By CloudY, Vincero
Editor: Vincero, YL
Reviewer: Natalia
introduce
As a trillion-level track, the LSD sector has gained a lot of attention riding on the momentum of Shanghai's upgrade. Not only have the leading projects $LDO $SSV risen a lot, but some new entrants to LSD and undervalued targets like $FXS $FIS $ANKR $CHESS have also seen obvious increases.
Since LSD became popular, there have been many excellent articles explaining the mechanism of LSD and DVT:
LidoFinance's first-mover advantage and potential risks, as well as the qualitative changes that v2 will bring to Lido.
SSV Network’s ability to capture value as the underlying architecture of LSD and its technical threshold.
Frax Finance's innovation in balancing liquidity and profitability.
The high mortgage rate of LSD pledge certificates leads to high capital utilization rate through revolving lending.
Eigenlayer's Re-Staking brings a new source of ETH staking income and also provides guarantees for project security.
This article will approach the issue from another angle and propose a new direction for the LSD track.
First, this article maps the current LSD projects (non-DVT and Re-Staking) and simply classifies the existing staking mechanisms.
Market share is the proportion of Staked ETH in the image project to all Staked ETH
ETH2.0 Staking Data
The launch of ETH2.0 staking has brought a stable and reliable source of income to the chain, like national debt, with the current APR being 4.7%. Since the ETH2.0 staking rewards come from Gas fees, MEV, and ZK proofs, etc., as long as ETH is still running, then this reward will definitely exist, and the yield will only be relatively reduced due to the increase in staking nodes. Therefore, given ETH's dominance over all public chains, ETH2.0 staking can be said to exist like national debt. Therefore, we can draw on the mechanism and storage absorption plan of national debt to provide the future development direction of LSD.
Current LSD Program
This article summarizes the current five LSD solutions based on the characteristics of various LSD projects:
1. Centralized custody solutions provided by CEX such as Binance and Coinbase to users:
Centralized exchanges collect user ETH, build/commission third-party component verification nodes, run nodes in a centralized manner, and stake user ETH. Centralized operations can minimize the profit of middlemen, but this requires the greatest trust of users. According to Binance, its APR is about 10%, which is very convenient and does not charge handling fees. Users can obtain BETH as proof of stake after staking. Relying on its own traffic advantages, exchanges can attract a large number of centralized users. Therefore, Coinbase's cbETH occupies 14.87% of the ETH LSD market share, ranking second.
2. Rocket Pool’s decentralized solution:
Rocket Pool collects, pledges, and distributes ETH through smart contracts, and decentralizes verification node service providers based on DVT technology, achieving the greatest degree of decentralization in the form of Pool Staking. Although Rocket Pool is also a custody solution, the existence of smart contracts and DVT makes it more trustless. This is also the reason why $RPL soared after Kraken was banned. But the cost of decentralization is a 15% commission on the incentive amount, so the 4.30% APR is not so competitive. Therefore, Rocket Pool has obtained a 5.61% market share of ETH LSD with its decentralized rETH, ranking third.
3. Lido Finance's pledge certificate ecosystem:
Lido Finance has leveraged its first-mover advantage to collaborate with many DeFI projects and build a rich ecosystem for stETH. Currently, financial services using stETH as an object can be seen in major mainstream DeFi protocols. A large amount of accepted stETH will inevitably be the first choice for most staking users, because it means a more flexible strategy.
For example, Aave allows mainstream assets to be lent by pledging stETH. In E-mode, the pledge rate can reach 90%. Currently, there are 991.91k stETHs worth $1.63B pledged in Aave, accounting for 17.7% of the stETH circulation.
On CurveFinance, stETH-ETH can also be used to form LPs and pledge LP Tokens to earn transaction fees, CRV incentives, and LDO incentives. Currently, there are 535.3k stETHs formed into LPs on Curve, accounting for 6.2% of the stETH circulation. This part of LPs can obtain a total annualized return of 4.9215%.
After forming LP on Curve, users can also go to Yearnfinance to stake stETH LP to obtain an annualized return of 4.52%.
Therefore, although Lido Finance v1 is a relatively centralized staking service provider and has a 10% service fee, it still cannot stop Lido from taking the lead in market share.
4. Balance between liquidity and profitability of Frax Finance:
Different from the previous scheme, Frax Finance has established a scheme that balances liquidity and profitability. Users stake ETH to participate in the verification node and obtain frxETH as a voucher, but frxETH does not capture the staking rewards. All staking rewards are issued to sfrxETH. Users need to stake frxETH again to obtain sfrxETH.
Currently, a total of 108.23k frxETH have been minted, and only 59.4k frxETH have been further pledged in exchange for sfrxETH. Therefore, the staking rewards of 108.23k ETH are concentrated on sfrxETH, bringing sfrxETH an annualized return of 6.43%.
Frax provides 5.604% APR to the frxETH pool with its dominance on Curve, and a total of 39,197 frxETH form LP on Curve.
The returns of frxETH and sfrxETH far exceed Lido's 4.5% and RPL's 4.28%, thus achieving a monthly ETH staking growth of more than 33%, ranking fourth in ETH LSD TVL.
5.Stader’s cross-chain staking
As the big brother of the LSD sector, Stader ranked fourth in the total LSD project TVL before ETHX was launched. Stader supports multi-chain PoS staking, and currently supports Polygon, Hedera, Fantom, BNB, Near, and Terra 2.0. It will soon be launched on ETH, and plans to launch on Avalanche and Solana.
The special feature of Stader is that it allows users to stake Matic on the ETH network to obtain MaticX. If ETHX can also use this solution, ETH that has crossed other chains can flow back to the ETH network, which is equivalent to opening up a new battlefield for the competition for ETH LSD market share.
National debt mechanism
National debt is backed by national credit and provides long-term and stable returns. Countries attract funds to buy national debt through corresponding mechanisms and establish derivative markets based on national debt to expand the use of national debt. ETH2.0 pledge is similar to this. It uses the operation of the ETH public chain as an endorsement to provide stable returns based on the activity on the chain. The LSD project uses various mechanisms to attract ETH in the market to pledge and establishes corresponding derivative markets to expand the use of its pledge certificates. Therefore, understanding national debt will help us find potential directions for the LSD track.
Current national debt mechanism and deposit-taking methods:
With different expiry dates
Establish a government bond redemption mechanism to liberate government bond liquidity
Introducing multiple distribution platforms
Provide repurchase and reverse repurchase, and introduce financial lending solutions
Establish and improve the government bond derivatives market
Points that the LSD project can learn from national debt:
Treasury bonds have different maturity dates, and different maturity dates correspond to different yields. Generally, the longer the maturity, the higher the yield, because it bears a greater opportunity cost. However, there are also cases such as the inverted yield curve of US Treasury bonds. Based on the amount of treasury bonds with different maturity dates, the country can formulate corresponding policies in advance to adjust the use of funds.
In order to expand sales, government bonds are usually sold through multiple channels, such as bank branches, mobile banking, telephone purchases, post office counters, and agency sales by financial institutions.
In addition, derivative functions such as repurchase and reverse repurchase, as well as derivative markets such as bond funds and principal-guaranteed floating-rate financial management products can further expand the use scenarios of treasury bonds and increase market demand for treasury bonds.
LSD can be used as a reference
Based on the above national debt mechanism, we can get two solutions that LSD can learn from:
1. Zero coupon bonds and bond coupons with maturity dates
As we all know, after the Shanghai upgrade, verification nodes are allowed to exit, and users can withdraw previously staked ETH, but only 16 nodes can exit in each block, and the staked ETH can be withdrawn. At the same time, only nodes with the corresponding number of exiting nodes can enter, which is to ensure the stable operation of the network. Establishing an expiration date for ETH pledges can help maintain the stability of the ETH network, just like national debt. Everyone can intuitively understand how much ETH will be withdrawn at different times in the future and take corresponding measures.
In addition, after the maturity date is established, there will be more abundant LSD derivative strategies. Zero-interest bonds and bond coupons are one of them:
Taking Pendle Finance as an example, it can use ETH pledge certificates such as stETH to generate: tokens representing the certificate currency - PT and tokens representing the certificate income - YT, and they all have expiration dates. Only after the expiration date can the PT token be exchanged for a complete currency, and the YT token can retrieve the income generated by a currency during this period.
Different expiration dates mean different discounts for the native currency token pt. Longer expiration dates mean higher discounts, so the discount will decrease as the expiration date approaches. It also means different intrinsic values of the income tokens. Longer expiration dates represent more income, so the price will decrease as the expiration date approaches.
Based on PT and YT, users can build investment strategies around LSD credentials:
Buying discounted PT and waiting for the expiration date to obtain an equal amount of ETH pledge certificates is equivalent to going long on the certificate.
Sell/stake YT to lock in future staking rewards, which is equivalent to shorting staking rewards
Buying YT at a discount and waiting until the expiration date to receive the full staking reward is equivalent to going long on the staking reward.
Establish LP of PT and ETH pledge certificates, and obtain various stable incomes including PT value return over time, LP handling fees, ETH pledge certificate pledge rewards, and LP pledge incentives.
Combination Strategies: Expiration provides a variety of investment strategies for ETH staking.
When DeFi protocols can directly access ETH pledge certificate protocols with expiration dates, such as Pendle, which allows users to seamlessly pledge ETH and set expiration dates when borrowing, it can increase user deposits while increasing the amount of ETH pledged, thus ensuring the safety of ETH operations and increasing user benefits. This is equivalent to adding multiple participation channels for ETH2.0 pledge.
2. Establish and improve the LSD pledge certificate derivatives market (LSD Layer2)
In fact, protocols such as Lido and Rocket Pool directly participate in the staking of ETH, which can be regarded as the first layer of protocols. DVT protocols such as SSV provide verification node operation in a decentralized manner and belong to the zero layer. Protocols based on staking certificates such as Lido can be regarded as the second layer, namely Layer2. For example, the above-mentioned Pendle, as well as Aura, Curve, YFI, Aave, etc. In the current LSD sector, Layer1 is already very involuted, and Layer2 has just begun.
Based on the above maturity dates and zero-coupon bonds and bond coupons, we will be able to build more complex strategies and products to start Layer2 involution. In the traditional bond market, principal-guaranteed floating-income funds occupy a large market share. In the second half of 2022, the issuance of principal-guaranteed funds accounted for 19.05% of the total new legal funds, and the highest month accounted for 63.88%. However, this type of fund is very rare on the chain, so this will be a new opportunity based on the ETH LDS trillion market.
The essence of a capital-guaranteed floating-income fund is to spend a portion of the money to buy zero-coupon bonds equal to the principal, and you will get the same amount of principal after the zero-coupon bonds mature. The remaining funds after buying zero-coupon bonds can be used for high-leverage/high-yield investments to achieve floating returns that guarantee capital.
Of course, there are many high-leverage investments, but options are a common high-leverage trading method in traditional markets. Since high returns are often accompanied by high losses, this type of operation usually requires a certain degree of subjective judgment. Compared with the high returns of subjective transactions, in order to ensure on-chain transparency, it may be necessary to sacrifice some of the returns, and it would be more appropriate to use relatively low-risk and high-certainty option strategies. For example, the butterfly strategy is more controllable than the straddle strategy, and when using options as a way to increase value, the butterfly strategy will be a good choice. However, at the expense of a certain degree of decentralization, subjective transactions will bring users higher returns, and may also be accepted by users.
As a trillion-dollar market, LSD has many protocols competing for market share, such as Lido and Rocket Pool on Layer1, and there are also Layer0's DVT protocol and Re-Staking's EigenLayer exploring other levels of the market. The Layer2 pledge certificate derivatives market is still in its early stages and has greater potential. Whether it is zero-interest bonds and bond coupons with an expiration date, or principal-guaranteed floating income funds, or the LSD index made by YFI, they are all providing richer investment strategies, amplifying fund utilization and yields. I believe that more interesting projects will emerge. In the future, there will definitely be DAOs that choose subjective high-risk strategies to achieve high returns on principal-guaranteed floating income funds. And the principal-guaranteed floating income fund is just a drop in the ocean, and there will definitely be more sophisticated solutions.
Looking forward to the development of LSD Layer2, this will be a trillion-dollar market on top of a trillion-dollar market.
Future Outlook — Cryptopia
Based on LSD to ETH2.0, we talked about national debt, which in turn reminds us of the future development of Crypto and the country. Let’s first look at some relevant definitions:
“Network nations are online communities with highly aligned goals that have the ability to take collective action, crowdfund territory around the world, and ultimately gain diplomatic recognition from established states.” —Balaji Srinivasan
“A network state is a social network that has ethical innovation, national consciousness, and recognized founders; whose collective actions are powerful and whose members are civil and humble; which integrates cryptocurrency, establishes a government based on consensus, and whose power is limited by social smart contracts; whose crowdfunded archipelago is its real territory and its capital is virtual; and whose population, income, and estate size are verified by an on-chain census, making it large enough to win some degree of diplomatic recognition.” — Vitalik Buterin
With the development of human civilization and society, following the industrial revolution and the information revolution, the development of the Internet has brought great impact and changes to people's lives. In the most primitive African tribes, people can also have a smartphone to access the Internet. The Internet revolution has realized the interconnection of human information and greatly improved the efficiency of information transmission. On top of these infrastructures, the revolution of Bitcoin and blockchain has brought about the interconnection of human values and greatly improved the efficiency of value exchange. The vigorous development of the ETH ecosystem has once again brought about innovation in value applications and laid the foundation for the future "national" ideology.
Let’s imagine what the world will be like in the future: through the Internet, people transcend race, language, country, and geographical restrictions, and establish communities through consensus (as DAO); people’s value is stored in BTC, which is truly decentralized, open, transparent, and cannot be tampered with, and is the most fair and just currency; people’s transactions no longer require "legal currency", and the most efficient transactions can be achieved directly through crypto currency anywhere in the world; social rules, rights, and obligations are executed through ETH smart contracts without human intervention; people can choose the social organizations they want to join based on their own values and preferred ideologies, and escape the grand narrative of native politics; perhaps this may also be the first step for mankind to move from carbon-based civilization to silicon-based civilization, let us wait and see the AI revolution.
Cryptopia，for Love & Peace。
Reference
[1] How to stake your ETH and earn rewards while protecting Ethereum: https://ethereum.org/en/staking/
[2] DefiLlama, ETH liquidity staking derivatives, total value locked ETH LSD: https://defillama.com/lsd
[3] Kodi, Evaluation of top LSD solutions: Pros and cons analysis of Lido, Frax and Rocket Pool, TECH FLOW, 2023, 30 (1): https://www.techflowpost.com/article/1981
[4] Riddler, Learn about Stader in one article: Will LSD + real income drive a huge explosion in token value? , TECH FLOW, 2023, 18 (1): https://www.techflowpost.com/article/1953
[5] CapitalismLab, LSD advanced gameplay and its essence, BlockBeats, 2023, 06 (3): https://www.theblockbeats.info/news/35245
[6] China – Government Bonds, Investing.com: https://cn.investing.com/rates-bonds/china-government-bonds
[7] Option Strategies, Option Volatility Strategies - Butterfly Combination, CME Group: https://www.cmegroup.com/cn-s/education/courses/option-strategies/option-butterfly.html
