JitoSOL and ETFs
Since the launch of SPY over 30 years ago, the invention of exchange traded products (broadly and colloquially referred to as ETFs) has ranked as one of the most impactful innovations in financial markets. ETFs represent a paradigm shift in the way passive investment works and have introduced a wide range of benefits across all market participants. Their flexible construction has encouraged further innovation based on new strategies, structures and asset classes, including digital assets.
The success of digital asset ETFs is further evidence that the market has adapted to changing conditions and investor demand. Currently, however, ETF Issuers have limited options when it comes to what is known as “staking”. Staking refers to a technical process for certain blockchain networks whereby individuals agree to commit a certain portion of the network’s native cryptocurrency in order to align incentives between those validating and settling transactions on the network and the users of the networks themselves; by “staking,” the validators evidence their dedication to act appropriately within the network’s rules, and thus, provide security to the network.
The benefits of staking assets inside an ETF are clear - users get more choice and enhanced participation in the underlying network with reduced transaction and holding costs, while issuers can find new sources of revenue that helps maintain the health of the ETF ecosystem.
To date, U.S. regulators have not permitted staking within ETFs. The main constraints – as far as the industry has been able to discern — relate to asset servicing, e.g., how to meet redemption requests while appropriately managing the underlying asset; to the taxation of rewards earned by validators for network security; and the regulatory status of certain staking arrangements. Issuers, APs, attorneys and numerous other market participants have been working collectively on answers to these questions.
With the SEC poised to opine on whether staking can be permitted within ETFs, it is time to revisit some of the questions around how to implement staking innovation within these traditional financial vehicles.
The Jito Foundation has been vocal about a proposed alternative to direct staking - inclusion of Liquid Staking Tokens (LSTs) in an ETF.
LSTs are tokenised representations of staked digital assets, and the rewards accruing to such staked assets. LSTs are much more flexible and capital efficient than directly-staked assets — for example, they can be used as collateral at prime brokers or in decentralized finance (DeFi) applications, among other things.
Crucially, LSTs have many similar characteristics to ETFs:
- Holders get economic exposure to underlying markets while abstracting away the complexities of ownership
- Liquidity flywheel from primary and secondary market activity
- Can be posted as collateral for enhanced capital efficiency of investor portfolios
- Tax efficient In-kind creation/redemption mechanism
What is JitoSOL?
JitoSOL is a liquid staking token. These work as a yield-bearing receipt token, which represent a claim on a user’s Solana that has been staked to improve the security of the network. These LSTs can then be used as collateral at prime brokers and banks or on other DeFi applications. JitoSOL is structured as a continuously compounded total return product. To acquire JitoSOL, users can mint or acquire on the secondary market. To dispose of JitoSOL, users can burn existing JitoSOL to un-stake their Solana at the end of every epoch (currently ~2 days) or sell on the secondary market.
Why use JitoSOL inside an ETF?
JitoSOL offers a novel way to solve the problem of yield optimization and redemption risk. Because JitoSOL has both primary and secondary market liquidity, issuers can fully stake their assets to maximize the achievable yield for their users. Any large redemptions can be handled either by unbonding their JitoSOL (primary market), selling JitoSOL (secondary market) or, if the ETF allows for in-kind creations and redemptions, delivery of JitoSOL to the AP.
What is the utility of a JitoSOL ETF?
Long term holders will appreciate the long term convexity that comes with a continuously compounded total return product. Short term investors will benefit from yield enhancement without having to manage the technical or operational complexity of frequent staking and unbonding of their Solana. Delta-neutral traders can benefit from enhanced basis trading over vanilla SOL products, as JitoSOL yield also includes additional revenue if network activity increases. JitoSOL also offers novel ways to express the forward path of Solana, and provide another price discovery mechanism for the forward curve.
Is JitoSOL eligible for ETF inclusion?
Yes, due to its status as a non-security commodity. JitoSOL is unique among all LSTs, on Solana and otherwise, due to the autonomous delegation of stake. Because there are no humans involved in the allocation decision or implementation, it doesn’t fit the “efforts of others” test under Howey (see JitoSOL Securities Classification Report) . The practice of integrating non-security commodities into an ETF is very well established at this point.
How would LSTs work inside an ETF?
LSTs fit well into the existing architecture of ETFs, as they are already supported by much of the existing ETF infrastructure. Large LSTs are accepted at the main Qualified Custodians, APs can do creations and redemptions either via cash or in-kind, and it’s possible to calculate an NAV using the LST itself or indexed to the underlying asset. Because of the native staking/un-staking methodology, there is no price or slippage risk as they are treated as in-kind primary market transactions.
Can LSTs be considered highly liquid investments by Funds?
LSTs are digitally native instruments that can be liquidated via primary market or secondary market activity almost instantaneously as needed, so should easily fit the 3 day requirement for liquidity. Because most large LSTs are inextricably linked to their underlying asset by construction, the impact of redemption orders in these LSTs is better evaluated on the ability of the underlying market to absorb these orders. There is a similar dynamic in many ETFs, where large orders can be traded by OTC dealers based on their ability to source hedges in the underlying asset, as opposed to just using the lit liquidity available on exchanges.
Is there any price risk associated with mint/burn?
Minting is free and instantaneous, and there is a fixed 10bp burn fee on every transaction. There is no price or slippage risk on the mint/burn itself, as an in-kind primary market transaction.
What is the secondary market liquidity on JitoSOL?
JitoSOL is currently the largest LST on Solana by every metric, and offers the deepest liquidity as well. Additional trading platforms are being continually added, both CEX and DEX venues, to further enhance the liquidity. Because of the existence of firm arbitrage bounds versus SOL, the true available liquidity of JitoSOL is better evaluated on the liquidity of the underlying market. There is a similar dynamic in many ETFs, where large orders can be easily absorbed by OTC dealers based on their ability to source hedges in the underlying asset, as opposed to just using the lit liquidity available on changes.
Can JitoSOL be custodied by a Qualified Custodian (QC)?
QCs are a critical component of ETF infrastructure, ensuring that the assets held by the ETF are secured. JitoSOL is supported by the vast majority of eligible QCs of digital assets, and we are in active discussion with all others.
How secure is the smart contract layer?
Although the security of the underlying stake pools from which LSTs emanate may vary, ultimately all large liquid staking protocols have been audited by third party auditors and reputable developers publish the results of those audits publicly.
What are the tax implications of minting or burning JitoSOL?
Everyone will need to conduct their own review with their tax specialists. Independent experts have opined that supplying to stake pools is not a taxable event, and staking rewards that compound within the contract are not taxable income at the time of receipt, only upon disposition, due to their status as newly created property. Fenwick has published their view here.
How do you calculate an NAV with JitoSOL?
We are working with multiple index providers on calculating JitoSOL indices using their existing benchmark methodologies. We are happy to provide updates upon request.
Can I list a JitoSOL only ETF?
ETF issuers will have multiple options when deciding how to structure a product that includes JitoSOL. For example, issuers could choose to list a staked SOL ETF, indexed to a SOL price, but hold the assets in JitoSOL. Because JitoSOL represents a slowly increasing number of SOL, the tracking error should be within expected ranges to a SOL index. Issuers could also choose to list a JitoSOL ETF, indexed to a JitoSOL price, or include a mixture of the two approaches.
As financial innovation accelerates, ETFs should not remain limited to passive wrappers of idle digital assets. Liquid staking tokens represent a more complete picture of what ownership means in the era of proof-of-stake. With the right structure and regulatory clarity, LST ETFs could soon become a cornerstone of digital asset investing — offering the liquidity of ETFs and the yield of staking, all in one.