2.0 Staking Pools: What Are Staking Tokens?

Source | StakeWise

This article is divided into two parts, introducing what are staked ETH tokens (that is, tokens obtained by staking ETH) and how they work?

This article was co-written by Collin Myers @StakeETH and edited by Lito Coen of Cryptotesters and Francesco Renzi of Superfluid.

We are in an era of innovation and progress.

We don’t need to look too far ahead to see many innovative projects. Since the launch of Eth2 Staking, various third-party staking platforms have been launched (https://cryptotesters.com/ethereum-staking-platforms). There are centralized exchanges like Binance, and DeFi projects like Rocket Pool and StakeWise, and they are all different.

While each of these projects has its own merits, they all have one thing in common: they are all trying to provide solutions to reduce the necessary frictions that anyone encounters when staking ETH. What are these frictions?

First, staking ETH has certain technical complexities, which exceeds the processing power of ordinary users. Second, at least 32 ETH needs to be staked to run a validator node, which is an unattainable amount for ordinary users with the rising price of ETH (about $1,290 as of this article). Finally, the staked funds will have a lock-up period of 18-24 months. This security measure is designed to transition from the current Ethereum blockchain to Ethereum 2.0 in a safe and controlled manner.

Together, these three limitations exclude many less sophisticated users from the high-return Ethereum staking market.

How do staking pools solve these problems?

This is where Ethereum 2.0 staking pools come in. They accumulate the ETH of multiple users and run the Ethereum 2.0 staking infrastructure on their behalf, allowing anyone to earn staking rewards regardless of their skill level or deposit size.

In addition, they mitigate the illiquidity problem caused by staking by minting ETH1 tokens (as a certificate of the user's staked principal and the rewards they receive on the ETH2 chain). These staked tokens provide opportunities for holders: users can exit staking early by exchanging tokens for ETH on secondary markets such as Uniswap. They can also use staked ETH tokens in DeFi (such as staking in Aave).

However, the token model is implemented differently between different pools, which undoubtedly has some serious consequences for end users. For example, Lido’s stETH token is not the same as StakeWise’s stETH token, so it should be priced differently on the secondary market. At the same time, Rocket Pool’s rETH token is different from the stETH implementation, just like CREAM’s crETH2, Stkr’s aETH, etc.

In short, there are many differences in the token mechanics of different pools, which can cause confusion and lead to undesirable consequences for end users. However, these differences can be categorized and evaluated to find out the advantages of certain pools over others. Moreover, this comparative analysis lays the foundation for us to design different evaluation methods, thereby allowing users to obtain price efficiency among different Eth2 staking tokens.

This article aims to educate the community on the types of token economics used by different staking pools. We hope that people can avoid losing money due to insufficient understanding of the products, and hope that the community can actively discuss and contribute to finding effective pricing and arbitrage opportunities in the Eth2 staking pool industry.

In this article, we will demystify the tokenization of staked ETH and provide examples of how different staking pool tokens work. The following articles will focus on the evaluation framework for staked ETH tokens and analyze how the choice of token design affects the composability and usability of different protocols.

What are the Staked ETH token models?

There are two main modes: single token design (capturing the staked principal and rewards into the same token); dual token design (capturing the staked principal and rewards into two different tokens).

Single Token Design

The single token structure is based on a rebalancing/repricing token concept. This design is the most common and is used by most staking pools due to its simplicity. The pool mints a single token for users based on their deposits, thereby trying to capture the amount of staking rewards and penalties accumulated under the same token. This can be done in two ways:

➤ Staking rewards and penalties accumulated on Eth2 are reflected in real-time changes in token balances (hence the name “rebalancing”). In Phase 1.5, users can redeem ETH at a 1:1 ratio with their staked ETH tokens.

➤ The accumulated staking rewards and penalties on Eth2 will be reflected in the token price (hence the name “repricing”). In Phase 1.5, the ETH that can be redeemed for one unit of staked tokens fluctuates with the total rewards and penalties in the pool.

Here are some examples to illustrate the difference between these two token mechanisms:

1. Balance change: Deposit 1 ETH in the pool and get 1 staked ETH token.

As the total amount of rewards and penalties in the pool increases or decreases, the token balance of each participant in the pool will also change accordingly. For example, 1.1 ETH = 1.1 staked ETH token balance. Therefore, the user's staking rewards will be captured, and the token balance on their address will continue to increase, minted by the pool for the user. By Phase 1.5, all staked ETH tokens will be redeemed for ETH at a 1:1 ratio.

Among those using this design are Lido Finance and Binance.

Please note: the balance of staked ETH tokens is always equal to the amount of ETH in the pool; the exchange rate remains 1 throughout the staking period.

2. Price change: Deposit 1 ETH in the pool and obtain the corresponding staked ETH tokens based on the ETH/ETH2 token exchange rate during the same period.

The exchange rate given in the pool is determined by the ratio of ETH to the total number of tokens in the pool, and changes according to the total amount of rewards and penalties accumulated in the pool.

Assuming that the exchange rate at the time of deposit is 1, that is, the pool has not received any rewards, then 1 ETH = 1 staked ETH token.

As the total amount of rewards and penalties in the pool increases or decreases, the user's staked ETH token balance will remain the same, but the amount of ETH that can be redeemed for each staked ETH token in the pool will change. In other words, 1 staked ETH token = 1.1 ETH in the pool.

Therefore, the price of each staked ETH token changes from 1 ETH to 1.1 ETH, which represents the user's staking income. In Phase 1.5, users will redeem ETH with their staked ETH tokens at the final ETH/ETH2 ratio.

Rocket Pool, CREAM, Stkr and StaFi use this model.

Note the change in the exchange rate — it captures the growth in user staking rewards.

Although these two single token designs use different mechanisms to reflect the accumulation of rewards, they have one thing in common: they bundle deposits and rewards into the same token. This means that any time a user buys or sells the token on the market, or obtains tokens through staking, they are receiving/selling the deposit principal and any rewards accumulated in the past pool.

We will continue to discuss the impact of such a design in another article, but users should consider the design factors when evaluating different staking pools, as this determines the user's expectations for the annualized staking rate and the prediction of token pricing in the secondary market.

Dual Token Design

In contrast, under a dual token structure, there are two rebalanced tokens (respectively mapping deposits and rewards).

The user's deposit in the pool (some people like to call it principal) is mapped to the deposit ETH token. Like other rebalancing tokens, it is minted at a 1:1 ratio based on the ETH deposited by the user.

The deposit ETH tokens in the user's address will not grow, but will generate rwETH (reward ETH) tokens, mapping the growth of the user's income in the pool at a ratio of 1: 1. The sum of these tokens constitutes the user's total staked balance, which can be freely converted between Ethereum addresses and can be used in smart contracts like a single token.

For example:

1. Dual tokens: Deposit 1 ETH in the pool and get 1 deposit ETH token (stETH).

As the rewards in the pool grow, the balance of the deposit ETH token remains unchanged. However, when it appears in the user's address, it triggers the generation of reward ETH tokens (rwETH) to reflect the growth of the pool's income. As long as the user holds the deposit ETH token, the reward ETH token will be generated in the address.

In Phase 1.5, both deposit ETH tokens and reward ETH tokens can be redeemed for ETH at a 1:1 ratio.

The only staking pool that uses a dual token design is StakeWise.

Note that the total number of deposit ETH and reward ETH tokens is always equal to the total number of ETH in the pool; the exchange rate for both tokens is 1.

The dual token structure allows the creation of a new type of hybrid instrument with similar dynamics to bonds, but with the difference that dual tokens distribute the staked balance into different accrued values ​​and different cash flow expectations (principal and interest).

For example, when users receive reward tokens, they can gradually sell reward ETH tokens in the STRIPs market, and some users can get staking bonuses without staking themselves.

(The first part is over, the next part will explain how the staking tokens work)