What are LSTs, and why are they so Popular?
DeFi has seen a sudden surge of TVL recently, but why? The reason is simple: Liquid Staking Tokens
Overview
What are LSTs?
Since the Merge’s implementation back in September 2022, Liquid Staking Tokens (LSTs) have exploded in popularity, with over 20% of Total Value Locked (TVL) across all liquid staking protocols. The name “LST” comes from its inherently liquid nature, meaning users can stake their assets while still being able to navigate the DeFi landscape and earn additional yield. This is an extremely attractive option for those looking at new ways to earn returns on their assets while not being tied down to a lock period. Applications such as Vesper and Euler enable deposits of these assets so users can earn additional yield on top of their already existing staked ETH rewards.
Although Ethereum is amongst the top Proof-of-Stake (PoS) protocols, it has an incredibly low staking ratio of just under 15%. This is partly due to the learning curve associated with becoming a validator and further compounded by its high price tag of 32 ETH. This positions LSTs such as Lido and Rocket Pool to provide a much easier and cheaper solution.
Popular Protocols
Lido
Lido has seen incredible growth recently, surging to the number one spot with over $8.4b TVL and a 73.5% market share of staked ETH. It’s no doubt they are the hottest protocol right now, but let’s look a little closer to figure out why.
Firstly, Lido is a liquid staking solution that provides users with a versatile way to stake on ETH 2.0. They have a healthy ecosystem of growing Layer 1 and 2 blockchain support, which only strengthens their position in the marketplace. They can offer such a stable service because of their staking pool smart contracts, which automate the processes of withdrawing and depositing, delegating funds to node operators, resolving staking reward fees, and minting and burning tokens. Lido currently charges a 10% fee on the staking rewards, divided between node operators and the DAO Treasury. However, the DAO can adjust this fee through a successful vote.
Once users deposit an amount of ETH they are comfortable with into Lido, they will receive stETH (rebasing token) or wstETH (token accrues value) representing their pool share. These tokens are minted when users deposit and burned after withdrawal. They can also be used within other DeFi applications as collateral for lending or yield farming to earn additional yield on top of their ETH 2.0 rewards.
All the ETH that users stake gets distributed to the validators on the Lido network to then be deposited on the Beacon Chain. The deposited ETH from users gets divided into sets of 32 ETH among active Lido node operators, who will validate transactions involving the users’ staked assets using a public validation key.
Rocket Pool
Currently, at the time of writing, Rocket Pool is number 3 in deposits with a TVL of $650m, and it’s not hard to see why. Their solution is simple, lower the capital and hardware requirements that are typically associated with staking on ETH 2.0. They are able to achieve this by enabling users to stake towards a network of node operators trustlessly. A key difference between Rocket Pool and Lido is Rocket Pool’s decentralization. Lido poses a small counterparty risk as it doesn’t have control over the actions of its validators, whereas Rocket Pools enables anyone to become a node operator (if they have the capital).
Their solution serves two audiences, those who wish to stake ETH and those who want to run a node. The cheapest and easiest way to get involved is to stake with as little as 0.01 ETH, and in return receive rETH which can be further utilized in the DeFi ecosystem, much like Lido. The value of rETH increases with the performance of the decentralized network of node operators, so your crypto assets will not only work for you but also contribute to the security of the ETH 2.0 network.
With the imminent release of their Atlas upgrade, Rocket Pools node staking will enable users to become a node operator with 8 ETH instead of the previous 16. As a node operator, you’ll receive rewards on your deposit and an additional 15% on liquid staking deposits. Node operators must deposit RPL as collateral, which is 10% of the ETH value and capped at 150%, to cover potential penalties. Providing collateral can be a profitable opportunity as users receive RPL rewards based on the amount they put forward.
Put Your LSTs to Work
As previously mentioned, stakers can boost their yield gains by using their LST positions on DeFi apps. Euler Finance, a popular lending protocol, recently added support for cbETH, providing a solution for cbETH users who previously had limited options. This resulted in increased deposits in Euler, demonstrating the potential of LSTs. Vesper Finance also recently announced support for Rocket Pools rETH by adding a varETH Grow Pool. This enables users to deposit rETH into the varETH pool and gain extra rewards from their position through Vesper yield strategies, with no strings attached. With the growing popularity of LSTs recently, there are many options like the ones mentioned above that can provide extra yield sources for users, with more being added all the time.
The Future
Since September 2022, when “The Merge” occurred and switched from Proof of Work to Proof of Stake consensus, users who deposited 32 ETH into the Beacon Chain have been waiting to withdraw without a set date. Now, with the Shanghai Upgrade slated for March 2023, they finally have an idea of when they can retrieve their funds. This will be made possible through EIP 4895, which enables staked ETH withdrawals at a 1:1 exchange rate, opening up a whole new audience to liquid staking pools.
The Shanghai Upgrade is designed to reduce the risk for validators and lower the cost of getting involved. As the minimum duration for staking will be reduced to just 27 hours, there will be a lot more opportunity for users to start utilizing LSTs while still contributing to Ethereum’s Proof of Stake system.
Although the future is uncertain, the sudden increase in TVL from LSTs on Ethereum could prompt other blockchains, such as Polygon and Avalance, to consider incorporating liquid staking.
