Lido Note: ETP Liquidity Buffers Cut Ethereum Staking Yields

Lido published an institutional note on October 23 comparing European exchange-traded products (ETPs) for Ethereum, arguing that liquidity buffers and staking allocation significantly affect the yield investors receive. The note highlights that products holding an unstaked liquidity buffer may earn rewards on less than their full ETH exposure, promoting liquid staking as an alternative to traditional unstaked buffers.

Illustrative Yield Calculation

In the note, Lido presents an illustrative scenario involving a product holding 100 ETH. If the product maintains a 20 ETH unstaked buffer, only the remaining 80 ETH is available to generate staking rewards. Using a hypothetical annual staking rate of 3%, the staked portion would produce 2.4 ETH in rewards before fees and other adjustments. Lido explicitly states that these figures are hypothetical inputs for illustration purposes, not a forecast or a quoted product return.

The core argument is that the reward rate applies only to the capital actually earning it. By comparing this to products that stake their full exposure, Lido suggests that the choice of liquidity management strategy directly impacts the net reward available to investors. The note uses WisdomTree’s stETH-backed product as a specific example of a structure that utilizes liquid staking, though Lido acknowledges it has a commercial interest in this comparison.

Liquidity Buffers and Execution Risks

Lido notes that an unstaked buffer is not necessarily wasted capital. It can provide immediate liquidity when redemptions arrive or when other operational processes take time. However, the note argues that investors must weigh the operational benefit of the buffer against the reward given up. The useful question, according to the note, is what specific operational benefit the buffer buys and how much yield the product sacrifices in exchange.

The note addresses the mechanics of Ethereum withdrawals, stating that exiting validators must pass through network processes and that demand can affect the timeline. A fund’s need to meet a commercial deadline does not accelerate the underlying protocol queue. In contrast, a transferable claim on staked ETH, such as a liquid staking token, can be sold without waiting for every underlying validator to exit. However, this market exit route has its own risks. A sale requires buyers at an acceptable price, and transferability does not guarantee that a large transaction will execute at the value used in a fund’s accounting.

During ordinary trading, market makers may bridge liquidity gaps efficiently. Under stress, however, the amount of available liquidity and the cost of absorbing an order become more important. A structure that supports full staking can still face difficult execution decisions when many holders seek liquidity simultaneously. The note draws a parallel to Bitcoin products using options for downside management, suggesting that the underlying asset’s name cannot fully describe the investor’s payout. It also references CoinShares’ fund liquidation to illustrate why redemption rules deserve attention before a deadline arrives, emphasizing that trading a share and withdrawing its underlying exposure are distinct operations.