Liquid staking derivatives (LSDs) are shaking ethereum’s foundations. They offer users the ability to stake their ETH without losing their liquidity. This article serves as a complete how-to for LSDs. Here’s how they work, what their benefits and risks are, and how they could shape the future of Ethereum staking. At MetaBlock X, our goal is to arm you with the information you need to better understand the digital asset landscape so you can invest with confidence.

Understanding Liquid Staking Derivatives

Liquid staking derivatives (LSDs) allow users to stake the network’s native coin of a Proof-of-Stake (PoS) blockchain, such as Ethereum. Meanwhile, they preserve their own liquidity. This is done by minting an underlying derivative token that mirrors whatever is staked. This derivative token can then be used in other DeFi applications, unlocking the value of staked assets.

The surge of popularity in liquid staking is due to primarily two reasons. Here’s how it directly benefits you as a staker. First, it increases the value of your staked tokens. You can now earn new yield earning rewards or income through lending and borrowing! Second, it democratizes staking. Users are able to now engage with these features with smaller amounts of ETH, rather than needing to operate their own validator node. Liquid staking providers take these solutions and 5-10% of the staking rewards they generate.

Liquid staking on Ethereum, as anyone paying attention to Ethereum’s recent developments knows, has seen explosive growth. It currently has a TVL of $18 billion, making up roughly 38% of the total value locked in DeFi. Liquid staking protocols together currently have a total value locked (TVL) of $12.36 billion. They come in third behind lending protocols and decentralized exchanges, with a massive market share dominance of ~75%.

Key Players in the Liquid Staking Space

A handful of protocols have quickly become leaders in the liquid staking space, each with distinct features and philosophies. In fact, the top 5 most popular protocols for liquid staking derivatives are Lido, Coinbase, Rocket Pool, Frax Finance, and StakeWise.

  • Lido: As the largest liquid staking provider, Lido allows users to stake their ETH in exchange for stETH, an ERC-20 token representing staked ETH and accumulated rewards. Lido charges a fee on staking rewards, determined by the DAO, and currently has around a 75% market share with over 1.1M $ETH staked. Lido has become a dominant force in the staking space due to its user-friendly interface, support for smaller deposits, and strong integrations with DeFi protocols. Lido’s stTokens have gained significant adoption within the Ethereum ecosystem.
  • Coinbase: While Lido is the largest liquid staking provider, the second largest provider is actually Coinbase. This highlights the significant role centralized exchanges play in the LSD landscape.
  • Ankr Staking: Ankr provides staking services for multiple blockchain networks, including Ethereum, and issues aETH as its liquid staking derivative, focusing on offering easy-to-use staking solutions for both retail and institutional users.

Benefits and Risks of Liquid Staking

Liquid staking comes with many advantages, but understanding the risks involved is key.

Lido’s stTokens have quickly become the most used ETH staking tokens in Ethereum’s expanding ecosystem, resulting in an increasing number of DeFi integrations and use cases. Yearn, Harvest Finance and several other liquidity strategies have been developed on top of Lido’s stTokens. StETH is a collateral token on the AAVE v2 market on Ethereum mainnet. The two key liquidity venues are the stETH/ETH liquidity pool on Curve and the wstETH/ETH MetaStable pool on Balancer v2.

  • Liquidity: LSDs allow users to access the liquidity of their staked ETH, enabling them to participate in other DeFi activities.
  • Composability: LSDs are ERC-20 tokens, meaning they are fully composable within the Ethereum DeFi ecosystem.
  • Accessibility: Liquid staking lowers the barrier to entry for staking, allowing users with smaller amounts of ETH to participate.
  • Potential for Additional Yield: Users can potentially earn additional rewards by using their LSDs in other DeFi protocols.

The Ethereum Shanghai upgrade recently allowed for ETH that has been staked to be unstaked, via a long withdrawal queue. The Ethereum Shanghai upgrade, a key step on Ethereum’s roadmap, is on the horizon! It will allow stakers to withdraw their locked ETH, which will make staking more appealing to a larger audience. This upgrade is likely to increase the appeal of ETH staking and LSDs by eliminating the lockup period.

  • Smart Contract Risk: As with any DeFi protocol, there is a risk of smart contract bugs or exploits.
  • Depeg Risk: The price of the LSD may deviate from the price of the underlying ETH, leading to losses for users.
  • Centralization Risk: Some liquid staking protocols, like Lido, have garnered a significant portion of Ethereum’s staking market share, which raises concerns about centralization. Lido is seen as a fairly centralised service provider, whereas services like Coinbase and Binance are completely centralised. It’s safe to say that Lido is the market leader in the ETH LSD space.
  • Slashing Risk: Although less direct than running your own node, LSD users are still exposed to slashing penalties incurred by the underlying validators.

DeFi Integrations and Use Cases

The Shanghai upgrade will likely take place in mid-March 2023. We expect it to have an important ripple effect throughout the LSD ecosystem. Booming demand to stake ETH is just the beginning! That endless lock-up will now no longer be the case and users can finally have peace of mind that their ETH won’t be stuck forever. Such increased demand would increase staking rewards making this cycle even more reinforcing, snowballing the growth of the LSD market.

Liquid staking derivatives have changed the Ethereum staking game forever. This provides users with an opportunity to unlock the liquidity of their staked ETH, all while actively participating in the DeFi ecosystem. In spite of these benefits, LSDs pose considerable risks. It’s precisely their benefits—increased liquidity, composability, and accessibility—that contribute to their attractiveness and usage.

  • Lend and Borrow: Use stETH as collateral to borrow other assets on platforms like Aave.
  • Provide Liquidity: Earn trading fees by providing liquidity to stETH/ETH pools on decentralized exchanges like Curve and Balancer.
  • Yield Farming: Participate in yield farming strategies that utilize stETH to generate additional rewards.

The Shanghai Upgrade and the Future of LSDs

The Ethereum ecosystem is advancing quickly so this is just a snapshot in time. LSDs are increasingly positioned to be central players in deciding how staking evolves going forward. Keeping up with important new developments is essential. Knowledge of the risks and benefits of various approaches to LSD administration will equip you to make wise choices. MetaBlock X brings you the insights that matter. With our comprehensive expertise, we guide you through this dynamic and highly competitive landscape with nuanced intelligence!

The Shanghai upgrade is poised to take place around March 2023, and is expected to have a significant impact on the LSD ecosystem. It is expected to increase the demand for ETH staking, as users will no longer have to worry about their ETH being locked up indefinitely. This increased demand could lead to higher staking rewards and further growth in the LSD market.

Final Thoughts

Liquid staking derivatives have revolutionized the Ethereum staking landscape, offering users a way to unlock the liquidity of their staked ETH while participating in the DeFi ecosystem. While there are risks associated with LSDs, the benefits of increased liquidity, composability, and accessibility make them an attractive option for many users.

As the Ethereum ecosystem continues to evolve, LSDs are expected to play an increasingly important role in shaping the future of staking. Staying informed about the latest developments and understanding the risks and benefits of different LSD protocols is crucial for making informed decisions. MetaBlock X is here to provide you with the insights and analysis you need to navigate this exciting and rapidly evolving space.