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Why use LST ETH?

ETH is an exogenous collateral to this system, external to it, so the system cannot control the supply.

  • Examples like what happened with Terra/LUNA explain the issue of endogenous (internal to the system) collateral or seigniorage shares. It lead to a fast rise up and death spiral down (in the case of a bank run). When the same stablecoin system controls the supply of the collateral, it leads to highly reflexive behavior and volatility. The team was free to mint an infinite amount of LUNA to keep the price of Terra stable, until its inevitable failure.

There is little incentive to be a shorter with a non-staking collateral, if that collateral could have been used to stake. Staking is the base action to compare all actions against, so LST ETH is being adopted over ETH itself post-Merge.

What are the user incentives?

  • Buyers want a stable asset (dETH -> dUSD).
  • Shorters want extra yield for their ETH, which comes from the buyer side as well as any unmatched dETH.
  • Askers want to swap the stable asset back for collateral (dUSD -> dETH).
  • Primary Liquidators get a reward for liquidating.
  • Secondary Liquidators want to swap the stable asset for collateral if the asset peg might break (dUSD -> dETH).