A fundamental paradigm shift is coming: All of DeFi on LSDs.
LSDfi is the hottest thing in crypto since NFTs. Is it ushering in a sustainable growth model for DeFi?
(Any views expressed below are the personal views of the author and should not form the basis for making investment decisions, nor be construed as a recommendation or advice to engage in investment transactions.)
After Ethereum recently upgraded to Proof of Stake with ‘The Merge’, staking ETH to validate the network has become a competitive game for whales vs. funds. Massive amounts of TVL are locked up in Ethereum’s PoS contracts and protocols to squeeze out the purest elixir of life crypto has to offer: ‘Real Yield’.
Locking up that much ETH however is not exactly capital efficient, so developers were fast to present a solution: Liquid staking derivatives (LSDs). LSD’s (or LST’s as some prefer to call them) are a type of financial instrument that allows users to earn staking rewards on their staked cryptocurrency holdings without having to lock them up. The idle liquidity is simply derived into a new token: stETH (‘stakedETH’). This makes it possible for users to participate in staking while still maintaining access to their funds, and being able to trade in and out of their position on the liquid markets of these derivatives.
In this post, let’s explore the current state of liquid staking derivatives. First, lets look into the origins of LSDs and how they grew in the early days, pioneering a new yield bearing primitive: network validation. Then, lets discuss where LSDs stand today and protocols are the most significant players in the space. Finally, let’s look at what LSDs may bring to DeFi as a whole, where we can observe growth, and how it will affect the crypto markets in the future. Now, without further ado, let’s dig in!
The trippy origins of LSDs
The idea of liquid staking derivatives was first proposed in 2016 by Vitalik Buterin, the co-founder of Ethereum. Buterin argued that liquid staking would make it possible for users to participate in staking without having to lock up their funds. This would make staking more accessible to a wider range of users and could help to increase the security of the Ethereum network. Indeed, that idea was rather smart.
Some time after, the first liquid staking protocol, Rocket Pool, was launched. Rocket Pool allows users to stake ETH by depositing it into a pool managed by a network of validators. In return, users receive rETH tokens, which represent their staked ETH. rETH tokens can be traded on decentralized exchanges and can be used to access DeFi services. Today, rETH and its counterparts are widely integrated in all of DeFi. LSDs are used for a number of different ‘yield optimizing’ and ‘yield compounding’ strategies, not only on Ethereum but across all PoS chains.
The early days of liquid staking were marked by rapid growth. In 2019, the total value locked in liquid staking protocols was just over $10 million. By 2020, this figure had grown to over $100 million. This growth was driven by a number of factors, including the increasing popularity of staking, the launch of new liquid staking protocols, and the growing demand for DeFi services. In recent months, LSDs have become increasingly popular, as they offer a number of advantages over traditional staking: trading, composability, leverage, deeper liquidity.
Current State of Ethereum LSDs
Today, the liquid staking market is worth billions of dollars. The most popular ETH liquid staking protocol is Lido, which has over $12 billion in total value locked. Lido allows users to stake ETH by depositing it into a liquid staking pool. In return, users receive stETH tokens, which represent their staked ETH, derivative tokens which can be traded on decentralized exchanges, collateralized, and can even be used to access newer DeFi services such as bonded interest, or stablecoin yields.
In addition to Lido, there are a number of other liquid staking protocols in the market. These include Frax, StakeWise, and Swell. Each of these protocols has its own unique features and benefits. The most significant players in the LSD space are the liquid staking protocols themselves. These protocols are responsible for managing the staking pools and issuing the liquid staking tokens. The most popular liquid staking protocols are usually the safest ones, with proven TVL and strong community support.
In addition to the liquid staking protocols, there are a number of other players in the LSD space, such as Lending and Borrowing protocols, decentralized exchanges, DeFi yield aggregators, and staking service providers. While DeFi protocols allow users to use liquid staking tokens to access financial services in a fully non custodial manner, Staking service providers offer staking services to users who do not want to manage their own staking pools.
Why are LSDs so important?
Liquid staking derivatives bring a number of benefits to DeFi, and lead to it’s growth. Growth in TVL, growth in users, volume, and applications. LSDs are a catalyst for all of crypto. When looking more closely, we can observe growth in the LSD space in a number of areas, where the benefits are most impactful:
- Increased liquidity: Liquid staking derivatives can increase liquidity in the DeFi markets. This is because liquid staking tokens can be traded on decentralized exchanges, which makes it easier for users to buy and sell them.
- Better access to staking: LSDs can increase access to staking, because they allow users to participate in staking without having to lock up their funds. This can make staking more accessible to a wider range of users.
- Stronger security: Liquid staking increases the security of the DeFi markets. Users to stake their funds without having to worry about losing access to them, ultimately making DeFi markets more attractive to users who are concerned about security.
- Real Yield: The ‘Real Yield’ generated through the stake is stable, consistent yield originating from validating the network. There is a true interest on the LSDs, making them a perfect use case for DeFi composability.
- They enable new protocols: The number of liquid staking protocols is growing rapidly. This is due to the increasing demand for liquid staking services.
- The TVL: The total value locked in liquid staking protocols is also growing rapidly. This is due to the increasing popularity of staking and the growing demand for DeFi services.
- The adoption of liquid staking by other DeFi protocols: DeFi protocols are increasingly adopting liquid staking for advanced capital efficiency and DeFi protocol composability.
This growth, quickly resulted in LSD protocols being among the biggest protocols in crypto, with having the most users, the most assets under management, and the most liquidity in DeFi. They are also the most likely to continue to grow strong into the future as new cross-chain composability strategies emerge and new use-cases are developed.
Liquid Staking = Advanced Yield?
LSTs ‘Liquid Staking Tokens’ as they are also called, are still in their early stages, but they have the potential to revolutionize the DeFi industry. They offer a number of advantages over traditional staking, including yield optimization:
- Liquidity Yields: Users can create LP pools with higher yields, since tokens may now be paired with yield bearing assets — such as for instance LSD backed, yield bearing stablecoins.
- Leveraged True Yield: Liquid staking derivatives can offer higher yields than traditional staking when used as collateral, and borrowed against to deepen the position. This makes yield farming a more stable on a long horizon play.
- Flexibility of yields: Liquid staking derivatives can be used to earn interest on staking while also compounding yield with other real yield products such as RWA backed stablecoins, tokenized bonds or treasury bills.
As the crypto industry matures, liquid staking derivatives are likely to become increasingly popular due to these characteristics. According to several analysts they are already on an exponential growth curve due to their advanced yield bearing potential.
One thesis even goes as far as proclaiming that eventually all LP pairs will be paired with LSDs rather than the underlying principal, since it is just a much more efficient structure for the capital to flow through the protocols. Once we see true omnichain interoperability, the multichain LSDfi narrative should become an interesting one to follow.
If you want to be at the forefront of digital asset innovation, and earn the freshest yields in all of DeFi, then onboard now friends - buy the ticket, take the trip!
To conclude, we should mention that liquid staking derivatives are a new and innovative decentralized finance primitive that has the potential to turn the bear market around simply from making the whole system more capital efficient. They offer a number of advantages over idle assets, including liquidity, advanced yield, and flexible composability, and as the crypto industry matures LSDs are likely to become increasingly important as a key facilitator of optimized capital efficiency.
Finally, if you haven’t already go stake your ETH! Now!
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