Leading cryptocurrency protocol Aave [AAVE] recently introduced a new proposal detailing the addition of Lido’s wrapped stETH, wstETH, to its V3 deployment on layer 2 network (L2) Optimism. 

Users of Lido Finance receive stETH tokens as rewards for staking their ETH on the liquid staking protocol. However, because stETH is a rebase token, a user’s stETH balance changes as they receive daily staking rewards. 

Read Aave’s [AAVE] Price Prediction 2023-24

Some protocols, however, do not offer support for rebasing tokens, thereby putting holders of stETH at risk of losing out on daily staking rewards when they provide stETH as liquidity across these platforms.

To address this issue, Lido allowed users to deposit their stETH into a wrapper to create a wstETH, a DeFi-compatible version of the stETH token, which had an underlying share system to always reflect staking rewards. 

Aave’s decision to add wsETH to its V3 deployment on Optimism was inspired by the success enjoyed by its stETH Reserve on Aave V2. With $1.09 billion in deposits and USDC and ETH holdings exceeding $1.08 billion and $1.03 billion, respectively, the reserve is the largest reserve across all existing Aave deployments. 

The large size of the reserve is,

“Partially due to several communities having built products that deposit stETH and borrow ETH as part of a rewards-maximizing strategy.”

Lido announced stETH as collateral on Aave in February. Both protocols have since benefitted from the same. Aave stated in its proposal,

“The demand for stETH has increased as a result of listing stETH on Aave V2. Lido DAO takes a small percentage of rewards received by staking ETH as revenue. Listing of stETH by Aave has enabled Aave to offer the best return on ETH, in ETH terms, across major lending markets, continually outperforming Compound.” 

In addition to this, Aave confirmed that listing wstETH on the Optimism Liquidity Pool would enable developers to build and deploy similar projects on the L2 network. 

State of Aave

Per data from DefiLama, the TVL across Aave’s three deployments was $3.85 billion at press time. This fell by 73% on a year-to-date basis.

In August, Optimism launched its Liquidity Mining program on Aave, which saw the distribution of five million OP tokens to Aave users on Optimism within a 90-day period. Aave’s TVL declined by 41% since then. 

Source: DefiLlama

It remains to be seen whether listing wstETH on the Optimism Liquidity Pool would lead to a growth in the protocol’s TVL as the market gears up to close Q4 2022.