4 Leading Trends in LSD Narrative
Liquid Staking Derivatives (LSD) is clearly the biggest and most talked about innovation in DeFi in recent months. As of May 15, 2023, Lido, currently the largest liquid staking protocol in terms of TVL (Total Value Locked), is over 26% of DeFi’s total.
Since Shapella’s smooth upgrade, LSD have been exploding in popularity across Ethereum and have the potential to become equally as widespread among other Layer1 networks, such as Polygon, Avalanche and Cosmos, promising to lead the market in initiating a strong rebound in DeFi activity.
In this article, we will present the four trends in LSDs narrative now and in the coming period. We can see many projects are trying to bring new possibilities and opportunities to DeFi and the whole crypto market.
Trend 1: Old Brand DeFi Protocols Rushed into LSD Area for Liquidity Share
Early liquid staking protocols were created with the core purpose of freeing liquidity in ETH. And through tokenizations, LSD Tokens (subsequently referred to as LSD) can be used for trading, lending and collateral across the DeFi ecosystem, thus helping to create diverse revenue streams for users, which brings new momentum to the currently sluggish DeFi space. The old brand DeFi Protocols are looking to tap into LSD-related products and inject new ways to play DeFi Lego. In the process, high yield has also developed as a core pursuit for LSD products and protocols.
- Liquidity Wars for LSDs (Curve, Balancer, etc.)
DEX is one of the important exit channels for LSDs. Curve has been the preferred trading platform for LSDs swap and exit since long before the Shanghai Upgrade. It also supports users to provide liquidity for lsdETH/ETH pools which is similar to stablecoin pairs with lower market making risk, to earn a share of transaction fees.
After the Shanghai Upgrade, Curve remains an important trading platform for LSDs due to the limited number of daily withdrawals and the complexity of the process, although users can withdraw the staked ETH directly on Ethereum. As of this article, ETH/stETH (LSD token launched by Lido) has become the second largest pool of TVL on Curve (TVL of 1.21B), and ETH/frxETH launched by Frax Finance has a TVL of over $150M.
Balancer is the other major trading front for LSDs in addition to Curve. Compared to Curve, Balancer has an original Valut pooling mechanism in its product, which can reduce the gas fee for transactions involving multiple pools and provide a better user experience.
As of writing, 3/4 top pools on Balancer in terms of TVL are LSDs, namely wstETH/WETH (TVL of $197.9M), rETH/WETH (TVL of $78.8M), and wstETH/sfrxETH/rETH (TVL of $39.5M).
For LSDs to maintain stable anchor ETH prices and better user trading experience, they need to build lsdETH/ETH pools on the popular DEXes and attract sufficient liquidity. At the same time, the incremental volume of LSDs will in turn lead to an increase in TVL, trading volume and protocol revenue for the DEXes. The integration of the two is definitely a win-win situation.
- Option 1 for Yield Boost of LSDs: Introducing External Subsidies (Frax, Yearn, etc.)
Early liquid staking protocols (Lido, Rocket Pool, etc.) were all aimed at solving the basic pain points of Ethereum staking (like difficulty of node deployment, high stake threshold, etc.). Frax Finance changed that with the launch of frxETH, a new LSD-related product, on October 21, 2022, making staking yield a new focus of attention as well.
Frax achieved a combination with Curve Eco through its large CVX position and dual coin model product design, which allowed it to have a much higher yield than similar liquid staking products (APY was as high as 16% at one point) and successfully completed the cold start and early growth of its LSD product.
Compared to Lido, which launched in 2020, and earlier staking platforms such as RocketPool and Stakewise, Frax is a latecomer to the LSD track, but it has grown incredibly fast, leaping to become the fifth largest LSD solution within 3 months of launch. As of May 15th, the number of ETH staked on Frax has exceeded 190,000 (worth near $350M), with the number of ETH staked growing by over 20% in the last 30 days.
Essentially, Frax is boosting stakers’ yield by introducing external subsidies, and leading yield aggregator Yearn Finance has a similar product plan. In February, Yearn announced plans to launch yETH covering a basket of LSDs, aiming to diversify investment risk and increase returns for users. However, the proposal is still under discussion.
Many LSD project teams have sought to introduce external subsidies to boost the yield of their LSDs, popularly by creating pools of LSDs on DEXes such as Curve and Balancer and influencing the pool’s reward emissions (e.g. CRV or BAL) through the governance votes they hold, thus boosting the overall staking yield. Convex and Aura Finance have also both become important battlegrounds in the LSD liquidity wars as they hold significant governance voting rights in Curve and Balancer respectively.
- Option 2 for Yield Boost of LSDs: Introducing Revolving Lending (MakerDAO, Aave, etc.)
Unlike Yearn and others, which boost staking yield through external subsidies, head lending protocols offer a highly leveraged play on revolving lending for LSDs.
In early February, MakerDAO co-founder Sam tweeted to announce the launch of Spark Lend, the first lending app product, along with plans to launch EtherDAI (ETHD for short), a synthetic asset that aggregates a wide variety of LSDs, and Spark Lend (currently released as a betanet) will support ETHD as collateral for lending DAI.
Aave, the lead lending platform, also grants eligibility for LSDs as collateral. In Aave v3, users are supported to lend up to 90%+ of ETH using LSDs (e.g. stETH) via e-Mode. Compound V3 has similar terms for stETH/cbETH. Both give LSDs eligibility as collateral, In this way, the interest rate and volume of funds staked by users can be significantly increased through revolving lending, which is currently one of the main ways the LSD circuit is boosting yield.It is worth noting, however, that revolving lending will entail higher lending fees and liquidation risks.
Trend 2: Emerging LSD-Fi Protocols Continue To Innovate; DeFi Lego Upgrades Gameplay
While the old brand DeFi protocols explore how to open up LSD business lines, new LSD-Fi protocols and products continue to emerge, part of which are relative underlying protocol innovations aimed at furthering the decentralization and security of liquid staking, and part of which are model innovations in the upper layer applications aimed at promoting the combination of LSD and DeFi through diverse paths (e.g. leverage, structured strategies, options, bond derivatives, etc.) to maximize the capital efficiency and yield of LSDs.
- Underlying Protocol & Infrastructure
EigenLayer is a highly innovative Ethereum re-staking protocol that allows the re-staking of already staked ETH in other consensus protocols. This not only improves network security and data availability, but also creates a more connected and robust ecosystem, while creating more new opportunities for staking rewards. EigenLayer has been released as a testnet, Stage1 Mainnet is set to launch soon, with the full version expected to go live by the end of this year.
For its part, unshETH seeks to use incentives to drive the decentralization of LSD validators with two innovative products, Verifier Decentralized Mining (vdMining) and Verifier Dominated Options (VDO). The platform has been launched for more than a month and the TVL has now reached $34.68M, currently supporting several LSDs mainly sfrxETH, rETH, wstETH, cbETH.
There are also Stader Ethereum (DVT technical support, about to launch ETHx, expected to cooperate with Aave, Balancer and other DeFi protocols), Parallax Finance (LSD services for L2, currently in testnet) and others are also providing basic staking infrastructure services.
- LSD Stablecoin Projects
LSDx Finance aims to become a stablecoin DEX like Curve in the LSD asset segment (UI is also similar to Curve) to address the high barriers and fragmentation that currently exist in LSD assets. It uses a GLP architecture similar to GMX and has built a unified liquidity pool: ETHx, with plans to launch a stablecoin UM, backed by sovereign bonds and based on ETH staking returns. LSDx currently has a TVL of ~$16.14M and is in the process of multi-chain deployment at this stage, with ZKSync being supported first.
Lybra Finance is an over-collateralized stablecoin protocol. Unlike MakerDAO and Liquity, Lybra allows users to deposit ETH/stETH to mint an interest-bearing stablecoin, eUSD, in addition to the regular overcollateralization, clearing, and arbitrage. eUSD can be held for an annualized return of about 7.2%. The project was launched in late April and is currently operating with a TVL of over $16.6M and a cumulative value of interest-bearing stablecoin eUSD issued of over $8.9M.
- LSD Index Products
Index Coop has released two LSD-Fi-related index products: dsETH (Diversified Staked ETH Index) and icETH (Interest Compounding ETH Index). dsETH covers the current mainstream ETH LSDs, with a current supply of 814 units at 5.25% APY. icETH is a leveraged liquidity staking strategy product that offers higher yield mainly with the help of AAVE v2, with a current supply of 10,118 units at 13.06% APY.
And Gitcoin and Index Coop have jointly launched the gtcETH index product. gtcETH was launched not to maximize returns, but rather to facilitate the financing of public products by stakers by sharing staking rewards with Gitcoin, which gives us a glimpse of new scenarios for the use of LSDs. In addition, the previously mentioned yETH that Yearn plans to launch is also an index product.
- Other LSD-Related Derivatives
There are many derivative protocols developed based on LSD, the first one worth mentioning is Pendle, a DeFi income protocol that started as a derivative where users can execute various income management strategies. Pendle uses a standardized form to tokenize interest-bearing assets, opening the way for the development of fixed income and interest rate derivatives in crypto, which makes it easier to integrate other DeFi interest-bearing assets in the future. Pendle is currently backed by well-known projects such as Lido, Frax, Rocketpool, Aura, GMX and Stargate. Pendle has been deployed on Ethereum and Arbitrum, and TVL has grown from $7.8M in December 2022 to $66.30M today, a more than sevenfold increase in less than 6 months.
There are also other incentivized LSD projects such as Ion Protocol, Hord, and 0x Acid DAO that seek to maximize the return on LSD assets. There are also teams exploring building LSD aggregators. With the launch of these protocols, it is expected to set off more fancy plays in DeFi.
It is worth noting, however, that many of the projects mentioned above are still in relatively early stages of development. While in the short term, high yield has become an important weapon for many LSDFi projects to compete for market share, high yield may pose sustainability issues. Similar to other segments of DeFi ( DEX, Lend, Yearn, etc.), the LSD segment is bound to experience a battle for liquidity, with only a few quality head players remaining in the end.
Trend 3: Multi-chain Supports
Although the LSD mechanism was originally built exclusively for Ethereum, LSD-related business has now been extended to multi-chain ecosystem. The practice of Ethereum proves that LSD has already gained a firm foothold in the DeFi field and become another core business segment of DeFi after DEX, Lending and Yearn, which is highly valued by all major public chains.
We have researched the LSD product development of 8 top-ranked public chains by market cap. Overall, both established public chains such as BSC, Polygon, Solana, Avalanche and newer ones like Aptos have seen the exposure and growth of LSD-related businesses. Early-starting liquid staking service providers (Lido, Stader, Ankr, etc.) are also actively deploying multi-chain businesses. Specifically, the following developments are characteristic:
- Large liquid staking providers are all deploying multi-chain operations.
Among them, Lido has already taken the absolute head position in the Ethereum, Polygon and Solana ecosystems with its first-mover advantage. Stader, a latecomer multi-chain liquid staking protocol, has also occupied a larger share of LSD business in Polygon and BNB Chain, and is currently testing its LSD product in Ethereum- ETHx, and plans to support staking in Avalanche and Solana. Ankr has also covered the Liquid Staking business in Ethereum, Polygon, BNBChain, Avalanche, Polkadot and other mainstream public chain ecosystems.
- The size of the utility of the public chain tokens themselves is a significant core factor affecting the growth of their LSD business.
The main driver for the rapid expansion of LSD business is the yield. Public chains with rich application scenarios and substantial yields may not have much need to develop their LSD business. This is evidenced by the BNB Chain and Polkadot, where BNB’s native DeFi protocols (e.g. Venus) have high yield and rich utility as a Binance exchange platform coin (participation in Launchpad, transaction fee discounts, etc.), making it less attractive for BNB holders to participate in LSD staking. The largest decentralized staking platform on BNB Chain, Ankr’s LSDs (ankrBNB) only account for 0.13% of BNB’s liquidity. Due to the unique design of Parachain Slot Auctions (PLO) on Polkadot, lsdDOT is also not attractive in terms of yield, and many DeFi apps on parachains choose to build around PLO mechanism.
- The multi-chain development of LSD leaves a lot of room for competition.
The scale of LSD business in public chains other than Ethereum is still small, there are fewer basic LSD protocols, and the overall development is not too stable yet (TVL ranking changes fast and many LSD projects stagnate in business), which also means that there are still more competitive opportunities in the track.
Trend 4: Decentralization
In addition to the countless upper-layer applications, diverse new models combined with DeFi and the trend of multi-chain development, there is another trend worthy of attention in terms of the underlying technology of LSD, namely the development and application of DVT (Distributed Validator Technology) technology, which is also an important technical issue for the subsequent development of Ethereum.
The existing various types of Ethereum staking solutions are more or less facing the contradiction between decentralization and stable operation of nodes. Take Lido and Rocket pool as an example, Lido adopts the form of a white list to screen qualified operators to ensure the validity of block release, traceability and security of funds in order to ensure that users’ funds will not be lost due to node disconnection and failure, which makes Lido have the problem of centralization; Rocket pool binds the interests of both nodes and users through the way of joint staking, and further ensures the safety of users’ funds through the form of nodes staking RPL as forfeited inferior funds, but this undoubtedly raises the cost of operating nodes on Rocket pool.
DVT is a quality solution to the current problem of centralization of Ethereum staking operators. DVT, formerly known as SSV (Secret Shared Validators), is a concept proposed by two Ethereum developers, CarlBeek and Adiasg. DVT technology adds a fault-tolerant layer to the validator, helping to eliminate the possibility of a single point of failure, double signature penalties, and fork penalties during PoS validation. Notable DVT projects currently on the market include SSV.Network, Obol Labs, and Diva.
- SSV Network builds a DVT-based operator network and is the longest-established and most advanced development product in the DVT track. SSV has now released Jato, a public testnet, which the team says is the final step before its mainnet goes live. SSV has received $188,000 in donations from the Ethereum Foundation and $100,000 in LDO donations from Lido, and DCG, OKX, Coinbase and others are also investors in the project.
- Obol Labs is committed to building a staking middleware Charon that allows any node to participate in the operation of the distributed verifier of the DV cluster. Obol had also received a $100,000 LDO token donation from Lido DAO and closed a $12.5M Series A round of funding co-led by Pantera Capital and Archetype. Obol is currently in the Bia public testnet stage, is expected to open Circe testnet in June this year, after the completion of the main network online; The overall progress is slightly behind SSV.
- Diva’s goal is to combine LSD and DVT two models to create a one-stop product for liquid staking and distributed verification. The project is still in the early stage of development, but has already closed a $3.5M seed round led by A&T Capital with participation from Gnosis, Bankless, OKX and other institutions.
In the article of Vitalik Buterin, and the subsequent development plans of the Ethereum community, they have repeatedly emphasized a core point — Centralized production and Decentralized validation, which shows that the Ethereum community attaches great importance to the decentralized verification of nodes for block issuance, and DVT is the best and most secure verification signature technology. All of the above DVT products are aimed at ensuring the stability of Ethereum validation blocks while enhancing the decentralization of the network, reducing the operating costs of nodes and reducing security risks. As more and more DVT projects emerge, it can be expected that DVT technology will empower Ethereum staking, refresh the market pattern of LSD, and finally realize a truly decentralized Ethereum PoS network.
Summary
From the trend of LSD driven by the projects mentioned above, we can see that the LSD track is thriving and has become the core narrative of DeFi and the crypto market. More and more projects are moving towards LSD, from CEX and DEX, to lending and yield platforms, from Ethereum to other Public Chain ecosystems, and from Layer1 to Layer2, the rise of LSD business can be seen. A large number of project teams are pushing LSD towards multi-chain support, automation and decentralization, etc.
Ethereum Staking may give rise to hundreds of billions of LSDs, and this emerging asset class is reconfiguring and changing the revenue structure of traditional DeFi applications and protocols. DeFi, the Lego cornerstone of the crypto space, brings huge wealth effects and profound changes to the industry with each new concept boom. From DeFi Summer brought by liquidity mining, to the liquidity wars triggered by Curve, and the current liberation of LSD for staked token liquidity. The infusion of the LSD concept is expected to bring new combinability to DeFi, and in the future LSD as a core narrative of DeFi will continue to extend outward to specific applications such as GameFi and SocialFi, forming new gameplay.
About DFG
Digital Finance Group (DFG) is a global blockchain and cryptocurrency investment firm founded in 2015 with assets under management of over $1 billion. Through a wide range of sectors within the blockchain ecosystem such as Web3.0, CeFi, DeFi, NFTs, the Polkadot ecosystem.
Investments include Circle, Ledger, Coinlist, FV Bank, Astar, ChainSafe and over 100 more. DFG intends to create value, through analytical research, based on the most impactful and promising global blockchain and Web3.0 projects that will bring a paradigm shift to the world.
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