Original title: "The Future Of Liquid Staking"
Original post by Ben Giove, Bankless
Original compilation: Dongxun, the way of DeFi
If there's one segment of DeFi that's been particularly hot during the cooldown, it's the Liquid Staking market. Yields may be falling across the board, but there are bullish signs emerging for Ethereum’s outlook.
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Photo: Logan Craig
There is always a bull market somewhere.
While cryptocurrencies may be in the midst of a brutal bear market, Ethereum staking remains an area of long-term growth.
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ETH Beacon Chain Deposits - Source: Dune Analytics
There are currently over 15.7 million ETH staked, and while that number may seem large, it represents only 13% of the total supply. This is far below the average stake rate of PoS networks, which is 61%.
Due to the highly distributed nature of its supply, ETH's staking rate may never reach this average level, but regardless, the Ethereum staking story is clearly still in its early stages.
A major catalyst to accelerate this staking rate is the Shanghai network upgrade, which will reduce staking risk by enabling users to withdraw their deposits. This could result in millions of ETH being staked in the months after its expected implementation date of March-April 2023.
The entities most likely to benefit from this boom are liquidity staking protocols. These services represent the largest pool of stakers, accounting for 32.8% of Beacon Chain deposits.
The industry has found a clear product-market fit by eliminating the opportunity cost of staking by issuing liquid staking derivatives (LSD), an ERC-20 token that represents a claim on pledged ETH and allows it to be held People can still deploy their assets within DeFi while earning rewards.
Since LSD issuers earn a portion of the staking rewards, their business model is influenced by the price of ETH and demand for block space, which means that when the market recovers and on-chain activity returns, their revenue numbers will scale with the increase in new stakes. Join and soar.
Which begs the question...who is best positioned to capitalize on this staking craze? How will the competitive dynamics of staking change after the Shanghai upgrade?
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The Current State of Liquidity Staking
Lido's reign reigns supreme...but for how long?
Before we dive into how staking will change, and who will take market share following Shanghai’s upgrade, let’s take a look at the liquid staking landscape today.
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Source: Dune Analytics
stETH issuers are the largest entities on the Beacon Chain with a 29.4% market share, which includes a 74.0% share of liquidity stakers.
Several factors have contributed to Lido's dominance.
The protocol benefits from a first-mover advantage as it is the first LSD issuer to launch at scale in December 2020. In doing so, they built a key competitive advantage: deep liquidity.
Prior to the Shanghai upgrade era, liquidity had always been a top priority for stakers, as the secondary market for LSD was the only way to exit their positions.
stETH is undoubtedly the most liquid LSD, with hundreds of millions of DEX liquidity on Curve, Balancer, and Uniswap. Lido has been able to build this deep liquidity for stETH through a large-scale incentive plan, as the protocol has spent $208 million in Token incentives from 2022 year-to-date.
This helps create a very strong network effect for stETH as users will want to stake with the most liquid LSD to maximize their ability to exit, which in turn brings more liquidity to Lido, And thus gain more market share.
This network effect has led to speculation that the protocol will become a monopoly, and while the latter is working towards permissionless verification, many have pointed to Lido as a possible centralized vehicle for Ethereum, as LDO holders are the only ones able to add/ The one who removes the node operator.
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Source: Dune Analytics
Despite having the largest total growth, Lido has "only" the third largest growth rate among the major LSD distributors. The market share of stETH issuers has also shrunk during this period, with liquidity down 3.4% and overall down 1.0%.
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Source: Dune Analytics
While it has a 29.4% share of all staked ETH, Lido "only" gets 22.8% of the combined deposits. Furthermore, despite having a 74.0% market share in liquidity staking, Lido has attracted 53.0% of deposits to these protocols during this period.
As we can see, much of this market share loss can be attributed to the growth of Coinbase's cbETH. Since the merger, the CEX-issued LSD has captured a 33.6% share of inflowing liquidity staking, likely due to the ability to convert its existing staking pool to cbETH. As the largest CEX in the US, Coinbase has enormous resources at its disposal and it is likely to remain competitive for the foreseeable future.
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revenue commoditization
Another factor that could encourage a liquidity staking oligopoly rather than a monopoly is the commoditization of yields.
A common argument for why staking is consolidated is that large pools and specialized validators benefit from economies of scale due to their ability to execute proprietary MEV strategies. By doing so, these entities are able to generate higher returns relative to smaller stakers, thereby eliminating competition and leading to cartelization (Cartel, also known as monopoly interest group, monopoly alliance, is one form of monopoly organization).
While this seems likely to happen to some extent, in the long run there have been some technical changes at the Ethereum protocol layer and developers that will democratize staking rewards, allowing separate stakers and smaller The agreement generates competitive returns compared with larger competitors.
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Source: A Beginner's Guide to Ethereum Censorship
This represents an important tailwind for the commoditization of benefits by democratizing access to complex MEVs. While it will eventually be reflected at the protocol level, PBS is currently implemented through repeaters such as MEV-Boost.
The second factor driving yield commoditization is Distributed Validator Technology (DVT). DVT is like multisig for validators in that it distributes the validator keys across multiple different nodes instead of just one. In doing so, it improves validator uptime and resiliency by democratizing points of failure and reducing the risk of slashing events.
DVT is especially valuable for solo stakers, who are more prone to maintenance issues that can affect long-term returns. The two main DVT solutions are Obol and SSV, both of which are running on testnet.
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competitors
As liquidity will become less important post-Shanghai, and yields may become increasingly commoditized, in the long run, liquidity staking protocols will have to compete on product to attract depositors and validators.
In other words - the design of the protocol and the LSD itself will actually start to matter.
There are a number of product characteristics that will contribute to the success of LSD:
Validator selection for stakers
no license authentication
Slashing protection
LSD Capital Efficiency
LSD tax efficiency
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Rocket Pool
Rocket Pool is the second largest liquidity staking provider with 5.2% and 2.1% shares of Beacon Chain and liquid staking deposits, respectively. With a combined growth rate of 24.2%, the protocol ranked second among all LSD issuers, accounting for 3.2% of total deposits and 7.4% of liquid pledged deposits, respectively.
Rocket Pool has been optimized for high decentralization. The protocol is the first to support permissionless verification, as any node operator can verify the network by providing 16 ETH of collateral (½ of a validator) along with RPL bonds worth at least 1.6 ETH.
This over-collateralization creates built-in slashing protection for rETH, as bonds of NO will be sold to protect users from slashing events, in which case validators will lose part of their stake as a proof of deviation from PoS rules punishment.
Rocket Pool also benefits from tax efficiency, as rETH mirrors staking rewards by accreting in value (like Compound's cTokens), rather than utilizing a rebase model that creates a large number of taxable events.
The main weakness of Rocket Pool is capital inefficiency. Capital efficiency has been an important factor driving the dominance of stETH and cbETH, as each LSD can be minted 1:1 per base ETH deposit (though these LSDs rely on weaker curtailment mitigations such as insurance).
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StakeWise
StakeWise is an existing staking protocol that is going through a major transition.
While it currently uses a dual-token model, the protocol will soon launch StakeWise V3, which will feature a modular architecture where users can stake in separate vaults.
V3's design has several distinct advantages over single protocols like Lido, Coinbase, and Rocket Pool, such as allowing stakers to choose their validators.
The protocol also allows for better isolation of slashing risk, as losses can be more easily contained in a single vault, while providing further slashing protection through over-collateralization, as users can only mint osETH with LSD in the protocol, which only accounts for their A fraction of the pledge.
These features allow validators to join the network permissionlessly with low capital requirements, while also providing enhanced customizability to Vault, such as creating whitelists for institutions.
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Frax Finance
As the issuer of the FRAX stablecoin, Frax has expanded into liquidity collateral with the launch of Frax ETH. The protocol's offerings grew like weeds, attracting 44,707 ETH deposits while capturing a 0.7% share of the LSD market.
Frax ETH adopts a design similar to StakeWise V2, in which two tokens are issued to pledgers, frxETH representing their basic ETH deposits and sfrxETH generating staking rewards. This model provides greater capital efficiency for Frax ETH stakers, giving them the opportunity to deploy multiple assets in DeFi to earn yield.
While its growth is undeniable, and it has plenty of CVX to attract liquidity on Curve, Frax ETH faces several hurdles that could make it difficult to gain long-term market share.
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Other challengers:
Rocket Pool, StakeWise and Frax aren't the only ones looking to challenge the dominance of Lido and Coinbase.
There are many other protocols that will soon have unique offerings, these include:
Swell: This is the first protocol to ship a modular, isolated vault design to a testnet.
Alluvial: An LSD distributor dedicated to institutional clients.
Tranchess: A BSC-based liquidity staking protocol that is expanding to Ethereum and hopes to incorporate zk-proofs.
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A high tide will float (most) boats
By enabling withdrawals, the Shanghai upgrade is expected to spark a wave of liquidity staking and change the dynamics of the industry.
While Lido is dominant, it is facing increasing challenges from CEXs such as Coinbase and non-custodial protocols such as Rocket Pool, StakeWise and Swell, which bring product improvements such as enhanced slash protection, permissionless Verification, modularity and higher tax efficiency.
The disruptive design of these new challengers means they should be able to take market share and grow faster than Lido in the post-Shanghai upgrade era.
Another factor that increases the odds of success for these solutions is the likely commoditization of yields among staking providers in the long run due to upgrades and technologies such as PBS and DVT.
That's not to say Lido won't maintain its dominance. stETH’s capital efficiency and liquidity-based network effects, combined with the potential for clogged withdrawal queues, means it is unlikely to relinquish its position as the market leader.
Additionally, it, along with other well-capitalized LSD issuers such as Frax, Coinbase, and possibly Binance, should be able to leverage their resources to build liquidity-based network effects even if they have less competitive products.
All in all, liquidity staking appears to be heading towards an oligopoly, not a monopoly. In this case, the post-Shanghai escalation surge in staking likely represents an uptrend that will boost many "ships" in the short and medium term.
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