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

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Listed:
  • Xihan Xiong
  • Zhipeng Wang
  • Xi Chen
  • William Knottenbelt
  • Michael Huth

Abstract

Lido, the leading Liquid Staking Derivative (LSD) provider on Ethereum, allows users to stake an arbitrary amount of ETH to receive stETH, which can be integrated with Decentralized Finance (DeFi) protocols such as Aave. The composability between Lido and Aave enables a novel strategy called "leverage staking", where users stake ETH on Lido to acquire stETH, utilize stETH as collateral on Aave to borrow ETH, and then restake the borrowed ETH on Lido. Users can iteratively execute this process to optimize potential returns based on their risk profile. This paper systematically studies the opportunities and risks associated with leverage staking. We are the first to formalize the leverage staking strategy within the Lido-Aave ecosystem. Our empirical study identifies 262 leverage staking positions on Ethereum, with an aggregated staking amount of 295,243 ETH (482M USD). We discover that 90.13% of leverage staking positions have achieved higher returns than conventional staking. Furthermore, we perform stress tests to evaluate the risk introduced by leverage staking under extreme conditions. We find that leverage staking significantly amplifies the risk of cascading liquidations. We hope this paper can inform and encourage the development of robust risk management approaches to protect the Lido-Aave LSD ecosystem.

Suggested Citation

  • Xihan Xiong & Zhipeng Wang & Xi Chen & William Knottenbelt & Michael Huth, 2023. "Leverage Staking with Liquid Staking Derivatives (LSDs): Opportunities and Risks," Papers 2401.08610, arXiv.org, revised Feb 2024.
    • Handle: RePEc:arx:papers:2401.08610
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    References listed on IDEAS

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    1. Lee, Seungju & Lee, Jaewook & Lee, Yunyoung, 2023. "Dissecting the Terra-LUNA crash: Evidence from the spillover effect and information flow," Finance Research Letters, Elsevier, vol. 53(C).
    2. Lioba Heimbach & Eric Schertenleib & Roger Wattenhofer, 2023. "DeFi Lending During The Merge," Papers 2303.08748, arXiv.org, revised Aug 2023.
    3. Jiageng Liu & Igor Makarov & Antoinette Schoar, 2023. "Anatomy of a Run: The Terra Luna Crash," NBER Working Papers 31160, National Bureau of Economic Research, Inc.
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