The Rise of LSDfi and Innovative New Primitives
Decoding LSDfi: a deep dive into how liquid staking derivatives and innovative new primitives are revolutionizing DeFi and catalyzing competitive growth.
Liquid staking derivatives (LSDs) have emerged as a prominent driver of growth and are poised to reach a significant milestone of $20 billion. Liquid staking protocols hold a total value locked (TVL) of $17.9 billion, according to DefiLlama. This places them as the third largest category, trailing behind lending protocols and decentralized exchanges.
The Ethereum Shapella upgrade has dispelled any lingering doubts regarding the timing of unstaking ETH, granting users the flexibility to interchange between staked ETH - which fuels the blockchain - and unstaked ETH.
This newfound accessibility offered by LSDs has markedly diminished the risks linked with staking ETH. It also paved the way for staking yields to become the risk-free rate for holding ETH, extending risk reduction to LSD holdings.
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While certain protocols are still working on implementing a redemption process, the overall success of the fork has alleviated many user concerns. Additionally, the presence of deep liquidity pools for various LSDs ensures that converting back to ETH at a favorable rate is a convenient option.
As LSDs surge in popularity, another sub-sector of DeFi has also risen to capitalize on this trend. Combining LSDs and DeFi, the LSDFi vertical builds on top of LSD tokens increasing the utility and opening up yield opportunities to LSD token holders. These opportunities come in the form of borrowing against these LSD tokens, speculation on or hedging against the yield of LSD tokens, indexes of LSD tokens, and more unique primitives.
Future of LSDfi
As more users embrace the flexibility to transition between different LSD protocols, we can anticipate a fresh wave of competition striving to lure and retain stakers. This contest will revolve around three central pillars:
Liquidity: Protocols without withdrawal functionalities will place a significant emphasis on liquidity in the short term. The rising transactions and volume in Layer-2 (L2) chains will exacerbate the competition to become the leading LSD protocol on these networks. Incentives will play a crucial role in motivating users to transition from the mainnet to ensure adequate liquidity for L2-based protocols.
Incentives: The need for compelling incentives to persuade users to adopt an LSD remains paramount. Now, with the newfound freedom to interchange between LSD protocols in search of the most favorable staking APR, incentives will not only have to appeal to external DeFi protocols but also present competitive staking APRs. This could entail rewards amplified by Maximal Extractable Value (MEV) and a possible reduction in staking commissions.
Innovation: In the post-Shapella landscape, the competition will heavily focus on the creation of inventive use cases for LSDs. Protocols will strive to differentiate themselves by highlighting usability and facilitating a steady yield through unique DeFi products.
LSDfi Primitives on the Rise
New primitives are emerging in the rapidly growing LSDfi sector:
Lending Platforms: Platforms like Aave allow decentralized lending and borrowing of digital assets using smart contracts. LSD-specific lending platforms may be on the horizon, offering yield opportunities for LSD tokens.
CDP Protocols: CDP (Collateralized Debt Position) protocols like Lybra Finance or MakerDAO enable users to lock up collateral in the form of assets to generate stablecoin loans. LSDFi CDP protocols may enable users to use LSD-based assets as collateral to generate loans in LSD or other stablecoins, providing liquidity while maintaining exposure to LSD assets.
Yield Aggregators: Platforms like Yearn Finance and 0xACID actively seek the most profitable yield opportunities across various LSDfi protocols.
Yield Protocols: Yield protocols, such as Aura Finance, unshETH, and Pendle Finance, are designed to generate and optimize yields for users. The underlying yield for ETH staking is the same across all platforms; therefore, the most effective way to attract users is by providing extra yields. These protocols often involve complex mechanisms like structured products, tokenized future yields, or yield curve optimization.
Service Products: Service products in the LSDFi ecosystem, such as Cian and Instadapp offer additional tools to enhance the user experience, such as portfolio management, automated strategies, and transaction optimization.
The Bottom Line
The evolution of LSDfi and its innovative primitives signify the maturation of the DeFi industry, offering users enhanced flexibility, risk mitigation, and new avenues for yield generation. The competitive landscape and evolution within LSDfi are projected to spur further growth and innovation in the DeFi ecosystem.