The Explanation of Liquid Staking Derivatives – the Top DeFi Trend of 2023

Lido has emerged as the largest decentralized finance (DeFi) application on the Ethereum blockchain, boasting approximately $8 billion in deposited capital on its platform.

Lido forms part of a broader group of platforms that offer liquid staking services for Ether (ETH). With liquid staking platforms, users can stake their ETH and earn yield while also receiving a tokenized IOU for their staked ETH.

These tokenized IOUs, known as Liquid Staking Derivatives (LSDs), can be freely traded, sold, or utilized in DeFi applications just like regular ETH, providing users with a flexible and versatile asset.

The popularity of LSDs was already significant, but the recent Shapella network upgrade has provided a substantial boost to their momentum.

If you're interested in participating in this exciting trend, here's how it works and how you can join the action.

What are Liquid Staking Derivatives?

Liquid staking derivatives (LSDs) are an innovative trend in DeFi that present new investment opportunities while addressing certain limitations of Ethereum staking.

With Ethereum's shift from proof-of-work to proof-of-stake, validators replaced PoW miners, allowing anyone to become a validator by staking 32 ETH and earning staking rewards. However, this requirement creates a financial barrier for many potential investors, and staked ETH is not easily accessible for other investment opportunities.

LSDs offer a solution to these challenges. They are tokenized IOUs issued for staking ETH through a liquid staking platform. When users stake ETH through such a provider, they receive tokens equivalent to the value of their deposit.

These tokens, LSDs, automatically accrue yield, which goes directly to the user's wallet, eliminating the need for manual withdrawal as with traditional staking. Although liquid staking providers typically charge a 5-to-10% service fee, LSD holders retain the flexibility to use these tokens in other DeFi protocols, benefiting from various lucrative opportunities.

Importantly, LSDs remove the 32 ETH requirement, enabling small investors to participate in staking and earn rewards proportional to their investment. This inclusion opens up the benefits of staking to a broader range of users, allowing them to generate passive income without sacrificing liquidity.

The issue with staking

The challenge with staking on the Ethereum blockchain lies in the requirement of ETH for gas fees in every transaction, similar to road tolls. Validators, who maintain the network, stake their ETH and earn an annual yield, but the catch is that being a validator demands 32 ETH, amounting to a significant investment.

Liquid staking derivatives (LSDs) present a solution by allowing stakers to earn yield without sacrificing the liquidity of their staked assets. LSDs function as IOUs, maintaining a 1:1 value with the staked ETH, and automatically accrue yield, eliminating the need for gas fees to withdraw rewards.

Moreover, LSDs remove the 32 ETH entry barrier, enabling anyone to stake any amount of ETH and earn yield. LSDs offer versatility, as they can be held to earn yield, traded, used as collateral for borrowing, deposited into liquidity pools for additional income, or sold for cash.

The popularity of LSDs has surged, and stETH, an LSD issued by Lido, now ranks as the 8th largest cryptocurrency by market capitalization. With Ethereum's Shapella upgrade, LSDs are poised to gain even more popularity.

Introducing LSDs - Restoring Liquidity to Staking

Liquid staking derivatives (LSDs) is a trend in DeFi that offer stakers the opportunity to earn yield while retaining the liquidity of their staked assets.

When you stake your ETH, LSDs are issued as IOUs, maintaining a 1:1 value relationship.

LSDs also automatically accumulate yield, eliminating the need to spend on gas fees for withdrawing staking rewards.

Furthermore, they eliminate the 32 ETH entry barrier, enabling anyone to stake varying amounts of ETH to earn yield.

You can hold onto your LSD to earn yield, trade it, leverage it for borrowing, contribute it to a liquidity pool for added income, or simply sell it when you desire to liquidate.

The practicality of LSDs has driven their popularity, evidenced by stETH - an LSD from Lido - ranking as the 8th largest cryptocurrency by market capitalization.

With Ethereum's recent Shapella upgrade, their popularity is poised for further growth.



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The Demand Surge Following the Implementation of the Shapella Upgrade

Following the activation of the 'Shapella' upgrade on the Ethereum blockchain in April, there has been a significant surge in demand for liquid staking derivatives. This upgrade allowed stakers to withdraw their stakes in the network, making previously locked ETH available for redirection toward liquid staking platforms. Consequently, many ETH stakers have eagerly embraced the more liquid form of staking.

As a result of this growing interest, several prominent liquid staking platforms have emerged as leaders in the DeFi industry. Leading the pack is Lido, currently the largest DeFi protocol with an impressive total value locked (TVL) of over $14 billion, as reported by Dapp Radar.

Additionally, other notable platforms such as Rocket Pool, boasting a TVL of $1.93 billion, and Frax Finance, with a TVL of $807 million, have also risen to prominence in the liquid staking space. These platforms are gaining traction and reshaping the DeFi landscape as more users recognize the benefits of liquid staking derivatives.

How to Speculate on the Potential of Liquid Staking Platforms

Many liquid staking derivative (LSD) providers offer their own DAO or treasury tokens, providing an indirect investment opportunity. Investing in DAO tokens allows you to speculate on the success of a protocol, anticipating that its achievements will enhance demand for the associated token.

It's important to note, however, that DAO tokens don't grant ownership rights or profit-sharing. They serve as proxy investments that could potentially gain from the platform's triumph.

Alternatively, you can engage in liquid staking by staking your ETH and acquiring an LSD, or directly purchasing an LSD like stETH or cbETH through an exchange. This approach not only saves you gas fees but also offers the same advantages.

Certain platforms also incentivize stakers with DAO tokens to encourage participation.

How to Stake ETH and Obtain an LSD

The leading LSD provider is Lido, which issues stETH through an on-chain solution. stETH is highly liquid and constitutes more than 70% of the LSD market.

Distribution of ETH across the prominent LSD providers.

Another notable player is Coinbase and Rocket Pool, offering cbETH and rETH respectively.

Before you proceed, take the time to familiarize yourself with Ethereum staking mechanisms and carefully assess associated risks.

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Bottom Line

Liquid staking derivatives have emerged as a recent trend in DeFi, providing a fresh avenue to generate yield from your cryptocurrency holdings. The swift ascent of liquid staking derivatives serves as yet another illustration of DeFi's impressive capacity to swiftly expand and transform to address the increasing demands of its community. While Ethereum's shift to a PoS mechanism introduced ETH staking, it is now the advent of LSDs that are elevating this concept to new heights. If you would like to create your own decentralized project, our dedicated team is ready to help you, just contact us, complimentary consultation is available.