ARK Invest says accumulated Ether sets a benchmark for the cryptocurrency economy

• It is difficult for projects to beat the returns offered by ether betting on a risk-adjusted basis.
• Thus, the asset and its yield have become a benchmark for the cryptocurrency economy in a similar way to the federal funds rate and the traditional economy.

Slowly but surely, Ethereum (stETH) is becoming the standard for the entire chain economy.

according to New report From investment management firm ARK Invest Ethereum’s monetary policy has turned ether into a unique type of asset – one akin to sovereign bonds.

“The signature yield on ETH is a measure of smart contract activity and economic cycles in the digital asset space, just like the federal funds rate in traditional finance,” wrote Lorenzo Valente, research associate at ARK Invest.

Comparing betting ether to sovereign bonds

Ethereum is designed in a way that Ethereum (ETH) holders can stake their tokens, essentially locking them in the network in exchange for a return. At the time of writing, accumulating Ether yield was generating an annual yield of 3.27%, according to CoinDesk CESR data.

There is also a so-called liquid signature token, stETH, from Lido Projectwhich Ethereum miners can redeploy into DeFi protocols.

The fact that accumulated ether produces a return makes the asset similar to sovereign bonds, which are debt securities issued by governments to finance themselves. Investors can buy this debt and earn interest on it over time.

But the report said that pledged ether differs from bonds in several crucial aspects.

Some differences are positive. For example, while governments can default on their debt obligations – as Argentina did in 2020 – Ethereum cannot default on its debt obligations. The network is programmed to allow users to access their funds whenever they want, and the yield is designed to continue to be issued no matter what happens, although the interest rate will vary depending on activity on the chain. Another big risk to bonds is inflation. If the government prints too much money and the inflation rate exceeds the bond yield, investors end up losing purchasing power.

Ether can also suffer from inflation (as it currently does) if network activity slows so much that ether issuance ends up exceeding the ether burn rate – a mechanism that removes a portion of ether from circulation every time a transaction is made. However, on-chain data makes Ether’s inflation rate more transparent. Data collector Ultrasound. the money He appearsFor example, over the past 30 days, Ether supply has increased at a rate of 0.33% per year.

But exposure to betting ether also comes with its own risks. The accumulated ether can be destroyed by the network, for example, if validators are used – entities with which investors share ether; Their role is to process transactions – that is, to suffer an operational malfunction, or to behave in a way that is harmful to the network. This is known as “chipping”.

While government bonds come with political and regulatory risks, they won’t be obliterated by an automated system if anything goes wrong.

Finally, the main attraction of sovereign bonds is their lack of volatility. If the issuing country is stable, they are usually considered low-risk investments, and are sometimes even considered cash-like instruments. Ether itself is considered very volatile: at the time of writing, the value of the cryptocurrency has risen by 65% ​​in the past 12 months. Naturally, this means that investors cannot classify betting ether in the same low-risk category as bonds.

“While both can be affected by inflation, interest rate changes and currency depreciation, the nature and impacts of those risks can differ significantly,” the report said. “In addition, staking ETH introduces unique risks related to network security, validator behavior, and smart contract errors, which have no direct counterpart in traditional sovereign bonds.”

Growing usage in DeFi

Generally, there are two different ways investors can stake ether: by setting up their own validators, or through specialized DeFi protocols like Lido (LDO) or Rocket Pool (RPL). These protocols cooperate with trusted auditors and implement all technical aspects of collection for their clients.

More importantly, it also offers Liquid Storage Tokens (LSTs), which represent the amount of ether that an investor has deposited into the network. This is a huge benefit, because even though their Ether is locked out of the profit return, investors can continue to use stETH tokens (most commonly LST) for additional purposes – for example, as collateral in lending protocols.

This advantage is so great that stETH has begun to replace ETH as the collateral of choice in the DeFi economy.

“Today, the total supply of stETH as collateral in DeFi is approximately 2.7 million, or approximately 31% of the total supply of stETH,” the report said, noting that investors prefer it over other crypto assets because of the “capital efficiency it provides to users and liquidity providers.” And market makers.”

“Currently, the preferred collateral on Aave V3, Spark, and MakerDao, which are 1.3 million stETH, 598,000 stETH, and 420,000 stETH, respectively, are locked in those protocols and used as collateral for issuing loans or crypto-backed stablecoins,” she added.

become the standard

With stETH widely used across the largest DeFi protocols, the accumulated ether is slowly forcing the rest of the cryptocurrency financial system to reorganize itself, the report said.

This is because projects need to convince investors that their own assets, on a risk-adjusted basis, will provide higher returns than simply betting on ether, and doubling those returns.

“If ETH returns 4% after accumulating over seven years, [a] Closed-end fund should outperform ETH by more than 31% [over that period of time]Even without taking into account price increases, the report said.

This is one of the reasons why competing tier-one projects – such as Solana (SOL) or Avalanche (AVAX) – all offer higher interest rates for investors to stake their tokens. The point is that these assets are riskier and more volatile, and investors need to be incentivized by higher returns to hold them for the long term.

Demand for accumulated ether has also put pressure on DeFi protocols in the stablecoin lending space, according to ARK Invest.

For example, Sky (SKY) (formerly MakerDAO) was forced to increase the interest rate on locked DAI (the protocol’s native stablecoin) after significant selling pressure and a decline in circulating supply, the report said. Furthermore, investors in Aave (AAVE) and Compound (COMP) are seeing increased rewards for lending stablecoins – because users prefer to lend stETH and borrow stablecoins, rather than lending stablecoins directly.

In other words, the more stETH gains market share, the more the cryptocurrency economy will start making choices based on ether returns. This means that ether could play the same role in cryptocurrencies as the Federal Reserve funding rate does in the global financial system.