LSDfi Reimagined: The Unstable Equilibrium of Liquid Staking [1/3]

Vitalik’s latest blog post highlighted some of the issues around Liquid Staking protocols today: https://vitalik.ca/general/2023/09/30/enshrinement.html

Before we get into all this — a brief overview of the current liquid staking landscape!

In March 2023, the network-level Shanghai network made it possible to withdraw staked ETH from the consensus layer. This led to an explosive growth in ETH staking, with overall ETH staking percentage increasing nearly 50%!

This in turn led to the growth in Liquid Staking protocols (LSD or LST). But even as staking participation has risen and the number and types of LSD protocols have increased, the LSD market remains dominated by Lido.

The growth of Liquid Staking also drove a cambrian explosion in using staked ETH as a building block in DeFi — so called “LSDfi” protocols. The initial set of LSDFi protocols aimed to solve the aforementioned centralization issue by offering aggregators that promote the growth of new and emerging Liquid Staking protocols. Starting with unshETH — these protocols are helping grow smaller LSD protocols such as Frax, Swell, Ankr, MetaPool, etc.

As the LSDFi narrative has grown, the most popular use case has been to use Liquid Staked ETH (LSDs) as collateral to borrow USD stablecoins — these LSDFi protocols are aiming to replace native ETH (or WETH) with LSDs as the native money lego in all DeFi applications. This includes both LSDFi native protocols such as Lybra, Gravita, Prysma, R; as well as incumbents expanding their footprint, e.g. Yearn (Yearn ETH), Curve (crvUSD), Maker (SparkLend).

Finally, the latest sink for staked ETH is in the re-staking narrative pioneered by EigenLayer.

See below for the current landscape of LSDfi TVL:

Unfortunately, the growth of LSDFi lending protocols worsens centralization risks. For example, all new LSDfi lending protocols typically launch with only the dominant LSDs (primarily Lido) as supported collateral, quickly exhaust their stablecoin liquidity, and don’t get around to expanding support to the long tail of LSDs. Even EigenLayer only launched with the 3 largest LSDs (Lido, Rocketpool, and Coinbase), and is only now starting to expand support support to other LSDs — but even still requires a minimum 15k staked ETH to even consider a vote to support a newer LSD: https://x.com/eigenlayer/status/1714331512118919449?s=20

This makes it very difficult to launch and grow utility for the “long tail” of LSDs, include novel, innovative protocols and technologies — e.g. LSDs using DVT, SSV; MEV capturing LSDs such as Redacted’s pxETH; or diversified meta-LSDs such as unshETH.

Existing risk frameworks for onboarding LSD collateral has focused on on-chain liquidity with no consideration to the fact that LSDs are all backed by the ETH staked at the consensus layer. Emerging LSD protocols struggle to gain traction because they lack the “industry standard” pricing oracles (e.g. Major oracle providers won’t consider any LSD with < $100m TVL for a price oracle). Furthermore, it’s impossible for newer protocols to grow their presence on Layer 2’s because they have to spend so much on incentivizing on-chain liquidity in every chain they are live. Thus, Lido continues to gain market dominance as existing protocols don’t offer any immediate pathway for newer LSD protocols to be underwritten.

At Unstable Protocol, we believe there’s a better way to tackle this problem.

We are a team of DeFi native, ETH-maxi builders. Inspired by Vitalik, at Unstable Protocol we are building a pro-decentralization, LSDfi native protocol.

Unstable Protocol’s key offerings include:

• Accept any* LSD as collateral to mint the over-collateralized, “yield-earning” stablecoin $nUSD
• “Oracle-free” to onboard new collateral, powered by zkSNARK-based validator balance proofs
• Comprehensive LSDfi-native risk framework
• Omnichain from Day 1, enabling L1-native LSDs to unlock utility on Layer 2s

Follow us on Twitter for the latest updates on Unstable. Discord coming soon.

Stay tuned for Parts 2 and 3 of our blog series, addressing questions like:

• Why are we called “Unstable”?
• What makes our stablecoin “yield-earning”?
• How can a lending protocol be “oracle-free”?
• What does “$nUSD” stand for?
• How to qualify for Unstable Ecosystem Incentives?