God save the king! Welcome to the April edition of the DeQuantifi monthly newsletter. Each month, we bring you a summary of the crypto news from a UK and European perspective, along with a feature article, where we discuss a topic in depth.
This month, we discuss MiCA, the proposed EU regulatory framework, and look into the impact of the Shapella release on Ethereum. In our feature article we take a look at Liquid Staking Derivatives (LSDs).
Please feel free to forward to anyone you feel may find this interesting.
Shapella Upgrade Goes Live, ETH price soars to over 2100
Shanghai-Capella, also known as Shapella, went live on the Ethereum mainnet at 10.27pm UTC on 12 April. Shapella is the latest and last major release in Etherem’s Proof of Stake roadmap. It allows validators on the Ethereum network to withdraw their stake from the network.
In the run up to Shapella, ETH underperformed compared to BTC. Why was this?
- The most obvious reason is that the Shapella upgrade was expected by some to create selling pressure as stakers withdraw and sold their ETH, with $2billion worth of ETH rewards becoming available for withdrawal
- Kraken has to unstake ½ million ETH after settling with the SEC
- Another reason is high gas fees, the average transaction fee is above $5
- DEX volumes on Ethereum have fallen by over 80% since early March compared with 60% on other protocols. Perhaps this indicates concerns over centralisation following the Ethereum’s switch to proof of stake?
Similar sentiment was also evident in the options market, with the ETH options vol smile showing a bearish skew (in other words, put options were more expensive than call options).
Despite the slightly bearish sentiment prior to the upgrade, the market reacted very positively following the Shapella upgrade:
- In the days following the upgrade, the ETH price exceeded $2100
- Staking withdrawals did increase, and there was an decrease in the total ETH staked, but deposits increased too. This increase in deposits is clear sign of confidence in Ethereum going forwards
- The number of validators increased, another sign of confidence in Ethereum
The selling pressure that some had predicted did not materialise because of the mechanisms put in place that limited the amount of ETH that could be unstaked on any given day. On the other hand, the number of deposits and validators actually increased, not only reducing the supply of tokens and driving up the price of ETH, but also signalling confidence in the future of the Ethereum network.
Markets
Elsewhere in crypto markets, BTC has had a very eventful couple of months. BTC/USD broke 30,000 for the first time since last June, hash rates and difficulty are higher than ever, and 75% of the supply is in profit. In addition, the correlation between BTC and US Equities is rapidly decreasing, adding credibility to the view that BTC can be used as a hedge against traditional markets. BTC Options volumes had their second highest month ever in March, with $32 billion traded across the main exchanges, but dropped back to $22 billion in April.
Legal & Regulatory
The big news in Europe is that MiCA (Markets in Crypto Assets) regulation has been passed by the EU parliament by 13:1. Technically, it still needs to be passed by the European Council, but that is considered a formality, and MiCA is expected to come into effect next year. It has been well received by the crypto community, with Binance and Coinbase both calling it “pragmatic”, and Gemini noting the lack of similar legislation in the US.
By contrast, it seems that the crypto industry is becoming frustrated with the lack of regulatory clarity in the US. Brian Armstrong, the CEO of Coinbase, warned that Coinbase could move outside the US. Coinbase have accused US regulators of not having clear rules for digital assets and of “regulating by enforcement”. Coinbase have also filed an “Administrative Procedure Act”, which requests that a US federal court forces the SEC to provide regulatory clarity. Just days after the warning from Armstrong, Coinbase received its Bermuda license, which is most likely linked to its plans to add perpetual swaps to its offering via an offshore platform. Gemini too, revealed last month that they are planning to launch perpetuals on an offshore derivatives platform.
It looks like that frustration is shared by at least some US politicians. Gary Gensler, the SEC chairperson, appeared in front of the House Financial Services Committee. The meeting showed that there was much dissatisfaction amongst Republicans with Gensler’s approach to digital assets. In a key moment, Gensler was repeatedly pressed by the committee chair, Senator Patrick McHenry, to clarify whether Ethereum was a security or commodity. You can see the exchange here
Despite the controversy, the SEC charged Bittrex with operating an unregistered exchange. Bittrex was a big crypto player back in 2017, but most of its market share has been eaten by Binance. However, what is interesting is that this case could set a precedent for the SEC and bigger industry players.
Whilst crypto-exchanges have been under the spotlight from regulators, Decentralised Exchanges have not completely escaped scrutiny either.The US Treasury and French Central Bank both published reports on DeFi, and how well it meets anti-money laundering regulations. The key points were:
- DeFi has been subject to recent hacks, such as those by North Korea, who have been using DeFi to launder funds
- Whilst the open source model allows the community to find and fix weaknesses, it also allows attackers to find and exploit them
- Going forward, central banks need to engage more with private sector projects
- There should be a set of minimum standards for DeFi projects
However, there are at least some authorities that are embracing blockchain, the technology that underpins cryptocurrencies. The Bank of England and the Bank for International Settlements (BIS) have been testing distributed ledger technology for interbank transactions. The initiative, named Project Meridian, co-ordinates payments, such as central bank money, with delivery of assets.
Companies & Products
TradFi and other non-crypto companies are increasingly getting involved in crypto. Last month, the LSE announced that they were launching a clearing service for Bitcoin index derivatives traded on GFO-X via their French clearing house, LCH SA. Also last month, SocGen’s crypto division, SG Forge, has launched an EUR stablecoin, EuroCoinvertible (EURCV) on the Ethereum protocol. Microstrategy has bought another 1,045 BTC at a cost of just under $24 million, bringing its total holdings to 140,000 BTC. For those who don’t know, Microstrategy is a NASDAQ listed US business intelligence software company that has been using Bitcoin as a treasury reserver asset since 2020.
Deribit, the European crypto derivatives exchange that leads the crypto options market, has been busy. Following up their launch of volatility futures in March, they have launched spot trading on their platform, allowing traders to construct multi-leg strategies on a single platform.
Talking of options, Bumper.fi, a DeFi protocol aiming to provide price protection using barrier options, has publicly released its Litepaper.
Last month, we reported that Arbitrum had airdropped ARB, its governance tokens. However, decentralised governance hasn’t all been plain sailing for Arbitrum. The Arbitrum Foundation, the centralised organisation responsible for the development of Arbitrum, set up a 750 million ARB ($1 billion) special grants programme, named AIP-1, proposing that The Foundation can decide how the funds are spent once the overall package is approved by the DAO. However 77% voted against it. AIP-1 was subsequently broken up into a number of smaller proposals.
LayerZero raised $120 million in Series B funding, valuing the company at a cool $3 billion. LayerZero has developed infrastructure that allows interoperability and messaging across different chains. This is important because developers of DApps (Decentralised Apps) don’t need to worry about interfacing with multiple chains. The deal, which is notable for its size in the current environment, has tripled the valuation of LayerZero.
The newly launched meme coin, PEPE, has created a frenzy in crypto markets. Launched just 2 weeks ago, it has entered the top 100 cryptocurrencies with a market capitalisation of over $580 million. One MEV arbitrageur was able to take advantage of the demand for PEPE using sandwich attacks, making $2 million (and driving up gas fees in the process).
Crime
SushiSwap, the decentralised exchange, suffered an exploit related to a bug in their RouterProcessor2 contract. One user, 0xSifu, lost 1800 ETH ($3.3 million) in the attack. The bug allowed attackers to bypass authorisation checking on transactions. Yearn Finance, the decentralised yield farming platform, lost $11.6 million through an exploit of old versions of its contracts. It’s not just DeFi that has been hacked either. Bitrue, a Singapore based crypto exchange, suffered an attack, losing $23 million worth of SHIB, ETH, QNT, GALA, HOT and MATIC tokens.
A number of long dormant BTC addresses have suddenly become active. In the most prominent of such cases, over 2000 BTC ($60 million) was transferred out of a Bitcoin address that has been dormant for over a decade. Many have speculated that the reason for such activity is because there are ongoing wallet draining attacks against older wallets.
A Primer on Liquid Staking Derivatives
This month, we’ll introduce Liquid Staking Derivatives (LSDs) because the Shapella upgrade has shone the spotlight on them.
Let’s start with a little history. This helps us understand the problems that LSDs solve.
In Sep 2022, Ethereum migrated from Proof of Work (PoW) to Proof of Stake (PoS). Preceding this, there was a period when both PoW and PoS chains ran in parallel, with the PoS chain (called the Beacon Chain) launching in Dec 2020. Since this date, investors and enthusiasts have been able to stake their ETH and earn rewards by validating blocks. However, there were some issues:
- The minimum staking amount is 32ETH (around $64,000)
- The stake could not be withdrawn until Shapella went live last month
- The investor would have to spin up their own validator node, which requires the purchase of hardware as well as considerable technical expertise
To address these issues, Lido created a token, stETH, backed by staked ETH. When an investor buys a stETH from Lido, Lido issues the stETH token, and then pools all the ETH from the sales of stETH and uses those proceeds as a stake on the Ethereum blockchain, where it will earn staking rewards, which are distributed back to the stETH investors (after Lido has taken a fee). The issues above are addressed because:
- Minimum staking amount of 32ETH – an investor can buy fractions of a stETH on an exchange (1 stETH is approximately equivalent in value to 1 ETH)
- Stake could not be withdrawn – stETH can be sold (and bought) in the secondary market, thereby allowing an investor to unlock their investment whenever they want
- Investor would need to spin up their own validator node – this is taken care of by Lido
Lido is no longer the only LSD:
Whilst Lido has by far the largest market share and therefore the most liquidity, some of the other tokens have their own benefits. We’ll discuss a couple of the most interesting below.
RocketPool (rETH) focuses on decentralisation. One concern within the Ethereum community is that Lido centralises staking power, making an attack more likely. If an attacker can control more than 33% of the staked ETH, they can prevent the chain from being finalised. With RocketPool, anyone can run a node, including those who are not technically inclined, as long as they have 16 ETH. Rocketpool will then match stakers looking to join a Roketpool node to get to the 32 ETH minimum. In return for joining a Rocketpool node, the stakers will receive eETH tokens.
Frax (sfrxETH) is the fastest growing LSD, growing by 40% in Jan 23 alone. This will undoubtedly be down to the outstanding yield offered by Frax, almost double that offered by the others. To understand why, we need to delve into the Frax ecosystem. As an ETH holder, I can exchange my ETH for frxETH in the frxETH minter. Then, if I want to earn staking rewards, I exchange my frxETH in the sfrxETH Vault, and receive sfrxETH (Staked Frax Ether) in exchange. In this ecosystem, there is a second way to earn a return, and that is through yield farming. frxETH is eligible for farming rewards from the Curve/Convex ecosystem. However, those frxETH holders who choose to farm will not stake, and the ETH they deposit on the minter will still earn a staking reward, which is distributed amongst the sfrxETH holders, leading to a higher staking yield.
How has Shapella impacted LSDs?
- Since the staked ETH is no longer locked, one of the reasons for using LSDs has gone; could this lead to a reduction in demand?
- On the other hand, Shapella could also lead to a rise in the amount of ETH staked, thereby increasing demand for LSDs since they are a very easy way to participate in staking ETH
The graph of stETH price showed that it experienced a surge in price following Shapella upgrade on 12th Apr, and while some of the gains have been lost, the price is still significantly higher than pre-Shapella levels, demonstrating once again the market’s confidence in the future of ETH.
About Us
DeQuantifi is a consultancy that builds bespoke risk, pricing and other quantitative software solutions for organisations that trade crypto. What sets us apart from our competitors is that we leverage our proprietary crypto library to deliver value quickly whilst making sure that the solution is tailored to you.
The material provided herein is for informational purposes only and should not be construed as investment advice or an offer or solicitation to buy or sell securities.