# Lido reWARDs in Q2 and Beyond

14th March 2022

## Context

Post beacon chain launch and pre-withdrawals, incentives-driven deep DEX pools have been a key part of what made LSTs successful and stETH the most successful amongst them.
However, Lido's reWARDS program has been costly, with 4-5M LDO allocated monthly for a over a year and a half.

Budget reductions started in October'22 and have steeply brought down the amount of LDO distributed from 4.5M to 1.1M a month. This came in part from the realization that the Lido DAO had probably been overspending in incentives before, that a crypto bear market had installed itself, and that there were doable low-hanging fruit optimizations.

The fact that liquidity is still very well supported at current levels allied to "primary markets" opening up for staked ETH soon (via deposits and withdrawals) justify continuing this reduction direction.

Recently, different parties of the Lido DAO, from Finance to BD and Analytics, have been involved in proposing ideas for reWARDS, and it makes sense to summarize those inputs, as well as align on steps for the next couple months, and beyond.

## Stakehouse Ratchet

[Proposal link](https://research.lido.fi/t/rewards-february-23-budget/3713/5)

TL;DR:

- The ratchet is a budget reduction mechanism that assures reductions occur in all denominations we look at the budgets as.
- A reduction percentage is defined and the new budget must comply to that cut MoM relative to both the actual LDO amounts and the USD TWAP converted prices of them. A new budget must be capped at what would be the harshest reduction between the two.
- There is a lot of merit in the idea, but unless we cope with using small reduction percentages just to make it fit, some months it will be unrealistic or unsafe.
- I do think it is directionally, not strictly, correct and that we should both report as well as strive for the reductions to be hit in both terms (with wiggle room in months of very high LDO volatility).

## Stakehouse PID

[Proposal link](https://research.lido.fi/t/pid-regulated-liquidity-control/3969)

TL;DR

- The proposal is driven by the hypothesis that incentives also serve to keep the stETH<>ETH price ratio stable at ~1. And this has in fact been one of the reasons justifying having this large of a spend in rewards.
- A mecanism would supply incentives to LPs if the aforementioned price ratio drifted by some chosen amounts, and pull incentives during more stable times.

## [Report] *stETH Liquidity Design: post-Shangai Perspective*

[Analytics' paper link](https://docs.google.com/document/d/1uAdZmVtuQRxp22euFuGydau03DI5B5qrbcdMrNlX3g8/edit#)

TL;DR:

**stETH Exit post-Shangai**


stETH -> ETH Possibilities
1. Instantaneous exit via swaps on AMM and CEXes
2. Fast exit via the protocol buffer if there is enough ETH
3. Standard exit via withdrawals
With the user decision depending on stETH/ETH rate, staking demand and the Beacon chain state.

**Collateral**

- On Aave v2, cascading liquidations are modelled to happen from 0.865. And on v3 E-mode from 0.97. Overall, serious liquidations are modelled to start at 0.95.
- Even post withdrawals, serious liquidations (and integrations in general) will still need to be supported by liquid DEX pools.

**Curve Pool**

- The lower the A parameter, the more liquidity is left between the first potential liquidations and cascading ones; but the less costly it is to "depeg" stETH in the first place from a balanced pool;
- The lower the A parameter, the faster unbalances in the pool get converted to discounts in the price, which should lead to
- The trade-off between liquidity support and cost of attack was extensively modelled by Analytics with 20-30 being the final range reached that would optimize this trade-off safely. The ensuing vote was started in February and the A is 30 now.

- As a next step in general liquidity analytics, it is important we set up dashboards for in production behaviour of holders using the buffer as well as withdrawals once live. Particularly liquidity previsions and scenarios of those two as well as how they're competing with instant DEX liquidity.

## Business cases for incentives

Post beacon chain launch and pre-withdrawals, incentives-driven deep DEX pools have been a key part of what made LSTs successful and stETH the most successful amongst them. There are still cases where incentives are justified post withdrawals.

**Expansion**
- In general, it should be justifiable to have spend treasury funds in expansions of stAssets, be it the boostrapping of a new one or the expansion of an existing one into a new chain/ecosystem (needless to say, modulo the expansion making sense in itself).
- Being first to market on Arbitrum and Optimism, or the recent introduction of wstETH on Polygon PoS are business goals for the DAO -- and boostrapping TVL, liquidity and integrations in such cases seems a worthwile application of the reWARDS program.

**Integrations**
- Aave, Maker, and other important DeFi integrations have brought tremendous TVL, utility and defensibility to stETH.
- The most important integration type is for collateral use, and it relies on liquid markets to function (from being accepted in the first place to getting good risk parameters and usage).
- DEX liquidity will still be relevant for these to function safely post withdrawals, and fully unincentivized pools will probably not suffice (at least for a few more months).

## Denomination

**Denomination of accounting**

- There is value in having the accounting of rewards spend be done in USD and to display the budgets in the different denominations on the forums (LDO, ETH, USD). This shift came from the Finance team's inputs and does help different stakeholders view reWARDS the way that's most helpful to them (and ultimately, the DAO itself when approving).
- USD denomination helps to include rewards as part of the larger DAO budgets, and LDO denomination is useful in representing the actual tokens that are being distributed. Both are useful

**Denomination of distribution**

- For reasons better outlined in [*DAI vs LDO reWARDS*](https://carv.notion.site/LDO-vs-DAI-reWARDS-6ca05199b0e04855b3f4e11316bbcb2e) we should continue using LDO and the incentives token for the time being, and keep an open mind to the alternatives when liquidity represents a lower cost and/or the treasury situation changes significantly.

**Trading LDO**

- There has also been discussion about the DAO proactively trading LDO, as in diversifying parts of the treasury into stablecoins when LDO prices are considered high, or paying out rewards in stablecoins when LDO prices are considered to be depressed.
- With a more diversified treasury (or short term intentions of one), the distribution denomination discussion could shape up differently as that is one of the justifications for LDO usage currently. (applicable to both stETH as well as stablecoins)

## Short term plan & Withdrawals

### April
The current estimate for stETH withdrawals on mainnet is [mid May](https://twitter.com/LidoFinance/status/1635739580136652825?s=20). As such, April's reWARDS budget still needs to be drafted knowing that secondary markets will remain the only venue for stETH<>ETH exits, as in all previous budgets.

Reductions can and will continue in both LDO, USD and ETH terms. However, they can't be to zero (definitely) and can't be radical (safely).

Using the normal mix of business direction, month's performance, importance of stAsset to the DAO and growth, reduction numbers will be shared with the committee between the 16th and 17th of March ahead of budget prep.

Preliminarily, down to 750k overall LDO seems safe, and 500k (>50% reduction) is the stretch goal.
An OP reWARDS section will also be included from April's onwards, to be accounted separately.

### May and onwards

1. Liquidations will still need to use secondary markets
2. The promise of Liquid Staking will still rely on secondary markets if the withdrawals queue is longer than close to instant for the given size.
3. Non-continuously, there will be growth initiatives that justify rewards allocations

**Treasury LP**

Another changing point is that 30k ETH doesn't move the needle with 1m stETH/ETH overall in pools but it does with 100k.
Treasury ETH and stETH being used to support incentives-free liquidity is a topic that has come up forever in the community but that can/should be re-explored better at this time.

Outside of

**Year budget**

Additionaly, as part the larger lido-2 budget being done, an incentives budget from May/June until EOY will be proposed by the reWARDS committee.
It makes sense for this longer budget to have clauses that give it some flexibility in extreme cases such as extreme ETH prices.