Rocket Pool To Incentivize rETH Liquidity

The community behind Rocket Pool, the second-largest Ethereum liquid staking protocol, is rallying to increase traction for the project’s staked ETH token in a bid to narrow the gap with Lido, the liquid staking leader.

In an overwhelming show of support Wednesday, holders of Rocket Pool’s governance token, RPL, voted to approve a new incentive committee’s budget, charter and membership. 

The nine-member team will be tasked with boosting rETH liquidity. Rocket Pool allows users to stake ETH in Ethereum’s proof-of-stake Beacon chain in exchange for a token – rETH – representing that deposit.

All three proposals passed with at least 98% of votes in favor. 

With a market capitalization of $367M and about $2M in daily trading volume, rETH is a distant second to Lido’s stETH, which sports a $7B market cap and $4.1M in trading volume. 

Without greater liquidity – the ability to trade large amounts of an asset quickly and with minimal slippage between quoted and executed prices – there will be little rETH holders can do with the token, according to Rocket Pool advocates.

“The protocol has a responsibility to try and make rETH liquid for ETH,” Rocket Pool’s pseudonymous Community Advocate, Jasper_ETH, told The Defiant. “For most of the protocol’s history, this has only been true for small holders.”

Rocket Pool trails Lido, whose $7.3B in total value locked, or TVL, is more than 10 times that of Rocket Pool as of Wednesday.

Rise of Liquid Staking

Blockchains use a variety of methods to secure their networks and reach consensus on the legitimacy of each transaction. In mid-September, Ethereum is expected to transition to a proof-of-stake consensus mechanism, dramatically reducing its energy use. That transition will merge the current, proof-of-work execution layer with a proof-of-stake consensus layer that has been running in parallel since Dec. 2020.

To secure that proof-of-stake chain — and post-Merge Ethereum — users must stake their Ether, locking it up and earning modest rewards in the process. But those rewards are dwarfed by the potential yields from investing ETH in DeFi protocols. 

Liquid staking providers such as Lido and Rocket Pool address this by staking ETH on users’ behalf and issuing derivative tokens redeemable 1:1 for that staked ETH. These derivative tokens can, in turn, be invested in the broader crypto ecosystem, either directly or by swapping them for ETH. Meanwhile, users’ staked ETH continues to earn rewards at an annual rate of about 4%. 

In order to create liquidity, market makers or liquidity providers contribute an equal value of two tokens to a trading pool on a decentralized exchange like Curve – say $1,000 worth of rETH and $1,000 of ETH. Someone can purchase rETH from that pool using their ETH, or vice-versa, effectively buying tokens from the liquidity provider who, in turn, earns a small fee on the transaction.

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Trading fees tend to be higher for volatile token pairs in which the value of one token tends to swing wildly relative to the other, such as ETH-USDC. Because rETH is backed 1:1 by staked ETH, however, price fluctuations and trading fees are low. 

This means rETH holders who want to serve as market makers must trade away part of their yield-bearing rETH holdings for the second token needed to create a trading pool. And the trading fees they can earn are far lower than rETH’s 4% APR. 

Incentivizing Liquidity

“All the people who are providing liquidity on this pair [rETH and ETH] are kind of just generous people that are trying to help out the protocol,” Thomasg, the founder of open-source aircraft designer Arrow and Rocket Pool’s largest node operator, told The Defiant. “But if you want to attract enough volume to really make it worthwhile, we need to incentivize and kind of bridge that gap efficiently.” 

Lido faces a similar issue, which it has addressed with millions in liquidity incentives, he continued. 

“It’s easier for them because they’re a fairly centralized project and they can raise a bunch of money and do things like that,” he said. “For a DAO like Rocket Pool, it’s a bit harder because we don’t have a massive treasury we can throw at liquidity incentives.”

Liquidity means “safety in trading,” Jasper said.

“If rETH is able to handle 10 or 100x larger tx sizes without slippage, then the entire DeFi ecosystem will be able to adopt rETH.”

Maker Rejection

Liquidity issues became painfully obvious early this year when MakerDAO expressed reluctance to add rETH as collateral for its DAI stablecoin.

“We just want to be sure that rETH used as collateral can be sold in a timely manner without a large price impact,” rema, a member of MakerDAO’s risk team, wrote in a governance forum earlier this year. “It is fair to say that current liquidity is not sufficient.” 

Driving DeFi Integrations

After this week’s approval of the incentives committee comes the hard part — crafting incentives that drive adoption, some of which have been debated in Rocket Pool’s Discord and governance forums.

“There could be direct liquidity incentives on a simple rETH-ETH pool,” Jasper said. “There may be the use of bribes on the curve or balancer ecosystems. Protocol owned liquidity is another avenue.”

Thomasg has offered to match any incentives the committee approves up until the Merge. 

“It gives people that kind of time pressure,” he told The Defiant. “It’s like, ‘Alright, like we’ve got to take advantage of this before the offer expires.”

Among the few voices to oppose liquidity incentives during online debates over the past year, pseudonymous community member mbs says doing so would waste money – particularly if it is funded via token inflation. 

“It’s difficult to say if the people who stayed in the pools would have been there regardless of extra incentives,” they wrote. “Most people just farm incentives and run imo, hence just giving away free money at the cost of long term RPL price.” 

The incentives committee will have an annual budget of 67,500 RPL — about $140,000 per month — funded by existing inflation in RPL tokens.

“The ability to drive liquidity with this budget is not ideal,” Jasper said. “However, it is enough to begin and understand better exactly how much inflation we need.”

Chainlink Feed

In a best-case scenario, the liquidity incentives would generate the trading volume required for a Chainlink price feed, Jasper said. That would allow for rETH integration with DeFi apps such as Aave, Compound and more.

Incentive committee member Uisce recently summed up the problem facing Rocket Pool in the protocol’s governance forum.

“rETH is completely absent from DeFi in any meaningful way and this is largely a self-inflicted problem,” they wrote. “We must have integrations for Rocketpool to be successful. We can not achieve integrations without liquidity. Trading volume alone is not sufficient to attract liquidity regardless of timeframe. Liquidity incentives have proven to be extremely effective at attracting liquidity.”