1RC: Deploy $1 Million USDC into Diversified Staked ETH Index ($dsETH)

2.0 1inch DAO
1

1RC: Deploy $1 Million USDC into Diversified Staked ETH Index ($dsETH)

Authors: @Kene_StableLab _, _@Bobby_StableLab

References
https://dune.com/index_coop/dseth
https://www.rated.network/dseth?network=mainnet&timeWindow=30d
https://indexcoop.com/blog/understanding-the-diversified-staked-eth-index-dseth
https://app.indexcoop.com/dsETH

Simple Summary

1IP-XX aims to invest $1 Million USDC into the Diversified Staked ETH Index ($dsETH).

Abstract

1IP-XX will utilize the idle USDC in the treasury to acquire staked ETH via the Diversified Staked ETH Index ($dsETH). This creates another revenue stream for the protocol through the yield earned on these ETH liquid staking derivatives.

Motivation

With the 1inch Treasury, we have a valuable opportunity to generate significant yield for the treasury through the Diversified Staked ETH Index; with the Shanghai Upgrade around the corner, this investment could not be more timely. With access to multiple Ethereum Liquid Staking Derivatives, this investment will enable us to earn up to 4.86% APR (At the time of writing this) on this investment.

Shanghai Upgrade

Investing before the Shanghai Upgrade.
The biggest concern with investing in ETH liquid staking derivatives before the Shanghai Upgradr is the possibility of negative price impact that could arise out individuals possibly selling their previously staked ETH once it becomes available.

Investing after the Shanghai Upgrade.
It could be argued that investing after the Shanghai Upgrade would be less risky, considering that any possible negative price action to ETH would have blown over and the ETH market would have normalized after this upgrade.

Specification

Current State of 1INCH Treasury

There is currently $17 Million worth of assets contained in the 1inch Treasury, out of this total, $15 Million is in USDC, and there is about $600,000 worth of ETH in the treasury.

If this proposal passes, there would be an increase in the amount of ETH in our treasury to $1,600,000 worth of Ethereum Based Liquid Staking Derivatives and ETH.

What is an Index Token?

These tokens provide exposure to multiple assets through one token; an index is made up of various assets which have been put together in line with an Index Methodology; this methodology spells out the criteria based on which a particular asset has been selected to form part of an Index.

What is dsETH?

dsETH is an index token that is made up of the leading Ethereum liquid staking tokens. Holders of dsETH earn staking yield while incentivizing liquid staking protocols to be more efficient and decentralized. dsETH selects the assets that comprise the index through an inclusion criteria and weighting strategy that favor decentralized liquid staking protocols. dsETH currently comprises the following liquid staking derivatives.

dsETH is a fork of Set Protocol v2, with no changes being made to the core code. It has a similar infrastructure to other Index COOP products such as $DPI, $MVI & $BED.

The dsETH methodology

The dsETH methodology’s goal is to provide token owners with diverse exposure to liquid staking tokens, with a weighting that favors decentralized liquid staking protocols as determined by the number of node operators and the allocation of stake among node operators.

For a token to be included in this Index, a number of conditions must be met.

  • Liquid staking tokens must be available on the Ethereum blockchain
  • Liquid staking tokens must have a minimum of $25m secondary market liquidity on Ethereum mainnet
  • Liquid staking tokens must have a 30d Net APR that is not 10% below the mean Net APR for the largest liquid staking tokens
  • Staking protocols must be audited and reviewed by security professionals to determine that security best practices have been followed
  • Staking protocols must also be in operation long enough for the decentralized finance community to arrive at a consensus regarding its safety
  • Staking protocols must be open source
  • Staking protocols must have a bug bounty program
  • No single client can account for two-thirds (2/3) of a liquid staking protocol’s client distribution.

NB: In addition to the conditions above, a Node Operator Factor is also considered, this benefits staking protocols with more active node operators. Also, an HHI (or Herfindahl-Hirschman Index) Factor is then added, which measures the concentration of stake and broader competition amongst active node operators within each protocol.

How much could we make in return?

dsETH offers a weighted aggregate APR of the liquid staking tokens represented as an interest-bearing index token. Token holders do not need to worry about claiming prizes or starting taxable events because the execution layer and staking rewards obtained by the components gradually increase the net asset value of dsETH. The gross annual percentage rate (APR) of dsETH would be about 5% based on historical statistics since the Merge.
The core staking rate, execution layer rewards, and other factors under the control of liquid staking protocols, including commission rates, MEV management, and slashing insurance, determine prospective returns. According to conservative estimates, dsETH might eventually have a Net APR of 4-6%. A higher APR can be caused by more execution layer rewards and less protocol-level commission. In contrast, a lower APR can be caused by lower staking reward rates and protocol-level slashing penalties.


_ Historical returns of assets contained in the dsETH Index_

Fees.

Instead of charging a commission or performance fee for staking or execution layer rewards on the index, Index Coop uses a flat streaming fee of 0.25% annually. The net annual percentage rate (APR) for holders of dsETH tokens since the merge is roughly 4.75% (or the 5.10% Gross APR minus the 0.25% streaming charge).

Acquisition of dsETH

There are multiple methods to acquire dsETH;

  • Swap: We could swap USDC to dsETh, but this would not be a reasonable approach because dsETH currently has a market cap of $600,000; performing a swap would result in a significant price impact during the swap.\
  • Flash Mint: By minting fresh units from the underlying product components, Flash Mint can enable more cost-effective large exchanges than traditional DEX trades. This is especially useful when the cost of slippage would be greater than the gas expense for purchasing each token and producing a fresh batch of the goods.

You can mint a new unit using Flash Mint after indirectly purchasing an index’s constituent parts. Here is an illustration of how that functions for the Index Coop DeFi Pulse Index (DPI):

You send the contract in your preferred currency (ETH, USDC, or DAI).
Your money is converted into the precise quantity of underlying DPI assets required to create new units.
You receive new DPI units in your wallet along with the old ones.

If this proposal passes, we will acquire dsETH through a flash mint process and will liaise with the Index Coop Team to help facilitate this institutional purchase.

Multi-sig

If this is executed via safesnap, there will be time delay of 5 days due to snapshot and additional delays due to safesnap execution. This means atleast 5 days for price slippage which is not efficient. Instead we propose executing it via a multi-sig.

$1M USDC will be moved into the community Multisig and executed from there to reduce the impact of slippage. Once the transaction is completed, the funds will be transferred to treasury.

Community Multi-sig Members:

  • StableLab
  • RoundElephant
  • Natalia
  • DAOPlaomats

Rationale
Putting idle assets to use is the first step in developing the 1inch DAO Treasury Management Strategy that will ensure that we create value on behalf of the 1inch DAO through investments; through this investment in dsETH, we are signaling to the ecosystem that the 1inch DAO has a long term conviction in the economic utility of ETH, while we position the DAO to benefit from the growth of ETH significantly.

dsETH ensures that we are not reliant on one liquid staking derivative. Instead, we leverage various liquid staking derivatives while Index Coop manages the weighting of the assets depending on the yield they provide, their liquidity, node operator distribution, transparency and security. With dsETH, we can effectively diversify our investments into LSDs.

Considerations
The primary consideration for this investment is risk. Apart from smart contract risk and oracle risk,. There is also currency and liquidity risk.

  1. Currency Risk: There are currently no pegs in place to stop the trading of liquid staking tokens above or below their fair value in ETH because withdrawals from the Beacon Chain are not yet possible. As a result, the market determines how much various liquid staking tokens cost. However, with the Shanghai Upgrade, this is about to change, withdrawals from the Beacon Chain will become possible, and this risk will be eliminated.

  2. Liquidity Risk: Where there is persistent and/or significant sell pressure, liquidity will impact the price of a specific liquid staking token. Since the price of the tokens that make up dsETH determines the worth of the Index, a single liquid staking token’s low or poorly managed liquidity might cause the index’s value to decline when prices are falling. Because of this, a liquid staking token must have a certain level of secondary market liquidity in order to be included in dsETH. However, this risk will not persist for long since direct redemptions of liquid staking tokens will be possible once withdrawals from the beacon chain are enabled, and with the Shanghai Upgrade on the horizon, these risks will soon be eliminated.

Next Steps
After putting this proposal through the governance process and incorporating feedback from the community, we would do the following.

  • Conduct a Snapshot Vote
  • If the proposal is passed, then we will reach out to the Index Coop Team to make the investment.
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