Today, institutional ETH holders face operational and compliance limitations when it comes to liquid staking. Lido V3 introduces a new architecture, stVaults, that address many of these constraints by allowing vault owners to select operators, customize validator setup, and still mint stETH. This shift could open liquid staking to a broader range of institutional participants.
This article provides an overview of Lido V3, what it is, how it differs from previous versions, and why it represents a significant shift for both individual vault owners and institutional participants.
What is Lido V3?
Lido V3 combines the use of stETH and customizability of a staking position through stVaults. stVaults are smart contracts owned by their creator, which support staking ETH on Ethereum and, optionally, minting Lido’s liquid staking token, stETH. What makes stVaults so interesting compared to the Lido protocol we know today, is that stVaults give their owners control over operational decisions. This allows vault owners to choose their operator, fees and have greater control over the risk/reward profile of rewards.
But how is it possible to grant vault owners such flexibility while allowing them the same liquidity terms as all other stETH holders? Achieving this speaks to the magnitude of the V3 upgrade. In short, Lido V3 strikes a balance between flexibility for vault owners and safety for all stETH holders with some small restrictions such as maintaining reserve ratios and granting the Lido protocol the means to intervene if necessary through the VaultHub. Further details follow in the next section.
Importantly, Lido V3 is not yet live on mainnet, though aspects of it have been launched on Hoodi – see here for more technical information about the Hoodi testnet deployment. There is no firm date for the mainnet launch, but currently the best estimate is likely in November.
What are stVaults? (and how do they work?)
Lido’s stVaults are smart contracts owned by their creators. These vault owners have the ability to set up the vault, choose the operator and mint stETH against the staked position. The Lido protocol is obligated via its design to honor the exchange of stETH in a 1:1 ratio for ETH. This obligation applies across the protocol – for both Lido Core and stVaults. In order to protect the protocol and credibly honor the liquidity commitment, restrictions must be placed on stVaults.
Each vault has a buffer, ensuring that vaults are only able to mint an amount of stETH that is strictly less than the vault’s staked position. The reserve ratio defines this buffer amount and is a generalized risk framework meant to protect stETH holders in the event of a slashing incident.
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Different operators will have different reserve ratios and stETH minting caps. These restrictions seek to limit the risk incurred by Lido from stVaults. In theory, the lowest restrictions are reserved for operators adhering to the highest standards and risk management practices, while higher restrictions are placed on unknown or unverifiable operators. Here are some indicative numbers for Identified Node Operators:
These controls are designed to limit risk exposure from individual vaults, which is critical for institutions allocating at scale.
Additionally, as a single operator’s share of stake increases, incremental ETH faces a lower tier:
Beyond the vault-specific and operator-specific limits, there is an initial protocol-wide restriction that stVaults should represent no more than ⅓ of stETH on Lido; initially, this amount will likely be even less at ¼ of stETH.
Various actions will be taken by the protocol should any of these restrictions be breached. VaultHub is the smart contract (and mechanism) that monitors and enforces these rules (among other things). Connecting to VaultHub is a pre-requisite for minting stETH. The way to think about VaultHub is that it permits (or restricts) actions of a stVault; i.e., many requests first go through the VaultHub.
For instance, the VaultHub will identify situations where the forced rebalancing threshold has been breached and that action must be taken. The VaultHub gives the protocol (Lido) the ability to bring the stVault back into compliance. For now, it appears that this process will be manual, but in the future it could be automated.
More specifically, the VaultHub unstakes ETH from the stVault and reduces the stETH liability of the vault until the reserve is restored to the correct level; effectively it solves for X in the below equation:
At the stVault level, this mechanism activates when a stVault’s liability exceeds its Forced Rebalancing Threshold. Even in that case, the preferred method to lower liability is burning stETH within the Vault. But if that is not enough, the protocol may authorize ETH unstaking for the stVault, but only as a last resort, applied in precise amounts to bring the stVault back to a healthy state.
However, Forced Rebalance can also be applied to stVault at the protocol level when the total TVL of all stVaults exceeds the core protocol TVL. In this case, the mechanism ensures that withdrawal requests for the core protocol are fully satisfied even if some rebalancing for stVaults’ liabilities are needed. Burning stETH remains the primary method to reduce liabilities, while ETH unstaking is, again, an exceptional, carefully calibrated step to restore the protocol’s ability to handle withdrawals.
One last concept to bear in mind is that of obligations. Obligations are amounts of ETH owed by the stVault to the Lido protocol. Obligations can arise due to fees owed by the stVault to Lido (more on that below) or due to the Forced Rebalancing mechanism being triggered. It’s helpful to think of the latter case as obligations being created during the rebalancing of a vault, i.e., as a necessary step in the process.
What should stakers know?
First, in terms of risk, stakers should be aware of the new smart contracts that are needed to enable V3. Unlike V2 contracts that are more ‘battled tested’, these new contracts do add some marginal risk. That said, Lido V3 is currently going through the audit process and has proven its reliability with prior versions. Lido’s github can be reviewed for current contracts deployed on Hoodi.
In terms of the well-documented governance risk faced by stETH holders, Lido recently introduced a dual governance model, which allows stETH holders to withdraw before any changes are made to the protocol that could be harmful. The exact delay of enacting a motion depends on the proportion of stETH locked. This is not related to V3, but should be noted as a positive change for those interested in engaging with Lido either through the core protocol (V2) or through stVaults (V3).
Beyond that, Lido V3 also creates a “safety hatch” mechanism, which effectively allows vault owners to opt out of any pending upgrades. Vault owners must not have any outstanding stETH to use this feature. This feature along with dual governance goes a long way in minimizing governance risk. For more see here.
The regulatory stance out of the US has changed drastically over the last eight months or so, culminating in some key policy changes around things like liquid staking. That said, stakers are encouraged to understand the laws and rules in their jurisdiction about both staking and liquid staking. Particular attention around pooling, smart contract concerns, such as control, custody and mutability is likely warranted. The above changes could provide the assurance that many need to engage with Lido, but each staker must review their specific situations.
A result of the permissionless nature of Lido V3 is that vault operation for stVaults will not be subject to the same controls and oversight of the Lido Node Operator Subgovernance Group (LNOSG). As mentioned above there are some protocol-wide and vault-specific restrictions, but the same guiding force of LNOSG will not be present.
Lido has been a positive force for decentralizing their operator set and encouraging solo stakers, through the community staking module and related support programs. Vault owners will choose who operates their vault and determine some aspects of how the vault will be run, which could differ substantially from how Lido’s oversight would allocate the same stake. On the whole Lido V3 is a positive step as it moves to a more permissionless and market-based setup. That said, it’s also necessary to monitor how stVaults evolve and any related impacts on the ecosystem.
Why Lido V3 Matters for Institutions
- Control: Vaults can be dedicated, with validator selection and fees tailored to the staker
- Compliance: Connected stVaults maintain VaultHub risk controls, ensuring liquidity safety and fee transparency
- Rewards: Liquid staking (stETH) provides base rewards, with the potential for higher rewards when used in DeFi or restaking strategies
- Simplicity: ETH is deposited in the stVaults with an existing strategy, a format that resonates with treasuries and funds
Figment is evaluating how these new features could be offered in secure, compliant ways to institutional clients.
Fees
There are three types of fees (all quoted fees should be treated as indicative only):
- Infrastructure Fee (1%) – this fee is charged on the expected staking rewards in the stVault.
- Liquidity Fee (6.5%) – charged on the rewards generated from minted stETH.
- Reservation liquidity Fee (0%) – fee charged on mintable stETH, i.e., how much stETH could potentially be minted (as opposed to the amount actually minted).
Note that the fees above are charged in proportion to Lido Core APR; i.e., assuming Lido Core APR is equal to 2.9%, a fee of 1% would be equal to: 1% * 2.9% = 0.029%.
Node operator fee – distinct from the 3 fees above, which are levied by Lido.
Interesting use cases
The ability to permissionlessly create a vault and mint stETH is compelling. With stETH, users will be able to engage in all the major areas of DeFi, this is a great thing – giving stakers more flexibility and options as well as, arguably, making stake stickier. That said, users newer to DeFi are cautioned to do their homework. Staking is the most durable, consistent and lower risk reward generating activity in crypto. It’s natural to ‘reach for more rewards’ but the type of risks involved in some areas of DeFi are a difference-in-kind and magnitude compared to those related to staking.
As an example, looping is an activity which will likely see increased adoption with vaults. One example is looping (re-staking ETH using leverage). While potentially boosting rewards, it comes with significant risks such as liquidation or rate spikes – the idea is to create a vault, mint the LST then borrow ETH against the LST. The ETH is then deposited back into the vault and the process is repeated.
How looping stacks up against other DeFi strategies comes down to implementation details. The key risks with looping are:
- Basis risk: the risk that there is a significant divergence between the LST and the other token, ETH in this case. A divergence large enough will cause your collateral, the LST, to be liquidated and some loss of the initial stake.
- Variable borrowing rate: in most cases users will face variable borrowing rates. There is limited capital supplied to various lending protocols. A surge of demand for borrowing could cause borrowing rates to spike, leading to a loss on the looped position, i.e., the borrowing cost can become higher than the rewards earned.
- Illiquidity/macro risk: looping takes much more time to set up than to unwind. However, in the event that looping becomes a widely adopted strategy, an ecosystem-wide event leading to multiple unwinds will likely cause the exit queue to increase dramatically. As a reminder, Ethereum can only process 256 ETH per epoch, or 57,600 ETH/day – 0.16% of stake.
Looking Forward
At Figment, we’re committed to evaluating new staking infrastructure that could benefit our institutional clients. As Lido V3 matures, we are exploring how stVaults could be integrated into institutional staking workflows, combining the liquidity of stETH with the control, compliance, and risk management institutions require.
Interested in learning more? Reach out to our team to learn how Lido V3 could fit your staking needs.
