The Defiant

Developers Aim To Bring New DeFi Strategies To $17B Liquid Staking Market

Nascent LSTfi Sector Promises Profit and Peril

By: Samuel Haig Loading...

Developers Aim To Bring New DeFi Strategies To $17B Liquid Staking Market

Liquid staking tokens (LSTs) are rapidly becoming a popular source of yield in DeFi. But while LSTs have served as a boon to Ethereum in recent months, they also bring new challenges to the network.

The liquid staking sector has ballooned in value in recent months, with market leader Lido boasting $13B worth of total value locked (TVL) — twice that of MakerDAO, the second-largest DeFi protocol.

More than 19M ETH equating to 15.7% of the supply, is currently staked. LSTs account for a whopping 47% of staked Ether, meaning LSTfi protocols are competing to stake their claim to a potential $17B market at today’s prices.

Liquid Staking

LSTs represent an underlying position of Ether staked in the Beacon chain. They are yield-bearing tokens that allow users to access staking rewards without needing to run a node themselves. They also allow stakers to enter and exit their staked positions by simply buying or selling their LST tokens.

Ever since staked ETH withdrawals were enabled in April, a number of innovative protocols are looking to further integrate LST tokens into DeFi and offer new strategies for earning extra yields on top of staking rewards.

Basic LST Strategies

Many of the top DeFi protocols already support LSTs, with Lido’s stETH boasting the most widespread support and Rocket Pool’s rETH quickly closing the gap.

LST holders can deposit their tokens into a money market protocol like Aave, the third-largest DeFi protocol, to earn yield in addition to staking rewards. They can also borrow other assets against LST collateral, with the combined rewards and yield outweighing accrued interest — which unlocks recursive lending strategies.

“There is strong interest in using stETH to earn additional yield without taking on excessive risk,” said Stani Kulechov, Aave’s founder and CEO.

MakerDAO users can mint its DAI stablecoin against stETH or rETH collateral, offering a simple way to access stablecoins against LST liquidity.

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Curve recently launched crvUSD, a stablecoin that users can mint against Frax’s frxETH token. Curve has said it will expand support to other LSTs soon.

Users can also provide LST liquidity paired with ETH on a decentralized exchange like Uniswap to earn trading fees with negligible divergence loss.

LST Gold Rush

New protocols are also cashing in on the LST boom, with many offering inflationary tokens as bonus rewards.

Lybra Finance surged to $183M in total value locked (TVL) just five weeks after launching a collateralized debt protocol allowing users to mint its eUSD stablecoin against stETH. Lybra uses ETH staking rewards to pay a yield to eUSD holders.

Origin OETH, a yield-aggregating LST, also amassed $15M in TVL within two weeks of launching.

However, while new protocols might sometimes provide higher APYs, protocols that aren’t well battle-tested may be more vulnerable to exploits than their more established counterparts.

On Wednesday, UnshETH, an upstart marketplace for LST liquidity with $32M in TVL, froze withdrawals after it was hacked.

Leveraged Strategies

Some protocols combine multiple DeFi legos to create complex LST strategies.

Oasis.app, a front-end for MakerDAO, launched a service allowing users to leverage their exposure to stETH in October. The product allows Aave users to borrow ETH against stETH and then purchase additional stETH using the borrowed funds in a single transaction.

Gearbox Protocol offers leverage of up to 10x on stETH.

Pendle lets users deposit LST assets and then mint new tokens representing the yield accrued (YT tokens) and the underlying principal staked position (PT tokens) separately.

This means a user could choose to keep their yield-bearing tokens and sell off the underlying stake. Additionally, the trader that buys the PT tokens can purchase ETH at a discounted price compared to the market rate, but won’t be able to access the Ether until after a predetermined period of time has elapsed.

EigenLayer

Many in the Ethereum community are awaiting the launch of EigenLayer, an innovative “ restaking” protocol set to make its mainnet debut in Q3.

EigenLayer will allow Ethereum stakers to secure other services in addition to validating the Ethereum blockchain, allowing them to earn extra rewards. It’s also building support for stETH and rETH, enabling LST holders to also participate in restaking.

Centralization Fears

However, prominent voices in the Ethereum community are warning against overly financializing Ethereum’s underlying security mechanism.

“The goal of staking is not to promote DeFi, the goal of staking is to promote the security and the health of the Ethereum network,” said Superphiz, the co-founder of the EthStaker community. “You’ve got to keep those two goals separate.”

Some researchers fear the financialization of LSTs is contributing to the worrying dominance of Lido Finance, which currently controls 36% of all staked Ether and has attracted 32% of validators. Vitalik Buterin, Ethereum’s co-founder and chief scientist, recently prescribed that no single staking pool should control more than 15% of staked Ether.

While many in the community are trying to raise awareness of the issue, others believe more action needs to be taken. Anthony Sassano, the host of The Daily Gwei podcast and member of Rocket Pool’s oDAO, urged rival LST providers to use economic incentives to attract market users away from Lido.

“We all know the most powerful force in crypto is economic incentives, but too many people still want to sit around and hope that their social signaling will somehow lead to change with this issue… it's time to kick it into high gear and eat Lido's breakfast, lunch, and dinner,” Sassano tweeted.

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