icETH vs. dsETH: Understanding the Difference

Ethereum is the world’s second-largest crypto project by market capitalization and has over 444,145 ETH wallets active daily. Until recently, price appreciation was the only way for most holders to generate a positive return.

Since the Merge, however, staking and liquid staking tokens (LSTs) have provided new ways to earn yield on ETH.

LSTs allow users to participate in a proof-of-stake Ethereum network without locking up their ETH for an extended period of time. LSTs are created by depositing ETH into a smart contract, representing the user's ownership of the deposited ETH. The smart contract uses the deposited ETH to participate in staking and distribute rewards to LST holders.

At Index Coop, we’ve developed two tokenized strategies to simplify the process of generating a yield on ETH: Diversified Staked ETH Index ($dsETH) and Interest Compounding ETH Index ($icETH)

But how do you know which token is right for your situation, and what are the pros/cons of each? We answer these questions and more in this post.

• dsETH versus icETH

• Comparing the composition of each token

• Pros and cons of each underlying strategy

• Use case of dsETH versus icETH

• Getting started with dsETH and icETH

dsETH versus icETH

The Diversified Staked ETH Index (dsETH) is an index token of the leading Ethereum liquid staking tokens. Holders of dsETH earn staking yield while incentivizing liquid staking protocols to be more efficient and decentralized.  

dsETH accomplishes this with inclusion criteria and weightings that favor decentralized liquid staking protocols. To be eligible, liquid staking tokens must meet all inclusion criteria, which center around security, transparency, and liquidity. Tokens that meet these criteria are assigned equal weights before applying two factors: 1) the number of node operators supporting a protocol and 2) the distribution of stake across those node operators.

icETH, on the other hand, provides an enhanced yield on ETH using a leverage liquid staking strategy built on Set Protocol. Within Aave v2, icETH deposits Lido’s liquid staked Ethereum token—stETH—as collateral and recursively borrows ETH to procure more stETH.

As a result, token holders have spot exposure to ETH and nearly twice the yield compared to simply holding stETH. It is worth noting that the effective yield for icETH is variable and subject to staking rates and borrowing costs.

In essence, dsETH is for those looking for a simple, diversified way to gain exposure to staked ETH rewards. icETH, on the other hand, is better suited for those looking to up their staking yield with an automated leverage strategy.

Comparing the composition of each token

Both tokens are smart contracts that represent a portfolio of assets, and they can be traded on decentralized exchanges, just like any other ERC-20 token.  dsETH Composition (at launch)

• rETH - 41.84%

• wstETH - 30.80%

• sETH2 - 27.36%

icETH Composition

• stETH

• WETH

Pros and cons of each underlying strategy

Each type of strategy has its ideal use case.

dsETH

Benefits:

• Diversification across liquid staking tokens

• Ease of use

• Promote decentralization amongst liquid staking protocols

• Reduces gas costs associated with maintenance and rebalancing

Risks

• Currency risk

• Liquidity risk

icETH

Benefits:

• Composability

• Ease of Use

• Potential for a higher yield than LSTs

• Eliminates the need to manage collateral and debt balances

Risks

• Liquidation risk

• Interest rate risk

Use case of dsETH versus icETH

The case for dsETH

As more liquid staking protocols emerge, it’s not always clear what the best option is to earn yield on your ETH. Stakers are confronted with deciding which LST(s) to entrust with their ETH.

Since these protocols and their tokens are primarily based on the Ethereum mainnet, it can be costly to manually deposit to multiple protocols or purchase several tokens from secondary markets to diversify your stake.

Diversified Staked ETH (dsETH) addresses both of these pain points by indexing the most prominent liquid staking tokens and bundling them up into a single ERC20 token.

The case for icETH

A large number of ETH holders are keen to increase or compound their holdings of ETH. However, there are few simple, time-saving strategies for maximizing their returns. Lending rates paid on the largest money market protocols are negligible, and more sophisticated strategies like Yearn vaults or leverage protocols can be complicated and cumbersome for the average investor.

Staking is arguably the best way to earn yield on ETH, and tokens like stETH simplify the staking process by offering a tokenized, interest-bearing asset that is freely tradeable; however, stETH is only paying 6.5% APR at the time of writing, and that rate will fall gradually over time as more ETH is staked.

With the use of Set’s battle-tested leverage token infrastructure, the Index Coop can create a stETH yield product that is 1.5-2.5x the return of stETH in a low-risk fashion. By tokenizing this simple strategy, icETH creates outsized returns to token holders and offers the highest scalable yield on ETH in DeFi.

Getting started with dsETH and icETH

Once you’ve decided what strategy is right for you, you can allocate your ETH via a few different options:

dsETH - Buy/Mint

Ethereum - CoW Swap, Uniswap, Index Coop App zkSync - ZigZag Exchange & Argent

icETH - Buy/Mint

Ethereum - CoW Swap, Uniswap, Index Coop App zkSync - ZigZag Exchange & Argent

Summary

The development of liquid staking tokens has provided ETH holders with a new way to earn a yield on their holdings. Index Coop has created two strategies to simplify the process of generating a yield on ETH: the Diversified Staked ETH Index ($dsETH) and the Interest Compounding ETH Index ($icETH).

While dsETH offers a simple, diversified way to gain exposure to staked ETH rewards, icETH is better suited for those looking to increase their staking yield with an automated leverage strategy. Both tokens have their ideal use cases and risks and can be allocated through various options.

About Index Coop

Index Coop is a decentralized autonomous organization (DAO) that powers structured decentralized finance (DeFi) products and strategy tokens using smart contracts on the blockchain. We offer a suite of sector-structured products, leverage and inverse products, and yield-generating products. We aim to create products that are simple to use, accessible to everyone, and secure. Our products are built on Index Protocol and Set Protocol, twice-audited, self-custodial DeFi tools that allow for creating and managing Ethereum-based (or ERC-20) tokens. Among users, partner protocols, and our composable products, Index Coop maintains one of the largest partnership networks in the DeFi ecosystem.

How to buy Index Coop products with fiat currencies:

• First, you’ll need to create an Ethereum wallet like Argent, Metamask, or Rainbow.

• Next, you’ll set up your new wallet and connect your bank account.

• Once you’ve deposited fiat currency in your wallet, you can exchange it for Index Coop products like Diversified Staked ETH Index (dsETH) or the Interest Compounding ETH Index (icETH)

You can also buy dsETH or icETH tokens directly via a decentralized exchange like CoW Swap or DefiLlama.