The Birth of LSDfi
A successful Shapella fork has paved the way for a new market of DeFi products
The successful Shapella fork has brought forth a mental shift in how users now interact with ETH and its Liquidity Staking Tokens (LSTs). The risk of not knowing when you could unstake your ETH is gone and now users can move freely (with some limits) between staked ETH that earns yields to secure the blockchain and unstaked ETH. This change in accessibility has substantially reduced the risk of staking ETH, turning staking yields into the de facto risk-free rate of holding ETH. This has subsequently reduced the risk of holding LSTs. While some of the protocols have yet to implement a redemption process, the success of the fork has reduced many users’ concerns and the deep liquidity pools for many LSTs means swapping back to ETH at a good rate is easily feasible.
The New Marketshare Battle
As users will now be able to switch more easily between the different Liquid Staking Derivative (LSD) protocols, a new competition between the protocols will begin to attract and retain stakers. This competition will be driven by three main components:
Liquidity: This will continue to play a large role in competition between LSTs, especially in the short-term for those that have yet to enable withdrawals. Furthermore, as transactions and volume on Layer-2 (L2) chains begin to outpace mainnet, there will be more competition to become the primary LST on the L2s. Having a large enough LST supply to provide sufficient liquidity for protocols on the L2 chains to prioritize adoption will require a strong incentive push to get users to migrate off mainnet.
Incentives: Providing incentives for users to adopt an LST has always been a priority for LST protocols. Pre-Shapella incentives were focused on pools in AMM protocols to increase liquidity and get ETH holders to stake in their LST protocol. Now that redeeming LSTs for underlying ETH is possible, users have the ability to switch between LST protocols to find the best staking APR. This will mean that on top of providing incentives to external DeFi protocols to promote users supplying their LSTs to the ecosystem, the LST protocols will also need to stay competitive on the staking APRs they provide. This will come in the form of integrating MEV-boosted rewards and also potentially reductions on staking commissions that they charge.
New Use Cases: While related to the previous two components, the creation of new use cases for LSTs is where much of the competition amongst protocols will be in the post Shapella ecosystem. In the long-run, holding LSTs will likely be seen as equivalent to holding ETH. This means that LST protocols will need to differentiate between themselves by their useability. The one difference with holding an LST is the yield it earns from securing the network. Being able to unlock this steady yield with new DeFi products is what will be the new catalyst for user adoption of a specific LST.
Yield Bearing LSTs + New DeFi products: Welcome to the world of LSDfi
The Rise of LSDfi
LSDfi refers to the new world of potential products that harness the yields earned on LSTs. This potential has been one factor in why we continue to see growth in market share for many of the LSTs. The chart below highlights this growth, with Lido and RocketPool being some of the largest gainers in the last week with many US based CEXes being the biggest losers.
These new products and protocols being developed on top of LST protocols will have different goals and mechanics from many of the familiar DeFi primitives. For this reason, it will be important to dig into the design of each protocol to understand how yields are generated and what are the added technical and economic risks.
New and Revamped DeFi Products
Stable and consistent yields generated from LSTs make them appealing assets to build new DeFi products on top of. In addition to new products, now that staked ETH can be withdrawn, some existing DeFi products have seen new life breathed back into them. Below are some of the categories that could see success in LSDfi.
Loans
Self-repaying loans and borrowing future interest are some of the types of loans that could see large success using LSTs. While these already exist, protocols with these products could see increases in TVL in the near future.
An older protocol that has seen a resurgence, partly due to LSDfi, is Pendle Finance. This protocol allows you to buy assets at a discount now if you agree to receive that asset at a later date. This design works well for LSTs by effectively using some of the staking yields now to acquire the asset later.
Leveraged Yield
also known as leveraged staking. New and existing protocols will most likely look at new ways to unlock more capacity in this category.
Yield DeFi
Decoupling the yields earned from LSTs to develop a marketplace that is focused on different yield tokens. Yield swaps to hedge on which LSTs will have the best staking rates and derivatives, such as options, to hedge against drops in yields will be some of the products we will see in LSDfi.
UnshETH is a new protocol aiming to create a LSDfi marketplace. On top of building a yield marketplace, they have an added mission to improve validator decentralization among the different LST protocols. In this regard, they plan to create validator dominance options as a way to hedge against certain validators gaining too much marketshare.
Liquidity Aggregator
Harnessing the veTokenomics that were popularized by Curve, liquidity aggregating protocols are emerging that will have DAOs to vote on providing liquidity for protocols to bootstrap new pools or provide more depth to attract swaps from aggregators. Think something similar to Tokemak but only for LSTs.
Agility Protocol is an example of this new liquidity aggregator design. Framing themselves as a liquidity layer for LSDfi, they aim to use their pooled LSTs and ETH to “lend” out to other protocols that need extra liquidity in their market places.
The protocols listed here are examples of how LSDfi is being implemented. IntoTheBlock does not endorse any of the protocols specifically and users should always research each protocol in depth to find the products that suit their risk profile.
Not all that is shiny is gold
With all DeFi trends, there is a rush to the market to try and capture initial liquidity and attention of users in the ecosystem. While some of these products and protocols will last, the majority will most likely have short lifespan. It is important in these situations to dive into the protocols to better understand the products and their potential longevity.
Understand where the yields come from
Several protocols that have recently launched in LSDfi are aiming to attract liquidity through high APRs. In these cases the important questions to ask are:
If offered APRs are higher than that of LSTs
- Where is it coming from?
- What risk does it add?
- Is the user forfeiting ETH APR for a higher APR in another token?
How do Protocols Hold on to Liquidity
Protocols will often try to dissuade mercenary liquidity that comes to farm its pools and then leaves when the high yields dry up. Therefore, many protocols will put some sort of disincentive in place to deter users from withdrawing their liquidity so freely. These disincentives are often in the form of liquidity lock ups or redemption fees.
Revisited Tokenomics Designs
While new protocols may not be a fork, it is common to reuse certain tokenomic designs from previously launched protocols. When this is the case, review the other protocol where the design was taken from. If the protocol was not successful, it is worth understanding what went wrong and if these same problems could arise in the new protocol.
Roadmap Risks
While the new LSDfi protocol might check all the right boxes above, a roadmap full of exciting new upgrades and features can also present risks. Each new code change should be audited, but even then, exploits can sneak through. This is additionally important for protocols that have liquidity lock ups.
Conclusion
LSDfi is here. New products and protocols are popping up weekly since the successful Shapella fork. There will surely be some successful and innovative products among what will launch in the coming months. These successful protocols will be able to attract the attention of the LST protocols as they try to expand the use cases for their token to further increase their own market share. However, as with most trends in DeFi, there will be many unsuccessful launches and so it is important to do research into these new products.
