Diversifying Treasury ETH holdings with LSTs

PS Research
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Diversifying Treasury ETH holdings with LSTs

As of the last 14 Epochs, the DAO has begun accruing a significant amount of ETH as part of their treasury. This has helped diversify the treasury available for the DAO, and opens additional possibilities for the DAO to participate in securing the Ethereum network and receiving ETH rewards as a part of this.

The following research thread aims to open the conversation of considering to use part of the ETH treasury of the DAO towards LST diversification, as well as the choice of LSTs, its conversion methods to minimise the amount of manual work.

Assisting with staker diversity of the Ethereum Network

Ethereum and its related L2s constitute the vast majority of ParaSwap’s volume, and as such, the health of the network is also important for the long-term health of ParaSwap. For this reason, there are different factors that are worth considering when selecting potential tokens for LST diversification.

In addition to the degree of decentralization of the validators being used, another important factor that has recently been gathering more attention is the importance of Client Diversity, especially towards the avoidance of a supermajority client. While it is difficult to monitor what client a validator is running, there are different sites that can help report on this as well as the importance of the diversity, such as https://supermajority.info/

Automation Considerations

Unless this diversification is a one-time event - which comes with many downsides, such as slippage, potential premium, and the stake ever decreasing -, it’s likely that if a diversification proposal were to pass, it would require multiple conversations over time. Doing such conversions, or any swap for that matter, is currently challenging to coordinate on MultiSignature solutions such as the one the Governance Committee has.

Because of the coordination challenges, as well as the potential need of rebalancing of different assets, options for conversion, such as:

  • LST Liquidity Pools: Automatically balance the assets within the pool, and give swap fees whenever the pool is used, as well as potential rewards on top of it. However, they might also increase the smart contract risk and impermanent loss from asset deviation. Additionally, the best solution would be to add liquidity to an existing pool, which also means less choice by the DAO of the assets.
  • Automated Vault Conversions: By depositing the assets to the pool, these are then converted depending on the parameters set by the vault creator. The amount of fine tuning needed, as well as the degree of trustlessness of the vault, vary greatly from product to product. However, once it is setup it would simplify the epoch-by-epoch process (would have to simply deposit ETH to the vault),

Asset split, and deciding conversion percentage

Despite everything that has been discussed above, having a certain amount of unstaked ETH could still be preferable , as it both carries a lower degree of smart contract risk as well as more versatility of usage for future proposals. Prior to the final version of the proposal, different factors are going to have to be considered, such as:

  • Should the conversion to LSTs be a one-time event, or an ongoing epoch-by-epoch distribution?
  • What are the advantages of holding a basket of LSTs, as opposed to a single one?
  • Are there other major usecases that could be placed on the ETH assets? Eg. Depositing them on AAVE, incentives, gauges for sePSP2 pools.
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Hey @0xYtocin,

Thanks for initiating this interesting discussion on diversifying the DAO’s ETH holdings with Liquid Staking Tokens (LSTs)!

We are @moss and @ainsley representing Enzyme (DeFi infrastructure for onchain asset management) & Avantgarde (crypto-native DAO treasury advisory & research firm).

In light of the challenges mentioned regarding coordination, automation, and risk management, we propose exploring the use of an Enzyme vault. Enzyme provides a robust platform for managing digital assets, allowing for the creation of a custom vault with automated distribution mechanisms backed by risk-management frameworks.

Importantly, depositing assets into an Enzyme vault ensures the DAO can retain control and self-custody of the funds by holding ERC-20 vault shares on a multisig like Safe, while also avoiding the inefficiencies on multi-signing every single transactions, thanks to the trustless delegation mechanisms enabled by the Enzyme smart contracts.

Here’s how we think that an Enzyme vault, combined with the Avantgarde’s know-how addresses your needs:

Risk Management Framework: Avantgarde devises a risk management framework for allocating across different LSTs, which can be implemented in a systematic way to achieve the DAO’s objectives. This provides transparency in the strategy design and embeds consistency into the process, reducing the impact of the behavioural pitfalls in pure discretionary approaches.

Automated Implementation: An Enzyme vault automates the distribution of incoming ETH balances across different LSTs based on predefined parameters, minimising manual intervention and optimising asset allocation.

Self-Feeding Flow for Paraswap: With the Enzyme vault, you can configure a seamless process where all swaps or LST minting occur exclusively through Paraswap. This streamlined approach ensures that the entire treasury management activity remains fully in-house.

Forward-looking Flexibility: The DAO retains full control over asset allocation and vault management parameters, allowing for tailored adjustments based on market conditions and rapidly evolving strategic objectives (e.g. LRTs, etc.)

Regarding the questions raised in the final paragraph:

Conversion Strategy: the vault can support both a one-time and an ongoing epoch-by-epoch distribution. Weighing the advantages of each approach in maximising yield and minimising risk is beyond the scope of this reply and can be thoroughly analysed with a bit more time.

Advantages of Holding a Basket of LSTs: Diversifying holdings across multiple LSTs can help mitigate specific protocol risks and maximise overall yield potential, providing resilience and stability to the treasury.

Other Use Cases: In addition to diversifying into LSTs, we could explore other strategic opportunities for the LST tokens, such as providing liquidity on DeFi apps like Curve, Balancer, Morpho, Pendle which are either already integrated or will be coming soon in the Enzyme’s product roadmap.

If this high-level idea is of interest for the DAO, we can continue this conversation and flesh out in further details how it can be implemented, incl. technical specifications, vault parameters and associated costs for the DAO.

Looking forward to further collaboration and moving this initiative forward with you! :muscle:t2:

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