Author: Gate Ventures Source: medium Compilation: Jinse Finance, Shan Ouba

Introduction to LSD

Following Ethereum’s recent transition to Proof-of-Stake through a “merger,” the act of staking ETH to validate the network has become a popular low-risk passive investment strategy for investors worldwide. Huge amounts of Total Value Locked (TVL) are tied up in Ethereum’s contracts and agreements, all in pursuit of “real yield.”

However, the downside of locking such a large amount of ETH is the lack of capital efficiency. To solve this problem, developers quickly rolled out a solution called Liquid Staking Derivatives (LSD). LSD is a specific type of financial instrument that enables users to earn staking rewards for their staked crypto assets without locking them up. Instead, idle liquidity is converted into a new token called stETH (short for “stakedETH”). This innovative approach allows users to participate in staking while retaining access to their funds and the ability to trade their positions on the liquid markets these derivatives provide.

This article aims to provide an in-depth look at the current state of liquid collateralized derivatives. First, we'll explore the origins of LSDs and how they first became pioneers in the field of yield generation through network validation. Subsequently, we examine the current state of LSD and identify the protocols that play the most important role in this field. Finally, we will assess the potential impact of LSD on the wider DeFi ecosystem, analyze the growth observed so far, and speculate on their impact on the future development of the cryptocurrency market.

The origin and current status of Ethereum LSD

The concept of liquid collateralized derivatives was first proposed by Ethereum co-founder Vitalik Buterin in 2016. Buterin proposed that liquid staking allows individuals to participate in staking activities without locking up funds. This approach aims to expand the accessibility of staking to a wider range of users, while potentially enhancing the security of the Ethereum network.

Today, the liquidity staking market is valued in the billions. Lido is one of the most well-known ETH liquid staking protocols, with a total value locked (TVL) of over $14 billion as of this writing. Lido offers users the opportunity to stake ETH by depositing ETH into a liquid staking pool. As a result, participants receive stETH tokens, representing their staked ETH. These derivative tokens can be traded on decentralized exchanges, used as collateral, and even provide new DeFi services, such as bond interest or stablecoin yield.

LSD Market Share

Lido holds the largest market share at 79% as of July 10, 2023. Together, the top 5 platforms account for more than 95% of the market share. In addition to Lido, several other notable liquidity staking protocols exist in the market, including Rocket Pool, Frax, and Stakewise. Each of these protocols has unique features and benefits. Typically, the most widely adopted liquidity staking protocols are those that offer the highest level of security, backed by established Total Value Locked (TVL) numbers and strong community support.

In addition to the liquidity staking protocol itself, liquidity staking derivatives involve various other participants. These include lending protocols, decentralized exchanges, DeFi yield aggregators, and staking service providers. DeFi protocols enable users to access financial services in a completely non-custodial manner using liquid collateralized tokens. On the other hand, staking service providers cater to users who are unwilling to manage their own staking pools by offering staking services.

Top LSD protocol

1. Lido Finance: Lido Finance has the largest market share of the Ethereum LSD market, accounting for over 79% of the total value locked (TVL). It is a decentralized lending platform built on the Ethereum blockchain. Leveraging Collateralized Debt Positions (CDPs), Lido allows users to borrow funds while earning interest on the collateral deposited. The platform uses the Lido token ($LDO) for lending and staking. Lido aims to provide a decentralized and efficient alternative to traditional lending methods. Notably, it offers users the advantage of earning staking rewards with an Annual Percentage Rate (APR) based on the current Ethereum consensus. Lido charges a fair fee of 10% on staking rewards, which is split between node operators and the DAO treasury. Lido tokens are available on decentralized exchanges (DEX) and centralized exchanges (CEX) such as Sushiswap, 1inch, Uniswap and Hotbit. However, it does not distribute income to token holders.
2. Rocket Pool: Rocket Pool is the second largest liquid staking protocol designed to improve access to ETH staking for small-scale investors. It operates as a decentralized staking pool, allowing users to stake as little as 0.01 ETH and receive rETH tokens instantly. Rocket Pool charges a commission ranging from 5% to 20%, depending on non-operator deposits and node operator availability. However, it does not share revenue with token holders.
3. Stakewise: Stakewise is a current staking protocol designed to improve the decentralization of the Ethereum network. The protocol tokenizes deposits and rewards, with deposits represented in sETH2 and rewards provided in rETH2 tokens. Stakewise charges a flat fee of 10% per stake, and users can withdraw deposits and rewards on exchanges such as Sushiswap, Curve, and Uniswap.
4. Fraxfinance: Frax Share (FXS) is a utility token in the Fraxfinance ecosystem that grants governance rights and other utilities to the holder. Fraxfinance offers a range of DeFi products utilizing stablecoins such as $FRAX and $FPI. The protocol supports two types of ETH: frETH (Frax Ether) and sfrxETH (Staked Frax Ether). Token holders can lock up their FXS tokens to create veFXS, which offers special benefits, governance rights and AMO (Automated Market Operation) profits. Compared to many liquid staking protocols, Fraxfinance shares ~8% of ETH staking returns with veFXS holders.

Distributed validator technology will benefit from LSD industry boom

Distributed Validator Technology (DVT) is another sub-sector benefiting from the LSD industry boom. DVT is a method of enhancing verifier security by decentralizing key management and signing responsibilities among multiple parties. This strategy aims to minimize vulnerabilities caused by single points of failure and enhance the resilience of validators.

To achieve this, the private keys used to protect the validators are distributed among numerous computers organized into "clusters". This fragmentation of the key makes it very difficult for an attacker to gain unauthorized access because it is not stored in its entirety on any one machine. Also, this setup allows some nodes to become inactive without affecting the system, since a subset of machines in each cluster can handle the necessary signing tasks. As a result, the network is more resistant to single points of failure, increasing the overall robustness of the validator set.

DVT provides the following benefits to Ethereum: Decentralization of the Ethereum proof-of-stake consensus, ensuring liveness of the network, creating validator fault tolerance, trust-minimizing validator operations, minimizing risk of slashing and downtime, increasing diversity (client , data center, location), governance, etc.) and enhance the security of validator key management.

An interesting DVT protocol worth mentioning is SSV Network: SSV.network is a fully decentralized and trustless DVT network that provides a reusable infrastructure option for decentralized Ethereum validators. It is an open-source protocol that facilitates Ethereum's validation layer by distributing validator tasks among multiple trustless nodes, called operators. These operator node clusters perform validator operations on behalf of stake holders and address the key challenges of centralization, redundancy, and security present in Ethereum's proof-of-stake consensus.

The significance of LSD in DeFi

Liquid Staking Derivatives (LSD) offer multiple advantages to the DeFi ecosystem, contributing to its growth in terms of total value locked (TVL), user base, transaction volume, and applications. After careful inspection, we were able to identify specific areas where the benefits of LSD had the greatest impact:

• Enhanced liquidity: LSD facilitates increased liquidity in the DeFi market by trading liquid collateralized tokens on decentralized exchanges. This accessibility makes it easier for users to buy and sell these tokens.
• Improved staking accessibility: LSD allows users to participate without locking up funds, thus broadening the accessibility of staking. This increased accessibility makes staking available to a wider variety of users.
• Improved security: Liquidity staking helps to enhance the security of the DeFi market. Users can stake their funds without fear of losing access to their funds, making the DeFi market more attractive to individuals who prioritize security.
• Real Yield: LSD produces a stable and consistent yield, called "True Yield", derived from the network verification process. This genuine interest makes LSD an ideal use case for DeFi composability.

What is LSDFi?

LSDFi refers to a collection of protocols based on LSD. These protocols cover a wide range of projects, from traditional decentralized exchanges (DEXs) and lending platforms to more complex protocols that leverage the unique properties of Liquid Collateral Tokens (LSTs).

As adoption of LSD becomes more widespread, these protocols will play a vital role in the DeFi ecosystem. They will lay the groundwork for the DeFi space, while projects that use LSD as a foundation to develop more complex products will operate on the next layer. LSD has become the dominant category in terms of Total Value Locked (TVL), with notable projects including Lido Lead the Way. Not only has LSD become a standard in the Proof-of-Stake (PoS) ecosystem, but it has also become an important trend in DeFi. LSD provides a reliable and low-risk source of passive income that contributes to the overall stability and maintenance of the blockchain network.

Therefore, LSD plays a pivotal role in promoting the development of the entire DeFi ecosystem. LSDFi is a logical extension of LSD, creating an economy capable of generating substantial income while simplifying interaction with LSD projects. As of this writing, the Total Value Locked (TVL) in LSDFi currently exceeds $709 million, reflecting the substantial convergence of the DeFi and LSD industries, which has become a significant trend. At present, LSDFi has developed into an independent field within DeFi and has made significant progress. It includes both traditional DeFi protocols as well as more complex protocols such as money market protocols, stablecoins, DEXs, profit strategies, and more.

LSDFi Market Share

As of July 10, 2023, the overall TVL for LSD across various protocols is $709 million, an increase of ~700% from ~$100 million on April 12, 2023, when the Shapella upgrade occurred. The overall LSDFi market is expected to continue to gain momentum in the future as the TVL locked in LSDFi currently represents only a small fraction of the overall LSD market, implying huge potential for growth.

Among the various LSDFi protocols, Lybra Finance is leading with a market share of about 48.4% and a TVL of more than $343. The TVL of the top 10 protocols accounted for more than 90% of the overall market share.

LSDFi Landscape

The LSDFi landscape is quite diverse and can be roughly broken down into a few subcategories, namely interest rate swaps, LSD-backed stablecoins, diversified basket LSDs, and lending protocols.

1. Interest rate swaps: Protocols such as Pendle enable LSD holders to trade their pledge yield. Additionally, they can earn additional rewards by providing liquidity to these platforms.
2. LSD-backed CDP stablecoin: Lybra and Raft are stablecoin protocols that utilize Collateralized Debt Positions (CDPs) and allow users to mint stablecoins using LSD as collateral. Lybra uses the yield generated by LSD to create an interest-bearing stablecoin.
3. Diversified Basket LSD: Unsheth and Asymmetry Finance provide diversified Basket LSD, providing users with a variety of liquid mortgage derivatives. Additionally, protocols like unshETH have incorporated swap functionality into these baskets, enabling users to earn additional swap fees for higher yields.
4. Lending protocols: Lending protocols like Aave allow LSD to be used as collateral to obtain loans, thereby unlocking liquidity and leverage for LSD holders. Aave has been widely used in leveraged yield farming for stETH.

Top LSDFi protocol

Pendle

Pendle is a governance-minimized decentralized protocol that allows people to generate R, a USD stablecoin, by depositing capital-efficient collateral. R is the first Ethereum USD stablecoin backed only by stETH (Lido Staked Ether). In less than a week since launch, Raft’s Total Value Locked (TVL) has surged to $40 million. Raft provides users with the ability to generate the stablecoin $R by depositing $stETH and $wstETH, providing efficient capital utilization, strong incentives, a stable anchor mechanism, and sufficient liquidity across multiple trading pairs.

To participate, users must borrow at least 3,000 $R and have a collateralization ratio of at least 110% for every $R borrowed. The loan interest rate is determined by the sum of the base interest rate and the loan interest rate difference, with a maximum upper limit of 5%. Currently, the borrowing rate is 0.01% (to borrow 3,000 $R, the fee is 0.3 $R).

There are three ways to repay minted $R. The first option is via repayment: users can repay borrowed $R tokens in Raft and receive $wstETH collateral in return. The second option is redemption: users can exchange $R for $wsETH collateral with other borrowers. The final option is liquidation: users can get $wstETH and liquidation rewards from the liquidator. Metrics for the R stablecoin in Raft are also performing well, with deep liquidity in its trading pool.

in conclusion

In this article, we explore the benefits of Liquid Staking Derivatives (LSDs), which allow stakers to keep their staked tokens liquid while still earning staking rewards. With LSD, stakers no longer need to worry about the price fluctuations of their locked tokens, as the tokenized assets or derivative tokens they receive can be used for trading, lending, and other cryptographic activities in the DeFi ecosystem. Additionally, the introduction of LSD increases the earning opportunities for stake holders and contributes to the overall strength and growth of the crypto network.

All in all, we firmly believe that the concept of liquid collateralized derivatives is here to stay and represents the next big advancement in the DeFi space. Therefore, we can foresee further groundbreaking and exciting developments in the DeFi space.