Redefining Traditional Staking: A Close Look at Liquid Staking Derivatives
In this first part, we delve into the concept of LSDs, explaining what they are, how they work, and their relevance to the Ethereum network, especially in light of the recent Ethereum Shanghai update.
Abstract: In this first part, we delve into the concept of LSDs, explaining what they are, how they work, and their relevance to the Ethereum network, especially in light of the recent Ethereum Shanghai update. We'll also examine the various substructures that exist within the broad umbrella of LSDs, including Distributed Validator Technology (DVT), and single-level collateral LSDs. For the part 2 will be focusing on LSD Finance platforms (LSDFi). By exploring these concepts in depth, we aim to provide a comprehensive understanding of the current state of LSDs in Ethereum and their potential impact on the broader DeFi ecosystem.
Section 1: Introduction
Section 2: LSDs vs Conventional Staking
Section 3: Ethereum Shanghai update
Section 3.1: DVT
Section 3.2: Single-level LSD
Section 4: Conclusion
Introduction
As the world of decentralized finance (DeFi) continues to evolve and innovate, new concepts and technologies are continually emerging that challenge traditional financial structures. One such innovation that has been gaining significant traction in recent years is Liquid Staking Derivatives (LSDs).
It's important to underscore that Liquid Staking Derivatives (LSDs) are not a fresh concept. They have been around since the surge of Decentralized Finance (DeFi) back in 2020. LSDs propose a novel methodology for staking, providing an answer to the constraints tied to conventional Ethereum staking methods
Since The Ethereum Shanghai Upgrade event the narrative around LSDs has been increasingly prevalent within raves the cryptocurrency sphere. So what are LSDs and how does this connect to the Ethereum Shanghai update?
LSDs vs Conventional Staking
In a conventional staking scenario, while users can earn profits through staking rewards, their staked assets remain locked and inoperable. Moreover, the conventional Ethereum staking through validators required a significant minimum amount of 32 ETH (over $50,000 at the time), which posed a barrier to many potential stakeholders.
With the transition of Ethereum to Proof-of-Stake (PoS), new protocols began to emerge that offered both staking interest and a synthetic ETH-based asset for staking ETH - These protocols are known as Liquid Staking Derivatives (LSDs).
They have enabled investors to not only earn returns on staked funds but also retain the control over their assets. This is achieved by issuing token holders with LSDs in an equivalent amount to their staked ETH. In effect, LSDs create a secondary market for ETH, enhancing its liquidity and usability.
Ethereum Shanghai update
The Ethereum Shanghai upgrade, which occurred on April 12, 2023, significantly altered the dynamics of staking for Ethereum holders. Before the upgrade, Ethereum stakers were constrained by the indefinite lock-up period of their staked funds, effectively limiting their liquidity. However, the Shanghai upgrade introduced a more flexible withdrawal mechanism, leading to an expected increase in the circulation of ETH.
This increased fluidity has altered the staking preferences of Ethereum holders, who are now more likely to gravitate towards protocols offering higher returns along with liquidity preservation instead of traditional node staking. This shift in staking behaviors has catalyzed the proliferation of Liquid Staking Derivative (LSD) protocols, which have been emerging at an accelerated pace since the upgrade.
Moreover, despite concerns that the newfound ability to withdraw Ethereum from staking could lead to a mass exodus and a subsequent drop in Ethereum's price, the reality has been quite different. Data from Nansen indicates that in the 24 hours following the Shanghai upgrade, the influx of ETH into staking has actually surpassed the outflow, signifying a positive response from the Ethereum community towards the changes introduced by the upgrade
LSD structures
The realm of Liquid Staking Derivatives (LSDs) can be dissected into several key structures: Distributed Validator Technology (DVT), single-level collateral LSDs, and LSDFi platforms that facilitate collateralization, yield aggregation, and yield management, with platforms like ACID, AURA, and FXS leading the pack.
DVT
DVT stands for Distributed Validator Technology. The idea behind DVT is that it allows entities and individuals to run an Ethereum PoS validator on more than one node or machine.
The primary advantage of DVT is its enhancement of node resilience, minimizing the risk of shrinkage for honest validators and promoting decentralization. Moreover, by distributing the validator function across several nodes, DVT reduces the risk of a single node going offline, a situation that can incur severe penalties.
Several projects are currently working on DVT technology, such as:
SafeStake
Obol
Diva
SSV.Network.
These platforms not only support staking for those with 32 ETH, mitigating potential hardware failure risks, but also welcome those with less than 32 ETH, attracting more liquidity to secure the network.
The focus of these projects is currently on technical issues, which include different ways to manage validator node keys (DKG from SafeStake or software solutions from Obol and SSV), as well as hardware management of clusters and distributed computations between them. And so far, any kind of LSD for DVTs is only considered in the long run, as they have other tasks at the moment. But perhaps this will be an interesting technology after some time with simultaneous use of LSD.
It is also worth noting that LSD and LSDFi protocols are already starting to implement DVT support. These protocols include EtherFi and Stader, which make a DVT solution with Obol. RocketPool offers the use of Obol as a DVT solution on the side. Lido is introducing DVT technology, at least they mentioned it in April 2022.
Single-level LSD
Single-level LSDs include those protocols that issue synthetic derivatives backed by 1:1 staked ETH. These protocols include Lido (stETH), Ankr (ankrETH), Rocket Pool (rETH), Stake Wise (sETH2 + rETH2 reward token), Frax (sfrxETH), Stafi (rETH).
It can also include so-called Exchange Staking, which is when some exchanges, such as Coinbase (cbETH) and Binance (bETH), allow users to deposit ETH and bet on a Beacon deposit contract and receive a reward.
Single Level LSD Comparison
The largest at the moment (12/05/23) by TVL are Lido (6.2m ETH), Coinbase (1.1m ETH, Rocket Pool (450k ETH), Frax (187.5k ETH), Stake Wise (76.6k ETH). Ankr has held similar ranges since 2021.
Delving deeper into some of these protocols and the current state of staking rewards, we will exclude Coinbase and Binance due to their distinct status outside the DeFi sphere:
Lido: For every staked ETH, a stETH is issued. As the data above shows, this is among the most popular and liquid stacking protocols. Further enhancing DeFi compatibility is wstETH, a wrapped stETH that seamlessly integrates with DeFi protocols, including Uniswap and MakerDao. The brainchild of OG Ethereum, it enjoys robust support from veteran crypto venture capitalists such as Paradigm, a16z, Dragonfly, Jump, and others. However, Lido's yield has been steadily declining, currently at 4.8% for ETH (down from 4.9% in early February), and it charges a 10% commission on the yield. Apart from ETH, Lido also accommodates Polygon and Solana.
Lido's governance token, LDO, is used for platform control.
- Node operators: 29 operators
- Validators: 187,123 validators (source: rated.network, app.hex.tech)Rocket Pool: In exchange for staked ETH, users receive rETH. Offering direct liquidity staking on the node via its Staking as a Service program, Rocket Pool provides a 7.08% annual yield but requires a minimum deposit of 16 ETH.
Additionally, it has a simple staking system in a decentralized network of operators, which gives an APR of 3.47% (down from 4.37% in early February) with a minimum deposit of just 0.01 ETH. However, it charges a 15% commission on profits.
Unlike Lido's stETH, rETH is not a rebase token, i.e. it is initially fully integrated into the existing DeFi ecosystem, without losing the steering rewards. In addition, it is worth considering that rETH is more expensive than ETH as rewards accumulate. rETH, just like stETH, automatically receives rewards from staking regardless of where it was purchased.
RPL token is used to reward node operators for high uptime and discourage penalties. Also, node operators can stake on RPL to get a higher share of protocol fees, but will be penalized if the reward for ETH is reduced. Additionally, the token is also used for governance.Node operators: 2604, making Rocket Pool highly decentralized, though it hosts fewer nodes than Lido - 13,828 nodes (source: rated.network, rocketpool.net)
Stake Wise: sETH2, rETH2 tokens are used as a derivative. The approach may seem similar to Frax, but it actually works a little differently. When staking, 2 tokens are given: the sETH2 token, which represents the staked ETH, and rETH2, which already provides income for staking. APR 4.14% (at the beginning of February it was 4.9%), commission 10% from profit. Also, Stake Wise derivatives have a disadvantage with the fact that derivative tokens can be used to earn money in a fairly small number of strategies (Uniswap pools). But at the same time, StakeWise has the lowest entry threshold - 0.001 ETH.
Number of validators: 2372
Conclusion
In conclusion, the landscape of Ethereum staking protocols is diverse and dynamic, with each platform offering its own set of benefits and trade-offs. Lido maintains a dominant position in terms of popularity and liquidity, despite a slow decrease in yield. Rocket Pool, on the other hand, offers attractive yields but requires a higher minimum deposit for its Staking as a Service program. Frax, which initially started as a stablecoin, is now venturing into liquid ETH staking, while Stake Wise's dual-token system provides staking income with a relatively low entry threshold. Given these various options, investors should carefully consider their specific needs and risk tolerance before deciding which platform best fits their staking strategy.