Twitter Space Recap: Is LSDfi the Next 100x?
Liquid staking derivatives (LSDs) has emerged as a major trend in 2023. Simply put, LSDs are financial products that serve as a representation of a staked token within a DeFi protocol. By using LSDs, users can stake their tokens and still have the option to use them in other decentralized applications (DApps), providing greater flexibility.
Recently, Anling from MetaWeb Ventures moderated a panel about LSDfi with Stanley (Core Contributor of LiNEAR), Anton (Business Lead of Pendle), and Pablo (Co-founder of Diva). Here is the recap of the Twitter Space:
Anling: Please tell us about your project and how it’s linked to Liquid Staking Derivatives (LSDs)?
Stanley: LiNEAR is a liquid staking protocol built on NEAR. LiNEAR unlocks liquidity of the staked NEAR by creating a staking derivative to be engaged with various DeFi protocols, and we’re also building more DeFi legos on top of LiNEAR, which makes it the LSDs of NEAR token.
Pablo: DIVA is a liquid staking protocol for Ethereum. Through participating in liquid staking, users do not have to stake or “lock up” their assets, instead, they can use it for collateral, maybe resell it or lend it out. Therefore, liquid staking protocols and tokens are the major pillar of the LSDfi economy.
Anton: Pendle is a permissionless yield-trading protocol where users can execute various yield-management strategies. With Pendle, users are able to obtain fixed yield, long yield or even split their yields. We allow users to be able to trade and develop strategies around the underlying yield volatility.
Anling: How’s Diva different from other Ethereum LSDs? What’s the plan to catch up with Lido/Rocketpool etc. as a late starter?
Pablo: The problem with liquidity staking is that you need to trust someone. If they do something wrong, it could potentially harm your assets or ETH. Projects like Lido work collaborate with a small committee made up of around 30 node operators. These operators are like professional node operators. More importantly, they do not provide any collateral or guarantees.
The current setup for liquidity staking relies heavily on trust. This goes against the principles of blockchain technology for networks like Ethereum or NEAR, which are designed to be permissionless, decentralized, and trustless. Ideally, systems like staking should also function in a decentralized and trustless manner, where users do not have to rely on trusting any single entity.
Diva is utilizing distributed validation technology to expand Ethereum’s capabilities. With Diva, users are able to connect to the platform and create their own liquid staking tokens. By depositing ETH into Diva, users can receive divETH, which allows them to earn ETH staking rewards. For operators, connecting their machine to the network and contributing to its operation can result in higher reward levels. Diva essentially serves as an extension of Ethereum, making the staking process more accessible. Unlike traditional staking, Diva allows users to participate with as little as one ETH instead of the usual 32, and the software is much simpler to use.
Anling: Recent growth of Pendle is largely driven by LSDfi narrative. Do you think the trend is going to last? What’s Pendle’s plan to further generate value from its integration with LSDs?
Anton: In traditional finance, what Pendle does is similar to bond stripping, where you have the principal and interest of bonds separated. So our principal tokens essentially are equivalent to zero-coupon bonds, while the yield tokens are the attached coupons.
As a result, the principal tokens represent discounted assets that accrue value over time, and can be redeemed one-to-one for the underlying asset. This allows users to purchase any of the LSDs supported on Pendle at a discount.
Aside from that principal token, the yield token just represents the yield itself. So if you think that the yield will go up within the next few weeks, then you can just buy the yield token. And then you’re basically buying that yield cheaper, and you would be able to get that exposure to the underlying yield.
Whereas, on the other hand, if you think that yields are going down, then you can hedge your risk by selling all your yield tokens up front, and be able to get that future yield up front. So there’s basically this direct relationship between principal tokens and Yield tokens, and it kind of opens up to many interesting strategies for different sophisticated traders.
Now, we’ve done really well in the liquid staking sector, mainly due to the explosive growth of various liquidity staking primitives. Of course, it started with Lido, and then a large number of similar protocols emerged, such as Diva and LiNEAR. I think that in the future, it will represent the biggest growth. In fact, we are very optimistic about it. This may be the next frontier of LSDfii this summer, mainly because of the numerous protocols built on top of it.
Anling: What’s different about liquid staking on NEAR? How can liquid staking on DPoS chains generate more value?
Stanley: In some sense, it’s actually easier to do liquid staking on a DPoS chain like LiNEAR versus on Ethereum. For every 32 ETH you get, you have to bootstrap a fresh new validator. And that’s why the threshold to building an LSD protocol is actually higher on Ethereum because the protocol itself has to find a way to manage their own nodes.
But on LiNEAR, every single user can just choose to delegate their NEAR tokens to any validators out there in their wallet. So the liquid staking protocol doesn’t really have to worry about building and maintaining their own nodes. I think that’s actually a huge difference.
On the other hand, on a DPoS chain, the threshold to liquid staking is actually lower. So I’ll say there has been quite fierce competition because it’s not that hard to launch an LSD on a DPoS chain, but it’s actually hard to be the best and biggest one.So I think that’s also something that’s quite different.
I think a major difference between liquid staking on NEAR versus that on Ethereum is that NEAR gives a much higher yield. Currently, the yield on Ethereum is around 4%, while NEAR is close to 10%.
Besides yield itself, we’re trying to build it in a way that’s more decentralized and more trustless. Therefore, we recently launched the algorithm for Automatic Validator Selection Optimization. Previously, there was still some manual factor in NEAR protocol, and the team had to adjust the distribution of NEAR tokens among different validators from time to time. From now on, there will be zero manual intervention in terms of how we allocate users NEAR among different validators. I think that’s a big step forward in terms of decentralization and trustlessness.
We are trying to create more fun on top of LSD. We have established a protocol called Phoenix Bonds, which is like a staking game for users. For those who are willing to take a chance or trust their own judgment, they can actually contribute their LiNEAR to Phoenix Bonds.
And in return, you will get an amplified yield on your liquid staking derivative. And you won’t lose anything because all you could lose is your opportunity cost. This means that if you contribute your LiNEAR to Phoenix Bonds, you will provide staking rewards to the protocol and, in turn, receive higher returns.
But if you think it’s not worth it, or you’re not making money, you can withdraw at any time you want. If you simply withdraw, you will be able to keep all of your principal. So what you actually give out is only the staking rewards. Therefore, this is a very safe game to play. It is also one of the most popular DeFi protocols on NEAR at the moment. I believe this is also a way for us to make liquidity staking more interesting.
Anling: How will LSD change the current DeFi landscape? What new legos do you expect to emerge based on LSD?
Anton: Liquid staking in general is now the largest sector in DeFi, with a market cap of approximately $18.5 billion, overtaking DEX and money markets. We have been seeing developers creating many new primitives for LSDs. So I believe we will see many new building blocks in the future.
For example, there are a lot of new stable coins where they would accept LSDs as collateral. One that I found really interesting was EigenLayer, where it is a new protocol that introduces restaking as a primitive.
Re-staking essentially allows staked ETH to be used as a crypto economic security for protocols outside of Ethereum in exchange for protocol fees and rewards. They also support or accept existing LSDs. So I think it’s really interesting because we will definitely see more unique protocols or new DeFi building blocks that can be stacked on top of each other.
This is somewhat similar to Pendle’s positioning. We are basically this new layer where you can hedge the risk of different yield profiles of different types of LSDs in the market. And any chain that is basically PoS or supports PoS is likely to also have liquidity staking derivatives on its chain.
We also hope to support this. So I think this will create a very interesting market for Pendle, where you can not only trade yields, but also use discount assets or principal tokens as collateral in other money markets that would accept LSDs. But instead of the LSD itself, they would be accepting the discounted LSD.
So, yeah, I think that overall, the market is very bullish. We expect more developments to happen.
Pablo: The entire system in Diva is designed to protect users, as the operator should be responsible for any issues that may arise. We have considered all of these aspects of how to protect stakers in the crypto economic systems.
What we do is to introduce a penalty system that holds the operator responsible. It works by creating two tiers — one senior product and one junior product, where one is working and subject to penalty constraints, but they will get paid more. While others are passive. They are protected but they get lower yields. This sounds familiar because it is how lending markets work. You get less yield, but you are protected. Or maybe you do something riskier. So for Diva, what we are doing is allowing people to earn higher yields by engaging with the operator, or we allow people to choose a more comfortable passive staking by simply using liquidity staking tokens and being protected without having to worry about it.
So I think a lot of the innovation that we’re going to see is making things simpler, but also splitting the product into maybe two different sub products that go to more risk averse people or people who have a risk appetite.
Stanley: It’s cool that Anton mentioned EigenLayer, that’s definitely one of the most exciting projects recently. EigenLayer or restaking in general puts the PoS validators at risk, but it also comes with potentially higher returns. As far as I know, someone on NEAR is also building something like that for NEAR.
I think that’s definitely one of the things that LSD will bring to DeFi. Right now we have a relatively risk free yield staking environment by the decentralized network itself. And I think that’s something that will have a long term effect on DeFi.
I think this is the first time we can have some truly stable and relatively risk free that generates liquid yield on some assets. If you’re following the news, you might know Maker recently raised their DSR, which means their DAI Savings Rate is now over 3%. And I think that’s also partly because Maker accepts some LSDs, which can generate a stable 4% yield. This is how liquidity staking yields are transferred to other branches of DeFi.
I think that’s something that we will observe more in the future. In terms of new stuff, I think things like EigenLayer are definitely fun. And I think when people come to the crypto space, some are looking to speculate, while others are looking to make some value investments.
And for speculation, we have protocols like Pendle where you can speculate on yields. And for people who just want to hold, we have decentralized and safe liquid staking protocols like Diva and LiNEAR. And for me in general, I’m just looking forward to wider adoption of liquid staking of liquid staking derivatives. For a rational individual investor, if the protocol is secure enough, he or she should put most of their tokens in that particular protocol, if they are looking to hold long-term.
Pablo: When you have a solution like EigenLayer becoming a hub for the entire system, that could become a systemic issue. We already have systemic issues with platforms like Lido, which have 33% ownership of validators, and this has a huge impact on Ethereum because it’s almost like having a mining device that controls 33%, which is a lot of power and responsibility.
Therefore, I think EigenLayer may bring some systemic risks. I don’t think this is the only way we can get yields because now we have liquidity staking tokens, and we can also do some simple things to increase yield, such as lending it out, which will increase your yield. Or you can use it as collateral.
Just like if you’re running a Chainlink node, you can use LSD as collateral, which is re-staking, and you don’t need to use a complex solution and be systemically tied to the whole system.
The future of LSD is wider adoption, where we all adopt each other’s protocols. In the future, a network of different primitives will be formed, where different protocols are connected to each other without any kind of centralized source.
I think, as a community, we need to talk about where we want this to go? Because it’s really important to keep Ethereum as diverse as possible without any kind of centralized points of failure or systemic risks.
Anling: Liquid staking is growing fast. What do you think the future LSD will look like? What features/changes do you want to see the most?
Anton: Whether there’d be on Ethereum or the other L2s on Ethereum, we would love to support all those. In addition, I think that there are other LSDs that would be bringing their liquidity into the Ethereum ecosystem. So whether they’re from the Cosmos ecosystem or other ecosystems, we are happy to support them.
And we also recognize that there are other liquid staking markets outside of Ethereum, so whether they’d be in BNB Chain,NEAR, Avalanche, etc. If any of those ecosystems are growing, then we would love to take part of that as well.
We’ll be seeing the same protocols copied over or forked over, but they will introduce their own similar innovations in the same way. I think we can find some very unique things, for example, things that can only be seen on NEAR do not really exist on Ethereum.
And as a layer on the DeFi side or on the application layer side, I think that it’s just really important for Pendle to be able to support all those use cases. So yeah, in general, we just would love to work with everyone and we’re very forward looking into any chains that would be having such an ecosystem growth from such a very basic primitive such as proof of stake.
Anling: Can you share more about your roadmap or things they might be working on?
Stanley: We just launched the Automatic Validator Selection Optimization,and our Phoenix Bonds have also performed well on NEAR, which is one of the DeFi protocols that people really enjoy playing with.
For us, the next thing will be expanding to other chains, and all eyes on Ethereum, but we do think there is still vast space to be explored on other non-Ethereum chains or even like non-EVM chains.
We plan to expand to Cosmos and other ecosystems. Because in our vision, what comes next is actually about standards. Just like now, everything is fragmented, with different chains and isolated ecosystems, and we lack a widely adopted liquidity staking standard.
So for LiNEAR it’s really about finding the best way to actually unify liquid staking standards across multiple domains, maybe not Ethereum. Ethereum is just so big. But maybe try to unify liquid staking on different smaller domains and make them more useful in DeFi.
Besides Ethereum, the development of LSD on other chains is doing quite well, such as LiNEAR on NEAR, but we still have a lot of room to grow in terms of DeFi adoption. So for us, this is actually about expanding to more chains while increasing the liquidity of our LSDs, making them more useful in DeFi. And even better, we want to make other chains’ LSD also more useful on DeFi. And with bridges, we can actually bridge things back and forth. So I think that’s how we envision the mid to long term development of LSD.
Pablo: We are very focused. We are and will remain forever an Ethereum-only protocol. This is because the way Diva is built and some of the architecture decisions we made are specifically suited for Ethereum. Where we are on a roadmap now is there is an operator testnet coming next week. So if anybody wants to play with it, you will be able to install it, run your server. There’s also a staker testnet that you can try right now. If you go to the Diva website, you can play with that, deposit your ETH, and test how it works.
We’re going to start distributing over governance, and call the community and ask “Hey, how do you want this protocol to work?”. Because Diva is not a company, nor a for-profit project. We hope people participate in governance, or participate in development, research, and so on. We’re still a few months away from the mainnet, and a few big decisions are pending. So we would love to get the input from the community and see what’s the best way we can design this.
Anton: So right now, we’re mainly in the Ethereum ecosystem for our v2. And we’re soon expanding into other chains that are outside of Ethereum. So yeah, I guess just watch out for the news in the coming weeks or so. And aside from that, we’re definitely looking at the upcoming LSDs that we’ll be supporting.
We’re in talks with a lot of different protocols and projects. And we definitely look forward to working with Diva and LiNEAR as well in the future.
About MetaWeb Ventures
MetaWeb Ventures is a global venture capital firm focused on pre-seed and seed investments in Web3 start-ups. MetaWeb’s Fund 1 is backed by Sequoia Capital, Dragonfly Capital, SevenX, NEAR Foundation, GSR, SNZ and more.
