Paper 2023/1842

Leverage Staking with Liquid Staking Derivatives (LSDs): Opportunities and Risks

Abstract

In the Proof of Stake (PoS) Ethereum ecosystem, users can stake ETH on Lido to receive stETH, a Liquid Staking Derivative (LSD) that represents staked ETH and accrues staking rewards. LSDs improve the liquidity of staked assets by facilitating their use in secondary markets, such as for collateralized borrowing on Aave or asset exchanges on Curve. The composability of Lido, Aave, and Curve enables an emerging strategy known as leverage staking, where users supply stETH as collateral on Aave to borrow ETH and then acquire more stETH. This can be done directly by initially staking ETH on Lido or indirectly by swapping ETH for stETH on Curve. While this iterative process enhances financial returns, it also introduces potential risks. This paper explores the opportunities and risks of leverage staking. We establish a formal framework for leverage staking with stETH and identify $442$ such positions on Ethereum over $963$ days. These positions represent a total volume of $537{,}123$ ETH ($877$m USD). Our data reveal that the majority ($81.7\%$) of leverage staking positions achieved an Annual Percentage Rate (APR) higher than that of conventional staking on Lido. Despite the high returns, we also recognize the risks of leverage staking. From the Terra crash incident, we understand that token devaluation can greatly impact the market. Therefore, we conduct stress tests under extreme conditions, particularly during stETH devaluations, to thoroughly evaluate the associated risks. Our simulations indicate that leverage staking can exacerbate the risk of cascading liquidations by introducing additional selling pressures from liquidation and deleveraging activities. Moreover, this strategy poses broader systemic risks as it undermines the stability of ordinary positions by intensifying their liquidations.