Despite a recent rise in liquid staking tokens, RocketPool (RPL-USD) is not valued even remotely close to fair value for the underlying fundamentals of the network and multiple upcoming catalysts. There is an opportunity to potentially see 5x upside from today’s prices.
Ethereum is secured by a network of stakers who put their ETH at risk in the promise they will accurately verify transactions and the state of the network. In return get a stream of revenue from multiple underlying sources (new issuance, tips from users, and maximal extractible value (MEV)) for doing so. That staked ETH is not usable while earning rewards. This ETH and associated rewards are also not redeemable today, but this will change with a network upgrade (“Shanghai”) in the coming weeks. Even after withdrawals are enabled ETH will have to be locked to earn rewards. A new set of solutions has emerged to solve this issue.
Liquid staking derivatives (LSDs) allow users to earn rewards while having their tokens available for use in decentralized finance or other primitives. For example, users can trade 1 ETH for one stETH and earn the roughly 5-10% annual rate of the network. They can then freely use the stETH LSD across crypto ecosystems. LSDs should naturally trend to match the supply of outstanding Ethereum, as there is little reason to hold the “naked” version that does not earn yield, as LSDs become engrained across DeFi. Today only 14% of Ethereum is staked, in part because of the existing lockup and associated illiquidity risks. LSDs make up ~45% of staked ETH. The additional stakers are ether centralized exchanges, staking pools, or whales (likely to utilize LSDs after withdrawals are enabled).
Once withdrawals are enabled this 15% amount should rise steadily over time. Other Proof of Stake networks have staking rates from 50-70%. This is one vertical where there is a clear product market fit within crypto.
Source: Staking Rewards as of March 11, 2023
Liquidity for LSDs like stETH and others, within decentralized finance, is still expanding. These yield-bearing tokens will tend to become the base pair for transactions. The version of LSD you use will be like the currency you use in traditional finance.
Looking into late 2023 and 2024 new middleware solutions like EigenLayer can further boost the yield of these LSDs. Using EigenLayer stakers can re-stake their staked ETH to secure bridges, oracles, and other infrastructure in exchange for additional yield. There are two ways of re-staking on EigenLayer: 1) as a solo staker, set your withdrawal credentials to the Eigenalyer contract 2) take an LSD and deposit it into the EigenLayer contract. Both give EigenLayer the permission to slash you if you are a bad actor. With 2000+ independent node operators RocketPool can directly bootstrap the Eigenlayer network validator set itself. No other entity has the network of independent nodes to enable this partnership. EigenLayer has already discussed their intention to build this relationship.
On Ethereum today there are a handful of major players with varying market shares: Lido (~31%) Coinbase (~12%), RocketPool (~2%), StakeWise (<1%), and Frax (<1%).
Lido dominates the existing market because they 1) were first to market 2) most integrated in defi 3) have strong marketing and liquidity incentives 4) the cheapest option (10% of fees). These existing advantages for Lido come with a range of disadvantages the market has mostly looked through including its censorability due to a small group of validators (<30).
Coinbase’s LSD (cbETH) has found market share through its ease of access for its deep retail user base (100M+ users). cbETH has the highest fees at 25% of rewards, and does not currently distribute MEV to its users.
RocketPool makes its claim as the most decentralized and trustless among the competition, though more expensive than the dominant Lido (15%). For those who want to run their own node, RocketPool is the only LSD option.
Longer term the competitive landscape will include a range of defi players with their own stablecoins with native yield. Curve (cUSD), AAVE (GHO), and others are emerging while these primitives may be useful as yield solutions, they do not inherit the yield of Ethereum and it is unlikely they will have the liquidity of something like a true LSD due to their niche vertical. Yields will be more variable, the risk profile will be different and use cases will be defined.
To understand the investment case we first understand how the protocol works. RocketPool has two: two tokens rETH (derivative token of ETH) and RPL( the governance and collateral token).
For every RockePpool transaction, there are two parties who utilize these tokens in different ways. Stakers who utilize rETH and node operators who utilize RPL. It requires 32 ETH to run an independent node on Ethereum. Node operators put up 16 ETH, while a collection of independent stakers put up the other 16 ETH. The independent stakers receive the LSD rETH for their use. Node operators receive rewards on their 16ETH plus 15% of the rewards from the stakers 16 ETH. The independent stakers receive their rewards less the 15% fee. Node operators put up 1.6ETH (~10%) collateral in case they are negligent and their stake is slashed. They can put up more than this to receive a greater share of RPL rewards. This relationship ties the RPL token to ETH. RPL is fully distributed with a flat 5% inflation rate: 70% of rewards go to node operators and 30% to stakers.
The constraint on the supply of rETH is the number of stakers who are willing to put up 16 ETH to form these “mini pools”. The queue on the independent staker side is full but there are not enough node operators. This is the primary cause of the ~2% market share of RocketPool today.
The current numbers as described are all being adjusted with the “Atlas Upgrade” coming in April. The 16 ETH staking requirement for node operators is being lowered to 8 ETH. Now operators will borrow 24ETH from the protocol for every mini pool. This triples the capacity to mint rETH. Someone with 16 ETH would now run 2 minipools, borrowing 48 ETH in total. This leaves 48 ETH for independent validators to mint against vs the previous 16.
Fees can now also be lowered because node operators are making a percentage on 48 ETH vs 16 ETH. Initially, the fee will be lowered from 15% to 14% but this will likely go lower in the future. These fees are still higher than Lido which currently charges 10%, however due to the way rETH accrues rewards, holders inherent tax advantages Lido LSD (stETH) holders do not.
Finally, with the Atlas upgrade the collateral requirement moves from 1.6 ETH in RPL on 16 ETH, to 2.4 ETH in RPL on 8 ETH. This produces mechanical buy pressure on the asset for new and existing stakers.
Potentially positive investment implications with uncertain externalities include the support key industry figures for the protocol, the importance of decentralization for investors, and value of lack of censorabilty.
Atlas upgrade lowers the threshold for running a node
A lower threshold for running a node leads to more validators, which leads to expanding rETH supply. The code review is ongoing and the upgrade is launching likely in May maybe as early as April.
Withdrawals coming to ETH in late March/early April
Withdrawals will be a de-risking event. Many more stakers likely to join network as the withdrawal process is enabled. Post-withdrawals solo stakers can easily redirect their ETH to RocketPool and earn more rewards. 30% of depositors are solo stakers today or a 40M ETH / 5M validator addressable market. Additionally, RPL has a pool to smooth MEV to make rewards more predictable for these validators providing further advantages over solo staking. The confluence of these events will lead to a growing number of nodes, which leads to growing rETH share.
Expansion within defi
RocketPool has recently announced partnerships with Euler Finance and others. They are the most decentralized option with no risk of censorship, therefore are aligned with the core principles of Defi. The lack of integration to date is because of liquidity constraints of rETH.
Mechanical buy pressure/supply squeeze
With Atlas the requirement of collateral in RPL increases (1.6 in ETH terms to 2.4 in ETH terms). This creates buy pressure for stakers, especially as the staking population increases. There is a limited supply of RPL with ~90% of the supply effectively illiquid.
Because of the mechanics of RPL as a collateral asset and the denomination of RPL collateral in units of ETH, it’s possible to project an RPL value using a few simple inputs.
% RPL Staked: The % of the total supply that will be staked.
RocketPool has constantly garnered 5% of ETH staking inflows since its release despite limited marketing and the constraint on rETH supply. We use a range of 5% in bearish scenarios to 15% in bullish scenarios.
Tied to this assumption is an assumption of the amount of ETH staked. From 14% today, we assume a range of 17% to 22%. About 3% ETH has been staked the last 6 months, with the de-risking of withdrawals we think these numbers are extremely conservative.
rETH Supply (in ETH): A product of total staking participation, Rocket Pool market adoption, and the amount of capital collateral efficiency per validator. These values should increase due to expanded capacity via Atlas, lower barrier to entry for stakers, and at least a portion of the 40M ETH from solo stakers migrating to the protocol.
Average Collateralization: The amount of collateral you must post of RPL in ETH terms. Today the minimum is 10% but the average is 90% due to the more rewards you receive with higher collateral amounts.
Using those inputs we can get a price target for 2023 in ETH terms. If we assume a value for ETH in dollar terms. We can also find a price target for the RPL token. Utilizing what the author thinks are fairly reasonable assumptions we find a ~5x upside for the RPL token for 2023.
Strong competition: Existing players have deep connections in the industry. There are numerous emerging players throughout the ecosystem
Smart contract risk: RocketPool is completely permissionless and relies on smart contracts. There is always the risk of an unforeseen issue and/or bug.
Limited defi integration: rETH today has limited defi integrations when compared to incumbents. There is the possibility other players hit escape velocity before rETH supply is expanded or fees are reduced.
Higher absolute fees today: Fees remain higher than Lido (when not adjusted for taxes). There is the possibility most users aren’t aware of this or are non-US users.
Liquidation risk: The risk of lowering the stake required from node operators means higher liquidation risk.
LSDs have a clear product-market fit with an upcoming event that should increase their adoption. RocketPool stands well-positioned to benefit not only from the increase in liquid staking but also from protocol upgrades that should grow its supply and demand for its associated tokens. RocketPool looks like a strong accumulation target into the spring and hold for the rest of 2023 and staking expands.