# Collateral Risk Assessment - Swell Network's swETH


### Useful Links

Website: [Swell Network](https://www.swellnetwork.io/)
Documentation: [Documentation](https://docs.swellnetwork.io/swell/what-is-swell) | [Github](https://github.com/SwellNetwork)
Social: [Twitter](https://twitter.com/swellnetworkio) | [Discord](https://discord.com/invite/swellnetworkdao) | [Linkedin](https://www.linkedin.com/company/swellnetworkio/)
Contracts: [swETH](https://etherscan.io/token/0xf951E335afb289353dc249e82926178EaC7DEd78) | [Deposit Contract](https://etherscan.io/address/0xb3D9cf8E163bbc840195a97E81F8A34E295B8f39) | [Node Registry](https://etherscan.io/address/0x46DdC39E780088B1B146Aba8cBBe15DC321A1A1d) | [Repricing Oracle](https://etherscan.io/address/0x289d600447a74b952ad16f0bd53b8eaaac2d2d71) | [Access Control Manager](https://etherscan.io/address/0x625087d72c762254a72CB22cC2ECa40da6b95EAC)
Governance: [Forum](https://forum.swellnetwork.io/)
Markets: [UniV3 ETH/swETH](https://etherscan.io/address/0x30ea22c879628514f1494d4bbfef79d21a6b49a2) | [UniV3 ETH/swETH 3](https://etherscan.io/address/0x4ac5056de171ee09e7afa069dd1a3538d2381565) | [UniV3 GRAI/swETH](https://etherscan.io/address/0x00e8d9811c8fee0d8dedbe4891fafda493d6ac66)
Dashboards: [swETH in DEXs](https://dune.com/swell-network/sweth-in-dexes) | [swETH dashboard](https://dune.com/swell-network/sweth-in-dexes) | [Swell Network V3](https://dune.com/swell-network/swell-network)

## Introduction

**This report is conducted by the Prisma independent risk and research team operated by [Llama Risk](https://cryptorisks.substack.com/) as part of a series on LSD collateral risk assessments. In this report, we examine Swell Network’s swETH.**

This report will comprehensively cover all relevant risk factors of swETH for collateral onboarding. Our approach involves both quantitative and qualitative analysis to help determine whether the collateral can be safely onboarded and to what extent there should be restrictions on the protocol’s exposure to the collateral.

As Prisma will be onboarding a variety of LSDs as collateral, our review involves comparative analysis to determine suitability as collateral. Risks are categorized into:

- **Market Risk** - risks related to market liquidity and volatility
- **Technology Risk** - risks related to smart contracts, dependencies, and oracle price feeds
- **Counterparty Risk** - risks related to governance, centralization vectors, and legal/regulatory considerations

These risk categories will be summarized in the final section of this report and are meant to assist tokenholders in their determination around swETH onboarding and setting suitable parameters.

# Section 1: Protocol Fundamentals

This section addresses the fundamentals of the proposed collateral. It is essential to convey (1) the value proposition of swETH, and (2) the overall architecture of the Swell protocol. This section contains descriptive elements that cannot be quantified and serves as a descriptive introduction to the collateral.

This section is divided into 2 sub-sections:

- 1.1: Description of the Protocol
- 1.2: System Architecture

## 1.1 Description of the Protocol

**Key Metrics (as of October 6, 2023):**

* **Circulating Supply:** 46,989.73 swETH
* **Staked Tokens:** 48,774 ETH
* **Number of validators:** 1,517 active
* **Number of operators (mainnet):** 8
* **Market Share of ETH staked:** 0.04%
* **Market Share of LSDs:** 0.4%

### 1.1.1 Underlying Collateral

Swell's liquid staking product introduces the swETH token, serving as a representation of a user's staked ETH on Ethereum. When a user chooses to stake their ETH with Swell, they interact with the [swETH contract](https://etherscan.io/token/0xf951E335afb289353dc249e82926178EaC7DEd78). Upon this action, an equivalent share of swETH, Swell's liquid staking token, is minted to the user. This staked ETH is then moved to the [DepositManager contract](https://etherscan.io/address/0xb3D9cf8E163bbc840195a97E81F8A34E295B8f39). Here, it is combined with other staked ETH until a batch of 32 ETH is deposited. Once this amount is accumulated, the next validator(s) from the [NodeOperatorRegistry contract](https://etherscan.io/address/0x46DdC39E780088B1B146Aba8cBBe15DC321A1A1d) is selected using a systematic round robin process. A deposit is then made into the Ethereum deposit contract with the validator key(s). This validator is then placed in a waiting line, set to be activated in the consensus layer.

### 1.1.2 Yield Accrual Mechanism

Swell's staking system offers rewards that can be broadly categorized into two main types:

**Consensus Layer Rewards:** These rewards are the standard ETH issuance given to validators for their role in attesting transactions and proposing blocks. The rewards in this category are combined with the staked ETH and remain 'locked' in the system.

**Execution Layer Rewards:** This category encompasses "tips" (also known as priority fees) and the Maximum Extractable Value, commonly referred to as "MEV." This category of yield tends to be highly volatile, being influenced by current demand for blockspace.

The swETH token represents the user's staked ETH, including any rewards or penalties from the consensus layer, as well as MEV (Miner Extractable Value) and 'tips' from the execution layer. While the quantity of swETH tokens a user holds remains constant, the swETH:ETH exchange rate increases over time (i.e. it is non-rebasing). The appreciating internal exchange rate is the method by which staking rewards are distributed to tokenholders.

For stakers, the rewards obtained from the consensus layer are locked, and this is mirrored in the progressively increasing exchange rate. Likewise, the rewards from the execution layer are fully restaked, effectively compounding them back into the staking pool. Both types of rewards are accounted for in updates to the exchange rate, ensuring it reflects the true value of the staked assets.

### 1.1.3 Provider Fee

A clear distribution structure has been established for the total rewards earned, ensuring transparency for all involved parties. The current distribution is as follows:

| Entity | Total Rewards Distribution |
| ------------------ | -------------------------- |
| Staker | 90% |
| Node Operator | 5% |
| Swell DAO Treasury | 5% |
| Total | 100% |

The illustration below shows the portion of fees that Swell collects from staking rewards:

Source: [TokenTerminal](https://tokenterminal.com/terminal/projects/swell)

### 1.1.4 Node Operator Set

Swell has assembled a permissioned group of 8 professional node operators to make up its initial node operator set. This method ensures that only a curated group of professional node operators, meeting specific criteria, are allowed to participate.

The primary criteria for the selection of the node operators were:

1. Demonstrated technical expertise and commercial experience, underscored by a consistent record of security, stability, and on-chain performance, complemented by evident risk management practices.
2. The capability to enhance Swell's objectives of maximizing diversity and decentralization across various domains, such as geographies, server types, and client categories.

The selection emphasizes the importance of diversity and decentralization across various parameters, such as geographic location, server types, and client categories. This permissioned approach is a foundational aspect of Swell's security measures. Distributed validator technology (DVT) will be employed as a risk mitigation technology in future iterations. Swell has stated plans to transition to permissionless participation as a node operator at some point in the future.

### 1.1.5 Validator Selection

Swell employs a permissioned approach in its validator selection process. Whitelisted node operators have access to an operator app that allows them to upload, validate, and submit their validator keys on-chain. Node operators can submit keys in chunks of 50 and must specify the Swell Deposit Manager contract as the withdrawal address.

The deposited ETH from the swETH contract is sent to the Deposit Manager contract and "pooled" until the amount of ETH reaches a 32 ETH threshold. Once this threshold is reached, a validator is selected from the Registry Contract via a round-robin algorithm. This validator key, along with the 32 ETH, is then deposited into the Ethereum deposit contract. The validator then waits in the activation queue for participation in the consensus layer.

### 1.1.6 Validator Collateralization

According to the process described in section 1.1.5, validator keys and user deposited ETH is allocated to Node Operators without any collateral requirements.

### 1.1.7 Governance Model

Swell protocol is currently governed by team members, investors, node operators and advisers ([Ecosystem Council](https://www.swellnetwork.io/post/meet-the-ecosystem-council) of 7 influential DeFi contributors). Although the Swell protocol documentation collective [refers to Swell DAO](https://docs.swellnetwork.io/swell/governance-and-tokenomics) and promises the launch of the SWELL token over community channels like Twitter ([thread](https://twitter.com/swellnetworkio/status/1664096883613253634) also reveal SWELL tokenomics), the Swell protocol is still under the control of the Swell Labs team and the aforementioned interest/operational groups.

### 1.1.8 Funding Source

Swell [raised $3.75m](https://pitchbook.com/profiles/company/493604-11#overview) in a seed round from 25 investors (3/14/2022).

Source: [Swell website](https://www.swellnetwork.io/)

## 1.2 System Architecture

### 1.2.1 Network Architecture Overview

When users stake their ETH in the Swell swETH contract, they receive an equivalent value of Swell's liquid staking token. This staked ETH is then transferred to the Deposit manager contract, where it's pooled until reaching a minimum of 32 ETH. Subsequently, the next validator(s) from the registry contract are chosen using a systematic selection process. A deposit is then initiated into the Ethereum deposit contract using the selected validator key(s). Once this step is completed, the validator enters a waiting phase, set to be activated in the consensus layer, allowing them to start processing transactions and proposing blocks.

swETH, an ERC20 token, represents a user's staked ETH on Ethereum. It includes any rewards or penalties from the consensus layer, as well as MEV and 'tips' from the execution layer. While the number of swETH tokens remain constant, its intrinsic value can grow due to on-chain rewards. The swETH contract's exchange rate provides a measure of the total ETH staked, including rewards, against the original staked ETH amount.

The Swell team operates a bot that is trusted to accurately reprice swETH's internal exchange rate depending on ETH in the system. The bot typically reprices daily and is constrained by parameters on the frequency and magnitude of repricing updates. An integration with Chainlink proof-of-reserve additionally protects against unbacked minting by using a network of nodes to verify the daily system ETH balance on the consensus layer. This data aids in determining the swETH amount to be minted during staking and repricing swETH.

swETH cannot be redeemed at this time, and can only be swapped on several decentralized exchanges. The Swell team has stated plans to activate withdrawals in a future upgrade, by early 2024. At the current moment, the system is governed by a multisig. There are further plans to pass the control of the smart contract parameters by creating Swell DAO through the 'voyage' which is scheduled to launch in early 2024.

### 1.2.2 Architecture Diagram

Source: [Swell Documentation](https://docs.swellnetwork.io/swell/system-design/staking-with-sweth)

# Section 2: Performance Analysis

## 2.1 Usage Metrics

This section evaluates swETH from a quantitative perspective. It analyzes token usage and competitive metrics, and addresses any subsidized economic activity.

This section is divided into 3 sub-sections:

- 2.1: Usage Metrics
- 2.2: Competitive Analysis Metrics
- 2.3: Subsidization of Economic Activity

### 2.1.1 Total Value Locked (TVL)

ETH deposits into Swell were quite strong from inception in April 2023 until July, and has since tapered off. Total Value Locked in Swell protocol:
<iframe width="640px" height="360px" src="https://defillama.com/chart/protocol/swell?denomination=ETH&theme=dark" title="DefiLlama" frameborder="0"></iframe>

Source: [Defi Llama](https://defillama.com/protocol/swell)

### 2.1.2 Transaction Volume

Over the observed 60-day time frame, the average daily volume was $950,914.57. The standard deviation, indicating the variability of trading volumes, was approximately $1,002,121.

On August 3, 2023, the trading volume reached its highest for the period at $5,039,231. In contrast, September 14, 2023, recorded the lowest trading volume at $776.

Source: [Coingecko](https://www.coingecko.com/en/coins/sweth) | Date: 7/22/2023 - 9/22/2023

### 2.1.3 DEX Volume

Swell has a Dune dashboard on swETH in DEXs that covers trading on the primary pools (Maverick, Balancer, Uniswap v3) as well as minor pools and cross-chain pools. As of 10/5/2023, the average 30-day MA volume is $1.08m/day.

Source: [Dune Analytics](https://dune.com/swell-network/sweth-in-dexes) | Date: 10/5/2023

Looking at share of swap volume by DEX, the primary exchange volume takes place on Maverick, Balancer, and Uniswap.

Source: [Dune Analytics](https://dune.com/swell-network/sweth-in-dexes) | Date: 10/5/2023

### 2.1.4 Average Transaction Size

The graph below illustrates the daily average transaction size of swETH over a span of approximately two months. On July 27, 2023, we observed the peak average transaction size, which reached a value of approximately 4.54 swETH. Conversely, the smallest average transaction size was recorded on September 22, 2023, with a value of roughly 0.054 swETH. Taking into account the entire period, the average transaction size of swETH hovered around 0.57 swETH.

Source: [Dune](https://dune.com/queries/3046091/5066485) | Date: 9/22/2023

The second graph presents the daily number of swETH transactions. The day with the highest transaction count was September 19, 2023, on which a total of 434 transactions took place. On the other end of the spectrum, July 24, 2023, marked the day with the fewest transactions, with only 22 transactions being recorded. Averaging out the transaction counts across the observed duration, there were approximately 187 swETH transactions per day.

Source: [Dune](https://dune.com/queries/3046091/5066485) | Date: 9/22/2023

### 2.1.5 Trading Volume to Market Capitalization Ratio

The daily volume to market cap ratio for swETH serves as an indicator of the average daily trading volume relative to its overall market cap. The present ratio stands at approximately 2.14%. In the preceding month, this metric for swETH generally fluctuated between 0.001% and 4.73%. When compared with its competitors, stETH and cbETH, which have averages of 0.14% and 0.36% respectively, swETH exhibits a notably higher trading activity in relation to its market capitalization.

Source: [Coingecko](https://www.coingecko.com/en/coins/sweth/historical_data?start=2023-06-22&end=2023-09-20#panel) | Date: 9/20/2023

### 2.1.6 Active Addresses/Users

The graph below shows the daily active swETH addresses over a two-month period. The highest number of active addresses was on September 19, 2023, with 400 addresses. The lowest was on August 16, 2023, with 93 addresses. The average number of active addresses during this period was 173 per day.

Source: [Token Terminal](https://tokenterminal.com/terminal/projects/swell) | Date: 9/26/2023

### 2.1.7 User Growth

Over the past year, the number of total active users has fluctuated. The lowest recorded day was on August 28th with 13 users, whereas the peak was observed on May 23rd with 722 users.

When compared with competitors such as Lido, there is a notable difference. Lido consistently garners daily user figures in the ballpark of 400 to 600, which equates to approximately 10 to 15 times the users compared to Swell's current metrics. Such observations align well with our earlier expectations and are consistent with the market share research on Swell detailed in Section 2.2.1.

### 2.1.8 DeFi Integrations

Shown below is the quantity of tokens deployed in various DeFi applications over time against the total supply of swETH.

Source: [Dune Analytics](https://dune.com/swell-network/swell-network) | Date: 10/5/2023

Pendle, a yield futures platform that allows users to manage yields on their yield-bearing tokens, has emerged as the primary venue for swETH in its [SY-swETH](https://etherscan.io/address/0xaa68ca9c69a4ff22203ce189ce4448d7401875e8) strategy.

The largest DEX by swETH TVL is the [Maverick swETH/WETH](https://etherscan.io/address/0x0CE176E1b11A8f88a4Ba2535De80E81F88592bad) pool, followed by Balancer and Uniswap v3.

Gravita is the only lending platform that lists swETH currently as collateral in its [swETH vault](https://etherscan.io/address/0x2b0024ecee0626e9cfb5f0195f69dcac5b759dc9).

The only other noteworthy DeFi integration is the [unshETH vault](https://etherscan.io/address/0x51A80238B5738725128d3a3e06Ab41c1d4C05C74), an LSDfi platform that allows users to mint unshETH against their LSD token and swap between LSD tokens.

## 2.2 Competitive Analysis Metrics

### 2.2.1 Market Share

swETH currently commands a market share of 0.39%, which is modest in comparison to industry giants such as Lido and Coinbase. It ranks 7th in LSD products by market cap.

Source: [DeFiLlama](https://defillama.com/lsd) | Date: 10/3/2023

There has been an overall positive trajectory in its market presence since its recent inception in April 2023. The chart below shows its market dominance over time, which peaked in August at just over 0.4% and has slightly fallen since then.

Source: [DeFiLlama](https://defillama.com/lsd) | Date: 10/3/2023

### 2.2.2 Trading Volume Share in Total LSD Trading Volume

swETH has consistently demonstrated competitve volume share within the liquid staking derivatives market compared to its size. Although derivatives like stETH and cbETH have registered high trading volumes, swETH continues to maintain a steady position.

The average daily trading volume for swETH over the last 30 days is $697,606.22. The consistent trading activity indicates sustained interest in swETH within the overall LSD market.

Daily average volume for last 30 days:

| Token | Average Daily Volume |
|---------|----------------------|
| stETH | 22,563,952.48 |
| rETH | 2,460,067.86 |
| frxETH | 2,232,886.18 |
| cbETH | 9,040,471.79 |
| sfrxETH | 337,158.21 |
| ankrETH | 334,476.93 |
| sETH2 | 555,377.21 |
| swETH | 697,606.22 |

Source: [Coingecko](https://www.coingecko.com/en/categories/liquid-staking-tokens?__cf_chl_tk=xK9pVaY1OcOkKY84caTbI.IAwWaLp7ZnEZLjWHiTX9A-1695733788-0-gaNycGzNERA) | Date: 9/26/2023

### 2.2.3 Protocol Staking Yield

The token reached its highest APY on August 31, 2023, registering at 4.33371%. In contrast, the lowest APY was observed on July 23, 2023, at 2.10573%. These data points offer insights into the potential yield range for swETH holders. The rate fluctuates based on market conditions, making it challenging to predict exact future APYs.

Source: [DeFiLlama](https://defillama.com/yields/pool/ca2acc2d-6246-44aa-ae91-8725b2c62c7c) Date: 9/22/2023

Below is a look at the daily swETH staking APY volatility:

Source: [DeFiLlama](https://defillama.com/yields/pool/ca2acc2d-6246-44aa-ae91-8725b2c62c7c) | Date: 9/23/2023

As a snapshot comparison of staking yields compared to competitors, DeFi llama reports on October 3 the following figures:

- Lido stETH: 3.60%
- Rocketpool rETH: 3.07%
- Coinbase cbETH: 3.44%
- Binance WBETH: 3.58%
- Frax sfrxETH: 3.85%
- Swell swETH: 3.86%

swETH appears to outperform its competitors on yield, which may be attributable to the fact that swETH does not currently offer withdrawals so it does not require a buffer of raw ETH to facilitate withdrawal requests.

### 2.2.4 Slashing Rate

Swell ETH has not encountered any slashing events to date. This contrasts with other staking entities such as Rocketpool's rETH and Lido's stETH, both of which have experienced multiple slashing incidents. However, it's worth noting that Swell ETH's total consensus rewards are considerably lower than its competitors, as it has only been in production since April 2023.

Comparatively larger staking entities like Coinbase's cbETH and Lido's stETH face increased risk due to the higher TVL in their systems. Despite this, their respective penalties as a percentage of total rewards are within a competitive range.

| Protocol | Slashing Events | Consensus Rewards Earned | Total Penalties Accrued | Percent Loss from Penalties |
| --------------- |:---------------:|:------------------------:|:-----------------------:|:---------------------------:|
| Swell ETH | 0 | 287.42 ETH | -0.66 ETH | 0.23% |
| Rocketpool rETH | 8 | 22,353.11 ETH | -263.28 ETH | 1.18% |
| Coinbase cbETH | 1 | 185,812.27 ETH | -756.15 ETH | 0.41% |
| Lido stETH | 11 | 363,829.20 ETH | -1,267.34 ETH | 0.35% |
| Binance WBETH | 0 | 116,384.48 ETH | -510.94 ETH | 0.44% |
| Frax frxETH | 0 | 3,620.96 ETH | -6.27 ETH | 0.17% |

Source: [Rated.Network](https://www.rated.network/o/Swell?network=mainnet&timeWindow=all&viewBy=aggregate) | Date: 9/21/2023

## 2.3 Subsidization of Economic Activity

### 2.3.1 Existence of an Incentive Program

Swell does currently offer a liquidity incentive program. They have initiated an event known as the "Voyage," which serves as an indirect incentive mechanism for Swell users.

The Voyage is a multi-chaptered journey designed by Swell to progress from its launch phase to maturity. During this journey, participants, termed as "Voyagers," have the opportunity to earn "pearls." These pearls are an IOU offered for participation in the Voyage and will be redeemable for SWELL tokens at a future Token Generation Event (TGE).

Incentives outline:

1. **Holding and Staking**: Voyagers can accumulate pearls by holding swETH.
2. **Liquidity Provision (LPing)**: Providing liquidity in eligible pools, including but not limited to Balancer, Aura, Uniswap v3, Maverick, Bunni, and Pendle, allows Voyagers to earn pearls. Liquidity providers generally earn pearls at a higher rate compared to just staking.
3. **Community Bonus Milestones**: There exists a collective incentive where, if the community reaches certain milestones, like achieving 50,000 ETH in Total Value Locked (TVL), the overall distribution program size increases, benefiting all participants.
4. **Special Provisions**: As of June 8th, 2023, an additional mechanism was introduced where users can earn 20 pearls for every swETH minted through the Swell app.

Presently, its users are engaging in "farming" pearls with the primary intention of securing benefits from the forthcoming airdrop. The TGE is anticipated to occur in the fourth quarter of 2023.

While Swell's incentive mechanism isn't a conventional rewards program, it represents a community-centric approach to incentivize participation, loyalty, and growth. The Voyage aims to not only reward participants but also bootstrap decentralized governance in the future.

# Section 3: Market Risk
This section addresses the ease of liquidation based on historical market conditions. It seeks to clarify (1) the Liquid Staking Basis & Volatility of swETH, and (2) the liquidity profile of the collateral. Market risk refers to the potential for financial losses resulting from adverse changes in market conditions.

This section is divided into 2 sub-sections:

- 3.1: Volatility Analysis
- 3.2: Liquidity Analysis

## 3.1 Volatility Analysis

### 3.1.1 Liquid Staking Basis (LSB)

The LSB (Liquid Staking Basis) represents the price difference between swETH and its underlying asset, ETH. It measures the deviation of the stETH price from the ETH price.

In last 90 days, swETH has consistently exhibited a negative LSB. This could be due to the Swell protocol still not having activated ETH withdrawals.

<!--
Source: [CoinMarketCap](https://colab.research.google.com/drive/1rUJkEhKWUvGKcrNGT1VBsHpMUw6LI9oM?usp=sharing) swETH and ETH data (last 90 days) | Date: 6/23/2023 - 9/23/2023
-->

According to the swETH Dune Dashboard, the divergence rate between the market price and underlying value has been increasing over the lifetime of the product. The discount has grown from around -0.5% to -2.5%, with a noticeable jump in the divergence taking place in mid- September.

Source: [Dune Analytics](https://dune.com/swell-network/swell-network) | Date: 10/5/2023

### 3.1.2 LSD Volatility
The daily returns over a 90-day period are shown below:

Source: [CoinMarketCap](https://colab.research.google.com/drive/1NXOnBtfjvaIC-BMbhlURHXeCCCfBkkd3?usp=sharing) swETH and ETH data (last 90 days) | Date: 6/23/2023 - 9/23/2023

Although one might expect swETH to exhibit higher volatility than ETH, given instability of the peg, according to CoinMarketCap data, it generally exhibits similar or even lower daily volatility. This may be due to low velocity of the asset. The most notable data point is on September 17 when there was a relatively sharp change in the divergence from ETH fair value.

Source: [CoinMarketCap](https://colab.research.google.com/drive/1NXOnBtfjvaIC-BMbhlURHXeCCCfBkkd3?usp=sharing) swETH and ETH data (last 90 days) | Date: 7/8/2023 - 10/5/2023

### 3.1.3 Yield Volatility

Shown below is the swETH median APY daily volatility over time overlaid with the styETH Ethereum staking yield reference index (from July 17 - September 24, 2023). It shows the performance of swETH staking yield against a benchmark over time.

swETH has historically experienced several periods of high positive and negative yields against the benchmark, which may be due to delays in yield distribution.
<!--
Source: [Defi Llama historical median APY](https://defillama.com/yields/pool/ca2acc2d-6246-44aa-ae91-8725b2c62c7c) | Date: 7/17/2023 - 9/24/2023

Source: [Compass Financial Tehnologies](https://www.compassft.com/indice/styeth/) | Date: 7/17/2023 - 9/24/2023
-->

Source: [DefiLlama](https://defillama.com/yields/pool/ca2acc2d-6246-44aa-ae91-8725b2c62c7c) and [Compass Financial Technology](https://www.compassft.com/indice/styeth/) | Date: 7/17/2023 - 9/24/2023

## 3.2 Liquidity Analysis

### 3.2.1 Supported DEXs and CEXs

swETH has been listed on several DEXs and no CEXs. As of the snapshot date on 9/20/23, Maverick has around 48.4% of the total liquidity in the swETH/ETH pool. Balancer has 34.5%, mostly in the swETH/WETH pool. Uniswap accounts for roughly 16.9% of exchange liquidity in the .01%, .05%, and .3% pools paired with WETH. Meanwhile, Curve.fi has a small subset of overall swETH liquidity, with 0.2% of swETH liquidity in the lower utility frxETH/swETH pool.

Source: [Dune Analytics](https://dune.com/swell-network/sweth-in-dexes) | Date: 10/5/2023

Recent data reveals declining liquidity on Balancer and a rising trend on Maverick. Notably, centralized exchanges have not listed swETH, possibly due to the project and its team being DeFi native with a focus on DeFi adoption, and the early stage of the project.

Source: [Dune Analytics](https://dune.com/swell-network/sweth-in-dexes) | Date: 10/5/2023

### 3.2.2 LSD Token Total On-chain Liquidity

As of 9/20/2023, the majority of swETH's liquidity is concentrated on the Maverick ETH-swETH pool followed by Balancer, representing a significant portion of the total liquidity across all platforms. This is followed by Uniswap's V3 WETH-swETH (0.05%) pool, which has a TVL of more than $3 million. Other pools and platforms, such as the Uniswap V3 WETH-swETH (0.01%) and GRAI-swETH (0.3%) pools, as well as Curve<span>.fi, hold lesser amounts of liquidity.

| Platform | Pool | TVL | swETH Quantity |
| ----------------------------------- | ------------------ | ------------- | -------------- |
| Balancer | Vault (predominately WETH-swETH) | $7,126,875.48 | 4,341. |
| Uniswap V3 | WETH-swETH (0.05%) | $3,249,996.00 | 1,982 |
| Uniswap V3| WETH-swETH (0.01%) | $1,270,293.00 | 775 |
| Uniswap V3 | GRAI-swETH (0.3%) | $145,214.00 | 89 |
| Maverick protocol | ETH-SWETH | $11,030,000 | 6760 |
| Curve<span>.fi | swETH/frxETH | $44,177.00 | 27 |

While swETH on exchange makes up 25% of the outstanding supply thanks to liquidity incentives, the available liquidity is substantially lower than pool TVLs suggest. This is due to severe imbalance in all primary liquidity venues (Maverick, Balancer, Uniswap V3) as a result of swETH's persistent discount to its underlying, heavily weighting pool balances toward swETH.

As shown below, balances in the most liquid DEX pools have historically been very imbalanced with only 12.2% WETH in the Maverick swETH/WETH pool, 5.6% in the Balancer swETH/WETH pool, and 1.5% in the swETH/WETH 0.05% Uniswap V3 pool. On a 10/6/2023 snapshot, the available WETH in all swETH pools paired with WETH amounts to around $3.5m.

Source: [Dune Analytics](https://dune.com/swell-network/sweth-in-dexes) | Date: 10/6/2023

### 3.2.3 Liquidity Utilization Rate

The liquidity utilization over the period ranges from a minimum of 0.85% to a maximum of 217.96%. The average utilization during this time frame was 28%. The standard deviation of the liquidity utilization rate was 35.19%. The above figures show a high amount of variance across this period.

Source: [Coingecko Data](https://www.coingecko.com/en/coins/sweth/historical_data) | Date: 9/28/2023

### 3.2.4 LSD Leverage Ratio

The only lending platform where swETH is listed as a collateral type is Gravita. There is a debt limit of 2 million GRAI (i.e. $2m). As of 9/28/2023, the market comprises the following parameters:

| Lending protocol | swETH | swETH $ Value | Max LTV | LT | Utilization Rate |
| ---------------- | ------- | ------------- | ------- | ----- | ---------------- |
| [Gravita](https://app.gravitaprotocol.com/pool) | 799 | $1,310,000 | 80% | 80% | 65.5% |

### 3.2.6 Slippage

Based on the data obtained from DeFi liquidity sources using the DeFiLlama token liquidity tool, it's evident that swETH is fairly limited in its on-chain liquidity. A swap size around 837 swETH ($1.42m) produces a 1% slippage, based on the liquidity snapshot on 10/4/2023. Slippage increases exponentially beyond that swap size.

Source: [DefiLlama](https://defillama.com/liquidity) | Date: 10/4/2023

# Section 4: Technological Risk

This section addresses the persistence of collateral properties from a technological perspective. It aims to convey, (1) where technological risk arises that can change the fundamental properties of the collateral (e.g. unresolved audit issues), and (2) do any composability/dependency requirements present potential issues (e.g. is a reliable pricefeed oracle available?).

This section is divided into 3 sub-sections:

- 4.1: Smart Contract Risk
- 4.2: Product and Layer Composability
- 4.3: Oracle Pricefeed Availability

## 4.1 Smart Contract Risk
### 4.1.1 Protocol Audits

Swell Network underwent a comprehensive security assessment, as detailed in the [Sigma Prime report](https://github.com/SwellNetwork/v3-core-public/blob/master/Audit%20Reports/Sigma_Prime_Swell_Network_Security_Assessment_Report_v2_0.pdf). This assessment evaluated Swell Network smart contracts for potential vulnerabilities. The report categorized issues based on their severity and status. There were 3 medium severity and 5 low severity issues found. Here are the medium severity issues identified:

* **Bots can set ethReserves and swETHToETHRateFixed to any value**: This vulnerability could allow malicious actors to arbitrarily set values, potentially compromising the integrity of the system.
- Status: Resolved.
* **Reentrancy protection is recommended for staking vault**: Without proper reentrancy protection, the staking vault could be susceptible to attacks where external calls can be hijacked.
- Status: Resolved.
* **Updating an operator’s controllingAddress allows the previous operator to maintain control**: This issue highlights a potential oversight where updating an operator's controlling address doesn't revoke the previous operator's access.
- Status: Resolved.

The assessment also highlighted informational findings, which, while not necessarily vulnerabilities, provide insights into the contract's properties, including gas optimizations. Swell Network's development team acknowledged these findings, and necessary changes were implemented where appropriate.

### 4.1.2 Bug Bounty

Swell has initiated a [bug bounty program](https://immunefi.com/bounty/swell/) in collaboration with Immunefi, active since April 27, 2023. This program is designed to address potential vulnerabilities within its ecosystem by leveraging external expertise.

The reward structure of the program is determined by the severity of the identified vulnerability, in accordance with the Immunefi Vulnerability Severity Classification System V2.2:

* **Critical Smart Contract Vulnerabilities**: Rewards for these vulnerabilities range from USD 50,000 to a maximum of USD 100,000, with the provision that the reward will not exceed 10% of the funds potentially at risk.
* **Websites and Applications**: Vulnerabilities associated with Swell's web infrastructure have a distinct reward tier, with critical vulnerabilities offering up to USD 10,000.

A mandatory requirement for all reports is the inclusion of a Proof of Concept (PoC), ensuring that reported vulnerabilities are concrete and actionable.

The scope of the program encompasses several of Swell's assets, including specific smart contracts and its primary web application. While particular proxy implementation contracts are listed as in-scope, Swell's guidelines indicate that all updates to these contracts will also be considered.

Various impacts are recognized within the scope of this program, ranging from severe issues like unauthorized fund theft to other vulnerabilities that might result in system disruptions or unauthorized changes.

Swell's program documentation also outlines explicit exclusions. Certain vulnerabilities, actions, and behaviors are deemed out-of-scope to provide clarity for participants. Notably, testing on mainnet or public testnet contracts is prohibited, directing all efforts to be conducted on private testnets.

### 4.1.3 Immutability

All smart contracts are upgradeable proxies with the same five standard contract imports from OpenZeppelin's library: "BeaconProxy", "UpgradeableBeacon", "ERC1967Proxy" , "TransparentUpgradeableProxy", "AdminUpgradeabilityProxy" and "ProxyAdmin". All three Swell smart contracts have the same AccessControlManager with role-based access controls specifying a DEFAULT_ADMIN_ROLE, PLATFORM_ADMIN, and BOT.

We have examined each system contract using the a16z [Metamorphic Contract Detector](https://metamorphic.a16zcrypto.com/) tool. The tool checks for attributes of the contract that constitute a mutability vector.

**[swETH](https://etherscan.io/address/0xf951e335afb289353dc249e82926178eac7ded78)** token contract
- Code has changed: NO
- Contains SELFDESTRUCT: NO
- Created by Contract: NO
- Contains Metamorphic Init Code: NO
- Contains DELEGATECALL: YES
- Deployer contains CREATE2: NO

**[Node Operator Registry](https://etherscan.io/address/0x46DdC39E780088B1B146Aba8cBBe15DC321A1A1d)**
- Code has changed: NO
- Contains SELFDESTRUCT: NO
- Created by Contract: NO
- Contains Metamorphic Init Code: NO
- Contains DELEGATECALL: YES
- Deployer contains CREATE2: NO

**[Deposit Manager](https://etherscan.io/address/0xb3D9cf8E163bbc840195a97E81F8A34E295B8f39)**
- Code has changed: NO
- Contains SELFDESTRUCT: NO
- Created by Contract: NO
- Contains Metamorphic Init Code: NO
- Contains DELEGATECALL: YES
- Deployer contains CREATE2: NO

After checking contracts, only one out of 6 alert items (contains DELEGATECALL) were triggered.The screenshot below shows Metamorphic Detector explanation why DELEGATECALL opcode represents a potential risk:

Source: [Solidity documentation](https://docs.soliditylang.org/en/v0.8.13/introduction-to-smart-contracts.html?highlight=delegatecall#delegatecall-callcode-and-libraries)

### 4.1.4 Developer Activity

Swell's GitHub activity can be described as moderate. Notably, some of the Core 3 products underwent upgrades in June. As of the current assessment, the main repository does not have any issues raised or any pending pull requests. This indicates a stable codebase, but stakeholders should remain vigilant and monitor for any future updates or changes.

According to data from DeFiLlama, the majority of development took place from February-September 2022 and there have not been any commits since the launch of the protocol. There were a max of 5 unique developers making commits on any given day, with the majority of daily commits having consisted on 1-2 unique developers.

Source: [DeFiLlama](https://defillama.com/protocol/swell?devMetrics=true&devCommits=true&denomination=ETH&groupBy=daily) | Date: 10/5/2023

### 4.1.5 SC Maturity

All core contracts of Swell were successfully deployed on April 12, 2023. The deployments are linked below:

1. [**swETH Token**](https://etherscan.io/address/0xf951E335afb289353dc249e82926178EaC7DEd78)
2. [**Deposit Manager**](https://etherscan.io/address/0xb3D9cf8E163bbc840195a97E81F8A34E295B8f39)
3. [**Node Operator Registry**](https://etherscan.io/address/0x46DdC39E780088B1B146Aba8cBBe15DC321A1A1d)

Compared to other DeFi native LSD products such as stETH and rETH, swETH is a recent offering, with only around 6 months in production.

### 4.1.6 Previous Incidents

There were no previous incidents noted related to Swell Smart Contracts.

## 4.2 Product and Layer Composability

### 4.2.1 Dependencies

The SwellNetwork's v3-core-public repository is a set of Ethereum smart contracts designed to facilitate specific functionalities within the Swell Network ecosystem.

#### AccessControlManager.sol

The AccessControlManager.sol contract manages access control within the protocol. It handles roles, permissions, and provides mechanisms to pause certain functionalities.

* **initialize:** This function sets initial parameters, including the admin and the SwellTreasury address. It also assigns the PLATFORM_ADMIN role to the deployer.
* **withdrawERC20:** This function allows the platform admin to retrieve any ERC20 tokens sent to the contract. It checks the contract's token balance and transfers it to the specified recipient.
* **System addresses:** The PLATFORM_ADMIN can set system contract addresses.
* **Pausable Methods:** The contract has functions that allow the platform admin to pause or resume various operations, ensuring user safety and protocol integrity.

#### DepositManager.sol

The [DepositManager.sol](https://github.com/SwellNetwork/v3-core-public) contract manages the depositing of ETH.

* **deposit:** Users can deposit ETH and receive swETH in return. The deposited ETH is directed to the appropriate destination within the protocol.

#### NodeOperatorRegistry.sol

The [NodeOperatorRegistry.sol](https://github.com/SwellNetwork/v3-core-public) contract manages node operators and their details.

* **_getOperatorSafe:** This function retrieves specific node operator details.
* **add:** This function allows for the addition of new node operators to the registry.

#### swETH.sol
The [swETH.sol](https://github.com/SwellNetwork/v3-core-public) contract manages operations related to swETH.

* **reprice:** This function allows the BOT role to adjust the conversion rate between swETH and ETH. It is the method to distribute rewards to swETH token holders.
* **reprice parameters:** The PLATFORM_ADMIN can set restrictions on magnitude and frequency of repricing updates.

#### Whitelist.sol

The [Whitelist.sol](https://github.com/SwellNetwork/v3-core-public) contract manages a whitelist mechanism.

* **_checkAndAddToWhitelist:** This function verifies an address and adds it to the whitelist.
* **_checkAndRemoveFromWhitelist:** This function allows for the removal of an address from the whitelist.

#### Chainlink Proof of Reserve
Chainlink offers a proof-of-reserve service that monitors the ETH reserves backing swETH. Updates are conducted every 24 hours with a threshold set for a 2% deviation. The system uses 13 oracles, requiring at least 9 of them to confirm a price update. This oracle system aids in verifying the reserves supporting swETH.

Source: [Chainlink](https://data.chain.link/ethereum/mainnet/reserves/swell-eth-por) | Date: 9/26/2023

### 4.3.2 Token Liquidity and Distribution

On the snapshot date, the majority of token liquidity resided on Maverick followed by Balancer and Uniswap V3 pools. Note that the primary data sourced used by RedStone for its pricefeed data come from Maverick and Balancer where there is the most liquidity for swETH.

Source: [Etherscan](https://etherscan.io/token/0xf951e335afb289353dc249e82926178eac7ded78#balances) | Date: 9/23/2023

### 4.2.2 Withdrawals Processing

As of yet, withdrawals have not been enabled in the system. The development team has indicated that the functionality to facilitate withdrawals is still in progress and is expected to be completed in the first half of 2024.

The specific reasons behind the absence of withdrawal functionality in swETH are not clear. This situation presents an element of uncertainty, as users cannot access the ETH they deposited. The inability to withdraw, combined with swETH's limited liquidity, could make it susceptible to significant depegging events.

## 4.3 Oracles Pricefeed Availability

### 4.3.1 Understanding the Oracle

The predominant pricefeed oracle for swETH employed across lending protocols is RedStone. Gravita has integrated the swETH oracle into its platform to fetch the real-time price of swETH.

The RedStone Oracle's core design is modular, catering to the ever-expanding DeFi space. Instead of placing data directly into storage, which is suitable for larger update intervals and fewer assets, RedStone's approach involves an intermediate step. Data is first placed into a data availability layer and is then fetched on-chain when necessary. This design allows for high-frequency broadcasts of a large number of assets to a cost-effective layer, retrieving it on-chain only when mandated by a protocol.

For Swell's specific needs, RedStone implemented a price discovery mechanism using two dominant DEXes where swETH tokens were active:

* Balancer: swETH/WETH pool
* Maverick: Maverick swETH/WETH pool

Source: [RedStone app](https://app.redstone.finance/#/app/token/SWETH)

To counteract potential price manipulations, RedStone also introduced a liquidity monitoring system. This system is designed to adjust the pools based on any changes in the volume of tokens. Additionally, RedStone facilitates the deployment of multiple data provider nodes, relayer nodes, and monitoring services to consistently oversee the operations of the data-providing infrastructure. These data providers ensure that swETH price data is sent every minute. Furthermore, there are plans to integrate a dispute system where a dispute can be raised relating to a specific price update at a given time.

Source: [RedStone finance blog](https://blog.redstone.finance/2023/06/22/case-study-redstone-oracles-provides-sweth-feed-for-swell-network/)

**Data Flow and Aggregation**

RedStone's data flow sources price feeds from a mixture of on-chain and off-chain entities. The data, once collected, undergoes a refining process in independent nodes run by data providers. These nodes utilize various methodologies, such as median, TWAP, and LWAP, and implement safety measures like outlier detection. Once smoothed, the data is signed by node operators to vouch for its quality. Specifically for swETH, RedStone uses two data sources and uses the median of those to fetch the exact price.

The processed feeds are then broadcasted on platforms such as Streamr and directly to open-source gateways, ensuring broad access and redundancy.

For added reliability and security, RedStone employs an on-chain aggregation mechanism. This system mandates multiple signatures from various authorized data providers for a single data feed. By aggregating the values from different providers, the mechanism ensures that even if a small subset of providers become compromised, the aggregated value remains largely unaffected.

### 4.3.3 Attack Vectors

**Modular Design Vulnerability:** The modular design, while efficient, may introduce points of failure or vulnerabilities, especially during the transition from the data availability layer to on-chain retrieval.

**Oracle Operational Risk:** With RedStone as the exclusive oracle provider, any operational issues could lead to improper liquidation events. RedStone is a lesser known oracle provider, securing $83m in value according to [DeFiLlama](https://defillama.com/oracles). It ranks 7th by oracle providers in terms of Total Value Secured.

**Lack of Redundancy in Data Sources:** If one of the two data sources for swETH becomes unavailable or presents inaccurate data, the system heavily relies on the remaining source, which could lead to skewed price feeds. Also, if liquidity shifts suddenly to other exchanges, the performance of data aggregators to monitor the trends is unknown.

**Liquidity Concerns:** Compared to more established LSDs, swETH lacks significant liquidity depth. This makes it susceptible to price manipulations in specific pools. Additionally, with withdrawals disabled, arbitrators cannot intervene to stabilize the price, further compounding the vulnerability.

### 4.3.4 Associated Vulnerabilities

**Potential for Bad Debt:** Manipulation of the price feed, if it were to occur, could contribute to the creation of bad debt within the protocol. The accuracy of price feeds is integral to lending protocols in order to maintain correct collateralization ratios. Any manipulation may lead to the accrual of bad debt.

**Risk of Faulty Liquidation:** If an oracle were manipulated to significantly lower the collateral asset price, this could prompt improper liquidations. Such an event could result in substantial financial losses for users and disrupt the usual functioning of the lending protocol.

# Section 5: Counterparty Risk

This section addresses the persistence of swETH’s properties from an ownership rights perspective (i.e. possession, use, transfer, exclusion, profiteering, control, legal claim). The reader should get a clear idea of (1) who can legitimately change properties of the collateral (e.g. minting additional units) and what their reputation is, (2) the extent that changes can be implemented and the effect on the collateral.

This section is divided into 4 subsections:

- 5.1: Governance
- 5.2: Decentralization of the LSD
- 5.3: Economic Performance
- 5.4: Legal

## 5.1 Governance

### 5.1.1 Governance Scope

Currently, Swell protocol does not have governance infrastructure aside from a governance forum. The Swell Network protocol is currently managed by the Swell core team and protocol core contributors, most likely Swell Labs team members. Although the organization that currently makes decisions is called Swell DAO, the protocol does not have a DAO structure or any governance mechanism in place.

Swell DAO established the [Swell Ecosystem Council](https://www.swellnetwork.io/post/meet-the-ecosystem-council) and appointed the first 7 members. The Swell Ecosystem Council consist of members with deep DeFi knowledge from different professional backgrounds. The council members are:
* **Anton Buenavista** - Ecosystem Growth at Pendle
* **Bob Baxley** - Multi-startup founder and solidity developer
* **SmallCapScience** - An active DeFi participant with a background in angel investing. Has collaborated with several prominent DeFi protocols, including JonesDAO, Aura Finance, and Redacted Cartel.
* **SynthQuest** - A member of the Kwenta and Synthetix Grants Councils. He is also an active Dune dashboard creator.
* **Tritium** - Balancer team member, previously held a coordination role at BadgerDAO, and served as an advisor to Aura Finance.
* **0xLamentations** - Growth lead at Aura Finance, specializing in partnerships and integrations
* **0xGlue** - Long-time contributor to OlympusDAO among various other DAOs, presented as specialist in integrations indetification and execution

The Swell team has put in place the Voyager incentive program, whereby users can collect "pearls" that will the be main criteria for distribution of SWELL tokens in a future Token Generation Event.

### 5.1.2 Access Control

The [AccessControlManager](https://etherscan.io/address/0x625087d72c762254a72CB22cC2ECa40da6b95EAC#readProxyContract) contract serves as a core contract for the Swell protocol role-based access management system. The contract defines roles for privileged addresses and serves as the admin for methods to grant, revoke, and check roles. AccessControlManager is most significantly used to assign a PLATFORM_ADMIN to manage essential protocol functionalities.

Source: [Github](https://github.com/SwellNetwork/v3-core-public/blob/master/contracts/core/contracts/implementations/Whitelist.sol)

The PLATFORM_ADMIN role has significant control over the contracts, with the ability to modify various parameters and functionalities. Specifically, the following actions can be performed by this role:

* Withdraw (rescue) any ERC20 tokens from the contract.
* Update the address of key contracts such as swETH, DepositManager, NodeOperatorRegistry, and the protocol treasury.
* Pause or resume various functionalities within the protocol, including mints, repricing, and withdrawals.
* Manage whitelisted node operators and active/pending validators in the NodeOperatorRegistry contract.
* Set reward rates for node operators and the treasury, set min oracle reprice time and rate change in the swETH token contract.
* Set the PoR oracle address and set sanity check parameters on PoR value updates in the RepricingOracle contract.

A [multisig wallet](https://etherscan.io/address/0x20fDF47509C5eFC0e1101e3CE443691781C17F90#code) operated by the Swell team has the PLATFORM_ADMIN role, allowing it to execute these functions. The individual External Owned Accounts (EOAs) that act as signers for this 3-of-6 multisig are:

| EOA Addresses |
|------------------------------------------------|
| [0xD8DbDb15e91596c50A72E77d95dbC866ebdA8238](https://debank.com/profile/0xd8dbdb15e91596c50a72e77d95dbc866ebda8238) |
| [0x0fc59C9C998537c940a9Dfc7DacDe533a9c496Fe ](https://debank.com/profile/0x0fc59c9c998537c940a9dfc7dacde533a9c496fe) |
| [0x284C633962F2386590E934c4fBD2D3EafA0944A3 ](https://debank.com/profile/0x284c633962f2386590e934c4fbd2d3eafa0944a3) |
| [0x042d200e5375204F022570361f3913b245488091 ](https://debank.com/profile/0x042d200e5375204f022570361f3913b245488091)|
| [0x66Ed79Ee4865c1cb4574b42d467C7Fee28bB4D59 ](https://debank.com/profile/0x66ed79ee4865c1cb4574b42d467c7fee28bb4d59) |
| [0x5b27b9279251904AaF2127463eeFf91E0037F725 ](https://debank.com/profile/0x5b27b9279251904aaf2127463eeff91e0037f725) |

A [BOT](https://etherscan.io/address/0xb29f1af8720e5fd23aa745559d1deaae3d9cda17) role is assigned to fulfill automated tasks such as to periodically update the internal swETH:ETH exchange rate and to setup new validators. The role is set to an EOA address. Although this address is trusted to reliably update the exchange rate, the updates are rate limited with current parameters:
- [minimumRepriceTime](https://etherscan.io/address/0xf951E335afb289353dc249e82926178EaC7DEd78#readProxyContract#F11): 60 minutes
- [maximumRepriceDifferencePercentage](https://etherscan.io/address/0xf951E335afb289353dc249e82926178EaC7DEd78#readProxyContract#F9): 1%

There is also an integration with Chainlink Proof of Reserve specified in the [RepricingOracle](https://etherscan.io/address/0x289d600447a74b952ad16f0bd53b8eaaac2d2d71#readProxyContract#F2) contract that limits repricing to the amount of ETH held in Swell validators as reported by a network of Chainlink nodes.

### 5.1.3 Distribution of Governance Tokens

Swell protocol has not yet launched a token. However, as part of their ongoing rollout, termed the "Voyage", there are plans to introduce a token by Q1 of 2024.

According to the swETH docs, the SWELL token will include the following utility:
- Governance of the protocol via delegate voting
- Protocol growth incentivization through various liquidity mining, referral and air drop schemes

As described in the [blog post](https://www.swellnetwork.io/post/the-voyage) announcing the Voyage, there is a liquidity mining scheme involving pearl tokens, an IOU for SWELL tokens that are intended to be redeemable after the Token Generation Event (TGE).

### 5.1.4 Proposals Frequency

On the Swell Governance Forum there is only one proposal created on June 14, 2023: "[SWIP-1 : Swell Alerts (Analytics)](https://forum.swellnetwork.io/t/swip-1-swell-alerts-analytics/219)". The proposal was related to development of a Swell analytics dashboard and the grant amount of $6,000 was approved after internal consensus without public voting.

### 5.1.5 Participation

Governance participation can only be observed through [Governance Forum](https://forum.swellnetwork.io/) participation and Discord activity. Shown below are statistics from the Governance Forum:

Source: [Swell Governance Forum](https://) | Date: 9/25/2023

When we look at most active participants in Swell Forum, its visible those are Swell team members and Node Operators:

Source: [Swell Governance Forum](https://forum.swellnetwork.io/u?order=likes_received&period=all) | Date: 9/25/2023

## 5.2 Decentralization of the LSD

### 5.2.1 Number of Node Operators

Swell Network has 8 Node Operators and all of them are professional staking service providers. When it comes to Node Operators strategy, Swell uses the same approach as the market leader, Lido, who has 30 professional whitelisted node operators.

Source: [Rated Network](https://www.rated.network/o/Swell?network=mainnet&timeWindow=1d&viewBy=operator&page=1&idType=pool) | Date: 9/19/2023

Swell provides further information about each individual node operator in their [Know Your Node Operator](https://www.swellnetwork.io/post/know-your-node-operator) blog post.

### 5.2.2 Validators per Node Operator

[Rated Network](https://www.rated.network/o/Swell?network=mainnet&timeWindow=1d&viewBy=operator&page=1&idType=pool) shows that, as of 10/4/2023, the Swell pool has 1,514 validators for an average of 189.25 validators per NO.

DSRV: 190
Blockscape: 190
Stakely: 189
HashQuark: 189
Kiln: 189
RockX: 189
InfStones: 189
snc.xyz: 189

### 5.2.3 Market Share per Validator

The validators are evenly distributed across NOs, as the system uses a round robin process for adding additional validators. No node operators have been added since the inception of the Swell Protocol, so validator distribution remains essentially even across all NOs.

### 5.2.4 Validator Enter/Exit (Churn)

The Swell protocol still has not activated withdrawals, so churn rate is not relevant for comparison with other ETH LSD token issuers. Over all time periods, there have been no validators exited or value withdrawn.

**Validators Enter/Exit Churn - 7 days**

**Validators Enter/Exit Churn - 30 days**

**Validators Enter/Exit Churn - All-time**
Source: [Rated Network](https://www.rated.network/o/Swell?network=mainnet&timeWindow=all&viewBy=aggregate) | Date: 9/19/2023

### 5.2.5 Stakers per Validator
As of 10/4/2023, there are 13,515 unique stakers. At a total count of 1,514 validators, there are an average of 8.93 unique stakers per validator.

Source: [Dune Analytics](https://dune.com/queries/2446052/4020176) | Date: 10/4/2023

Of the over 13k unique stakers, only 988 have deposited 10 or more ETH. 92.7% of deposits are from addressing depositing less than 10 ETH to the system.

Source: [Dune Analytics](https://dune.com/swell-network/swell-network) | Date: 10/4/2023

### 5.2.6 Stake Distribution Across Geographic Jurisdictions

Swell has assembled a set of node operators that span multiple geographical areas.

The following table provides an overview of the selected node operators, as described in a Swell [blog post](https://www.swellnetwork.io/post/know-your-node-operator):

| Validator | Year Established | Location |
|------------|------------------|--------------------|
| HashQuark | 2018 | Hong Kong |
|Blockscape | 2019 | Switzerland |
| DSRV | 2019 | Seoul, South Korea |
| InfStones | 2018 | Texas, USA |
| Kiln | 2018 | Paris, France |
| RockX | 2018 | Singapore |
| Stakely | 2018 | Spain |
| SNC.xyz | 2022 | Netherlands |

Shown below is the geographical distribution of node operators. Since active validators are evenly distributed across the 8 whitelisted operators, this reflects the geographical distribution of the network.


### 5.2.7 Node Software Diversity

As of 10/5/2023, the overall distribution of Swell network's consensus client is 28.1% Prysm, 54.3% lighthouse, 13.1% Teku, and 4.5% Nimbus.

Source: [Rated.network](https://www.rated.network/?network=mainnet&view=pool&timeWindow=all&page=2&poolType=all) | Date: 8/5/2023

Rated.network data shows information about the consensus client distribution of individual operators, and additional technical specs and historical performance of Swell's node operators:

Source: [Rated.network](https://www.rated.network/o/Swell?network=mainnet&timeWindow=all&viewBy=operator&page=1) | Date: 10/3/2023

### 5.2.8 Node Hosting Infrastructure

Information about Swell node operator hosting infrastructure is not readily available.

## 5.3 Economic Performance

### 5.3.1 Revenue Source

The protocol earns ETH staking revenue and charges a protocol fee. Swell's structure involves taking a 5% fee from rewards. These funds are treated as profit and are used to grow the protocol.

| Entity | Total Rewards |
|-------------------|---------------|
| Stake | 90% |
| Node operator | 5% |
| Swell DAO Treasury| 5% |
| **Total** | **100%** |

Source: [Swell Docs](https://docs.swellnetwork.io/swell/system-design/rewards-and-distribution/rewards-and-fees)

### 5.3.2 Revenue

Swell protocol's total revenue from staking activities can be found on Rated Network (set metrics on all-time)

All time earned ETH from staking activity, as of 10/5/2023, according to [Rated Network data](https://www.rated.network/o/Swell?timeWindow=all&network=mainnet&viewBy=aggregate):

Priority fees earned: 91.3909 ETH
Baseline MEV collected: 33.2906 ETH
Execution layer all-time earning: 124.6815 ETH (Priority fees + MEV collected)
Consensus Layer all-time earning: 348.2597 (amount reduced for total penalties accrued: -0.7965 ETH, time slashed: 0)

Total protocol all-time rewards: **439.6506 ETH** (Execution + Consensus layer - accrued penalties)

### 5.3.3 Net Profit

The lifetime profit for the Swell protocol, as of 10/5/2023, is **21.98253** ETH to the treasury (5% of 439.6505 ETH total staking rewards).

According to data from Rated.network and DeFiLlama, as of 10/5/2023 there is 48,544 ETH actively staked in Swell at a 30-day average APY of 3.54%. If these figures are used to estimate annualized earnings, the protocol is currently earning around 94.5 ETH per year or 0.26 ETH per day.

## 5.4 Legal

### 5.4.1 Legal Structure

Swell Network is operated by LD Software Corporation, located at Via España, Delta Bank Building, 6th Floor, Suite 604D, Panama City, Republic of Panama. This places the legal structure of Swell Network under the jurisdiction of Panama.

LD Software Corporation is the legal entity that users are contracting with for the purpose of receiving services available on https://www.swellnetwork.io/. However, decisions about why and how personal data is processed in connection with the Services are made by Swell DAO, following the protocol’s [privacy statement](https://www.swellnetwork.io/legal/privacy-policy).

Specific details about the ownership structure of LD Software Corporation are not available via open search. We also can not identify any specific data or information pertaining to the governance processes of Swell DAO in relation to the formation of its operating entities.

### 5.4.2 Licenses

In Panama, there are not any [regulations](https://fmm.com.pa/blockchain-and-cryptocurrency-regulation/) specifically tailored to blockchain or cryptocurrencies. Both the Superintendence of Banks (SBP) and the Superintendence of the Securities Market (SMV) have made informal remarks regarding this matter. In 2018, the SBP conveyed that it doesn't oversee cryptocurrencies and that no financial institutions in Panama sought permission to engage with them. Similarly, in the same year, the SMV clarified that: (1) they don't categorize cryptocurrencies as securities; (2) cryptocurrencies are not recognized as official currencies; (3) no specific licensing is mandated for cryptocurrency operations; and (4) brokerage firms are not allowed to provide advice or trade in cryptocurrencies.

The SMV recently issued [Opinion No.1-2023](https://innovativelegalgroup.com/f/panama-regulator-just-issued-a-new-opinion-on-digital-assets) primarily crafted to address queries about the permissibility of licensed Broker-Dealer firms engaging in activities related to digital assets and cryptocurrencies. In keeping with its prior stance, the SMV reaffirmed that its jurisdiction is confined only to matters explicitly governed by law. Thus, it emphasized its inability to oversee, regulate, supervise, or make determinations on issues not expressly set forth in legislation. Following a thorough review of regulations, the SMV clarified that current rules do not classify cryptocurrencies as "securities," "money," or "electronic currency." Furthermore, referencing their earlier statement, SMV opinion 7-2018, concerning Bitcoin, they emphasized that the definition of "securities" excludes digital currencies.

Panama has evidently adopted a hands-off stance due to the absence of stringent regulations concerning cryptocurrencies. Currently, there are no legal precedents in the country that categorize cryptocurrencies as monetary tools, securities, official currencies, or digital assets. Given this backdrop, it's reasonable to infer that staking-as-a-service as part of the wider digital assets category is legally permissible in Panama at this time.

### 5.4.3 Enforcement Actions

There have been no documented regulatory enforcement actions or legal proceedings initiated against Swell Network to date.

### 5.4.4 Sanctions

Swell adheres to global export controls and sanctions. When staking Digital Assets, users must ensure compliance with these laws. Users, or any associated entities or individuals, must not have any sanctions against them by global authorities, such as the US Department of the Treasury’s Office of Foreign Assets Control or the European Union. Staking is prohibited for anyone associated with or residing in sanctioned regions or countries, including Belarus, North Korea, Russia, Syria, Yemen, Zimbabwe, the US, Canada, and China, among others. Attempted access from these restricted areas, including using VPNs or providing false documentation, is forbidden.

The Front-end operator (LD Software Corporation), along with its associated Swell Service Providers, is obligated to observe and act in accordance with Sanctions regulations. This means they cannot provide services to, or establish affiliations with, certain designated individuals or entities. To meet these compliance obligations, several measures might be enacted:

* **Termination of Agreement:** Swell has the authority to dissolve any existing contracts or agreements if they contravene Sanctions or other legal requirements.
* **Return of Staked Assets:** Supported Digital Assets that have been staked could be sent back to the original digital address of the user or to another address specified by regulatory bodies.
* **Mandatory Unstaking:** Staking Users may be instructed to remove their staked assets within a defined timeframe to comply with the regulations.
* **Suspension of Benefits:** There may be pauses in the accrual of a user’s share or the conversion capabilities of sw-Liquidity Tokens.
* **Regulatory Compliance:** The above actions can be initiated not just due to Sanctions, but also to ensure alignment with other Applicable Laws and Regulations, directives from regulatory authorities, or in response to legal orders.

It's essential to note that neither LD Software Corporation nor the Swell Service Providers bear any responsibility for financial or other losses a Staking User might experience as a direct or indirect result of these compliance actions.

### 5.4.5 Liability Risk

Swell and its associated service providers do not offer or intend to offer any form of professional advice, including but not limited to investment, tax, or legal advice, through the provision of their platform and services. Any decision to engage with activities available through Swell’s front end should be made independently without relying on information from the platform as professional guidance.

All services provided by Swell and its service providers are extended on an "as is", "where is", and "where available" basis. There are no warranties or representations concerning the accuracy, completeness, or fitness for a particular purpose of the platform or its contained information and services. Swell and its service providers expressly limit their liability. They are not liable for indirect, punitive, special, consequential, or incidental losses arising from the use or attempted use of the platform. This includes losses resulting from inaccuracies, delays, interruptions, or any events beyond Swell's control. Specifically, they are not accountable for decisions made based on the platform's information or services. The maximum aggregate liability irrespective of the nature of the claim (contractual, tort, or otherwise), is capped at the lesser of: (a) any platform commission paid by the user to Swell in the preceding three months or (b) US$100 if no commission was paid in said period.

By these clauses, Swell seeks to protect itself from a wide range of potential liabilities and clarifies the scope and limitation of its responsibilities toward users of the platform.

[Part B](https://www.swellnetwork.io/legal/terms-of-service#:~:text=PART%20B%3A%20STAKING%20SERVICES%20TERMS%20AND%20CONDITIONS) of the Terms of Services explicitly governs users’ relation with Swell in relation to Staking Services. The Platform facilitates users to pool or group together their recognized digital assets, called Supported Digital Assets. By doing so, they can collectively earn rewards, termed as Staking Rewards, which emanate from the operation of Staking Nodes managed by Swell and/or Swell Service Providers. The title or ownership of the Supported Digital Assets that are staked remains unaltered and vested in the Staking User. Swell does not gain ownership of these assets. Moreover, these staked assets are insulated from any claims by the Swell's creditors. It's noteworthy that the sw-Liquidity Tokens are non-custodial in nature, implying that they continuously stay under the dominion and control of the Staking User. Additionally, these tokens retain the flexibility to be transferred in secondary, unrestricted liquidity markets at the discretion of the user.

Staking Users guarantee that their digital assets are lawfully obtained and possess requisite knowledge about blockchain technology and digital assets. They confirm that interactions with the Platform are deliberate, accurate and that they'll address any tax implications arising from their transactions. By accepting the Terms of Service they recognize the inherent and irreversible nature of smart contract actions, understand that Swell doesn't control underlying digital asset protocols, and acknowledge risks like potential slashing, penalties, and inaccessibility of staked assets, especially ETH pending specific upgrades. The Users are aware of the experimental aspect of the technology, the potential for cyber risks, and internet transmission issues.

The above-reviewed terms have been crafted to shield Swell extensively from liabilities and responsibilities. They emphasize the experimental and uncertain nature of the technologies involved, disclaiming control or guarantee over underlying protocols, upgrades, or rewards. Staking Users are continuously reminded of the inherent risks and the necessity of their own diligence.

The [arbitration section](https://www.swellnetwork.io/legal/terms-of-service#:~:text=GOVERNING%20LAW%20AND%20DISPUTE%20RESOLUTION)'s inclusion in the Terms ensures clarity and possibly gives Swell a familiar jurisdictional advantage. If no resolution is reached within 30 days of notice, the dispute will proceed to arbitration following the rules of the Australian Centre for International Commercial Arbitration (ACICA). The arbitration will take place in Sydney, Australia, be conducted in English, and involve a single arbitrator. The purpose of the arbitration provisions is to serve as a basis to dismiss any court action initiated by users.

Users and Swell are mandated to resolve disputes through binding arbitration rather than in court. Swell emphasizes arbitration over litigation, which can be faster and less costly. The strict individual arbitration approach protects Swell from facing large class actions. The detailed structure, from dispute notification to arbitration rules, provides a structured pathway, potentially reducing ambiguities or delays.

### 5.4.6 Adverse Media Check

Based on the search results, there doesn't appear to be any adverse media allegations specifically related to "Swell Network" involving money laundering, corruption, sanctions exposure, threat financing, or other unlawful activity.

# Section 6: Risk Management

This section will summarize the findings of the report by highlighting the most significant risk factors in each of the three risk categories: Market Risk, Technology Risk, and Counterparty Risk.

### 6.1.1 Market Risk

**LIQUIDITY: Does the LSD have a liquid market that can facilitate liquidations in all foreseeable market events?**

swETH is a fairly small player in the LSD market, currently commanding around 0.4% of overall LSD TVL. It does have a focus on DeFi integrations, including incentivized pools on Maverick, Balancer, and Uniswap V3. Around 25% of the outstanding token supply is deposited into pool on these three DEXs. The nominal token liquidity is quite low. Accroding to the DeFiLlama token liquidity tool, a swap size around 837 swETH ($1.42m) currently produces a 1% slippage, based on the liquidity snapshot on 10/4/2023. Furthermore, persistent imbalance in DEX pools has inhibited available liquidity, with a combined value of $3.5m WETH in all pools paired with swETH (as of 10/6/2023).

**VOLATILITY: Has the LSD had any significant depeg event (post merge)?**

swETH has traded at a discount for essentially the entire lifetime of the product. Initially at a relatively stable discount of -0.5%, the divergence to fair value increased in mid-September to a -2.5% discount. Although there are liquidity incentives to several DEX pools, swETH may experience continued difficulty maintaining its peg. Withdrawals have not been activated on the platform, inhibiting arbitrage and increasing duration risk for users who are not given a clear timeline when withdrawals will be activated. Swell does intend to add withdrawal capability in a future upgrade in early 2024, but no further details are available.

### 6.1.2 Technology Risk

**SMART CONTRACTS: Does the analysis of the audits and development activity suggest any cause for concern?**

Swell Network underwent a comprehensive security audit, as detailed in the [Sigma Prime report](https://github.com/SwellNetwork/v3-core-public/blob/master/Audit%20Reports/Sigma_Prime_Swell_Network_Security_Assessment_Report_v2_0.pdf). No critical or high severity issues were found and all issues were otherwise resolved. A bug bounty program with Immunefi has been active since swETH has been in production, with rewards for smart contract vulnerabilities ranging from $50,000 to a maximum of $100,000, with the provision that the reward will not exceed 10% of the funds potentially at risk. The system has only been in production since April 2023, but is relatively simple, consisting of three primary contracts. The contracts are upgradeable and managed by the Swell team.

**DEPENDENCIES: Does the analysis of dependencies (e.g. oracles) suggest any cause for concern?**

As mentioned above, withdrawals are not currently activated and this limitation can increase uncertainty that can lead to temporary or prolonged depegs. Withdrawals are complicated by the division between the execution and consensus layer, requiring an oracle to intermediate withdrawal requests to validators. However, Swell is the only LSD protocol we have reviewed to date that does not have a solution to accommodate withdrawals. Swell intends to offer withdrawals in a future upgrade in early 2024.

The pricefeed oracle for swETH is available from RedStone Oracle. This is a lesser known oracle provider that is ranked 7th on DeFiLlama's oracle list based on Total Value Secured (securing around $83m). There are certain important features of this provider that aren't disclosed, such as the number and identities of unique nodes relaying the data. Outages and manipulation of oracle prices can result in unintended losses to users or accrual of bad debt to the protocol.

### 6.1.3 Counterparty Risk

**CENTRALIZATION: Are there any significant centralization vectors that could rug users?**

There is currently no on-chain governance, although Swell has outlined an intention to decentralize its governance. In the meantime, the system is managed by a 3-of-6 multisig controlled by the Swell team and their network of 8 whitelisted node operators. Since the team has the power to upgrade contracts, there exists a possibility to rug users.

There is a bot operated by the team to handle automated tasks like repricing swETH's internal rate and setting up new validators. The team has taken precautions to limit risk associated with the bot by setting rate limited repricing and integrating Chainlink Proof of Reserve to enforce limits on swETH minting. Users should nevertheless be aware that the proper operation of the team-controlled bot is necessary to maintain stability of the system.

The node operator set consists of known professional entities in geographically distinct regions and running a diverse set of consensus client softwares to limit risks associated with NOs. However, there remains an operational risk that node operators lose private keys, mismanage their node, or are otherwise unable to access ETH they manage.

**LEGAL: Does the legal analysis of the protocol suggest any cause for concern?**

The Panamanian setup offers certain conveniences such as a favorable regulatory environment and reliable liability protection. Opaque ownership structure however goes hand in hand with unclear operational mandates from SwellDAO. We should not rule out the FATF pressure over Panama’s lenient regulatory stance on cryptocurrencies which signals for a potential volatility of the regulatory landscape. Caution should be paid on the user activity to prevent hypothetical false declarations and attempts to by-pass front-end restrictions.

### 6.1.4 Risk Rating

Based on the risks identified for each category, the following chart summarizes a risk rating for swETH as collateral. The rating for each category is ranked from excellent, good, ok, and poor.

- We rank swETH **poor in liquidity** because has not yet gained significant traction and overall liquidity remains lower than competitors. Although Swell has liquidity incentives that has contributed to DEX TVL growth, the pools are highly imbalanced, heavily weighted in swETH.
- We rank swETH **poor in volatility** because withdrawals are not active, creating uncertainty for users that may result in temporary or prolonged depeg events. Peg strength has been deteriorating over the life of the product.
- We rank swETH **good in smart contracts** because the protocol has undergone a comprehensive audit by a reputable firm and offers a bounty program commensurate with the value contained in the protocol.
- We rank swETH **poor in dependencies** for not allowing withdrawals at this time. Additionally, although there is an oracle pricefeed provider, it is a lesser known service provider securing a relatively small amount of value and may not match the assurances of a market leader such as Chainlink.
- We rank swETH **ok in decentralization** because it is currently operated by the Swell team through a 3-of-6 multisig that can upgrade system contracts and certain functionality like repricing is entrusted to a team-controlled EOA.
- We rank swETH **ok in legal** because the legal entity provides reliable liability protection. However, the ownership structure is opaque and may become exposed to FATF pressure over Panama’s lenient regulatory stance on cryptocurrencies.

#### swETH Risk Score
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Compared to other LSD products we have reviewed, swETH generally underperforms in terms of its risk score. In particular, we have scored swETH lower in dependecies, liquidity, and volatility than most other products. These are primarily deficiencies related to the newness of the protocol and an associated immaturity compared to incumbents. There may be significant improvements to these factors as the project develops.

Most significantly, Swell protocol has not activated withdrawals. The team does anticipate withdrawal functionality in a future upgrade to the protocol, but for now the restriction may undermine swETH assurances to its users that threaten its peg and contribute to increased volatility. Poor historical peg performance has resulted in heavy imbalances in swETH pools, which negatively impacts the liquidity of the LSD.

The lack of a Chainlink pricefeed also creates some uncertainty about swETH's usefulness as a collateral asset. A quality collateral in DeFi depends on a protocol's ability to source reliable price data to facilitate liquidations. swETH has relatively low liquidity on a small handful of DEXs with price data provided by RedStone, a lesser known pricefeed provider that secures a relatively small amount of value. Concerns about liquidity and the oracle provider contribute to higher risk of improper liquidations or potential bad debt to the protocol.

Compared to other DeFi-native LSD products (wstETH, rETH, sfrxETH), swETH performs on par in terms of decentralization, although pathways to achieve decentralization differ between products. Similar to sfrxETH, swETH is temporary managed by a team-controlled multisig. Similar to wstETH, swETH has a whitelisting process to add node operators to its system with plans to allow permissionless node operation in the future. Given that Swell has not yet released its governance token, its pathway toward credible decentralization will likely be extensive with uncertainties remaining as to the team's commitment to the stated roadmap.

Our recommendation is to hold off on introducing swETH as a collateral asset until the project has had time to mature. A relatively straightforward threshold for reassessing swETH are preconditions that it enables staking withdrawals and introduces a highly reliable pricefeed.