LSDFi Explained: The Ultimate What, Why, Who and Prediction

8 min read
LSDfi-explained

Dive into the biggest trend of DeFi, LSDfi. Understand what LSDfi is, why it appears, who is leading this frontier, and predictions for 2024.

LSDfi has become a buzzword recently, especially after the Ethereum Shapella upgrade. It’s not just frequently mentioned by top DeFi key opinion leaders (KOLs), but LSDfi projects have also seen significant growth in Total Value Locked (TVL) and their token prices.

Let’s explore what is LSDfi. Why it is among the top DeFi trends that you should not miss out on in 2024-2025.

LSDfi-Pink Brains

In this article, we will cover the following:

  1. What is LSDfi?
  2. The Emergence of LSDfi
  3. Top 3 LSDfi Categories to Watch in 2023-2024
  4. Our Prediction On The Next LSDfi Summer

1. What is LSDfi?

LSDfi stands for Liquid Staking Derivatives Finance, referring to DeFi protocols built and operating on the foundation of Liquid Staking. These protocols include fundamental sectors of DeFi such as DEXs (Decentralized Exchanges), Lending, or more complex projects that leverage of LSD.

LSDfi enables users to flexibly utilize their LSD assets for various purposes, while also enhancing the liquidity of LSD tokens, improving capital efficiency, and generating profits within the DeFi ecosystem.

2. The Emergence of LSDfi

The successful transition of Ethereum to Proof-of-Stake (“PoS”) and the capability to withdraw staked ETH following the Shapella upgrade have significantly contributed to the growth in ETH staking.

The amount of staked ETH has rapidly increased to nearly 23 million ETH. This surge is partly due to the convenience offered by current Liquid Staking Derivative (LSD) protocols, which allow more users to participate in the staking process with smaller amounts while still maintaining the liquidity of their staked assets.

LSDfi - Liquid Staking TVL
Total Value Locked of Liquid Staking. Source: DefilLama

Post-Shapella, users who are staking their Ether of LSD protocols like Lido and Rocket Pool, can redeem their Liquid Staking Tokens (LSTs) for ETH on a 1:1 ratio, avoiding the previous swap slippages on DEXs. This change has laid a solid foundation for easier transitions between staking projects, thereby heating up the competition among LSD protocols.

Key areas of competition include:

  1. Liquidity: Ensuring deep liquidity for LSTs is crucial. Greater liquidity not only reduces costs for stakers (eliminating waiting time for ETH redemption) but also positions LSD protocols to take a lead in the burgeoning Layer 2 market, where DeFi activities are on the rise.
  2. Incentives: Post-Shapella, the focus of LSDs has shifted. Earlier, incentives aimed at drawing users to AMMs. Now, with the ease of LST to ETH redemption, LSDs are redirecting incentives towards other DeFi protocols to encourage LST deposits into their systems. These incentives are key to maintaining LSTs’ attractiveness for stakers.
  3. Innovating LST Features: While incentives are a draw, they can be expensive and unsustainable in the long term. LSD projects are now looking at developing use cases for LSTs, tapping into their unique yield-generating capability. This has led to the creation of a new secondary market, LSDfi, which aims to bring fresh functionalities to the LST asset class, encouraging users to stake more ETH and keep LSTs within the DeFi ecosystem for extended periods.

3. Top LSDfi Categories to Watch In 2024-2025

LSDfi projects - infographic
The new landscape of Liquid Staking and LSDfi projects. Source: Pink Brains

The LSDfi ecosystem comprises DeFi protocols that have established a market presence and have integrated LSD as a part of their product suite or are new projects with main products revolving around LSD tokens.

Some smaller categories in the LSDfi ecosystem are listed below:

  • Decentralized Liquid Staking Providers: These are DeFi protocols offering staking services. Users who stake their tokens receive LSTs and can use them for various purposes. Lido Finance, Rocket Pool or Frax Finance are the leading liquid staking providers for Ether, while BenQi is now dominant in AVAX liquid staking.
  • CEX Liquid Staking Providers: Some centralized exchanges (CEXs) also provide staking services. You can either stake ETH on Binance for BETH or on Coinbase for cbETH.
  • CDP Stablecoin: CDP stands for Collateral Debt Position. CDP protocols allow users to use LSD tokens as collateral to mint decentralized stablecoins. Those stablecoins can be staked on other yield protocols to earn rewards. Top protocols: Lybra Finance, Prisma Finance, and Gravita Protocol.
  • Index LSD: You lock their tokens to receive LSD tokens from the project. By doing this, you can hold a variety of LSD tokens to maximize the profits from your assets. Top protocols: Index Coop and Asymmetry.
  • Yield Strategy: These protocols enable you to increase your returns from LSD tokens through various strategies. There are a variety of protocols that offer good APRs on your LSD. However, make sure you stake your assets in legit and secure protocols. Notable projects: Pendle, Asymetrix, unshETH, and Instadapp.
  • Lending Protocol (Money Market): They are lending protocols allowing users to use LSD tokens as collateral to borrow other assets. Aave, and Silo Finance are two of the lending protocols accepting loans on LSTs.

Now, let’s look further into the top 3 LSDfi categories that are worth your attention in 2024.

Future Yield Trading

As mentioned before, yield is key to LSTs. However, the yield levels of LSTs vary and change continuously (depending on the amount of ETH staked and network activity). Capitalizing on this niche, some Yield Trading products have been initiated, with the first and most notable project being Pendle Finance.

LSDfi-pendle-1

Pendle is an innovative DeFi protocol operating on Ethereum and Arbitrum. It allows for the tokenization and trading of yield, offering DeFi participants enhanced control over their earnings and access to sophisticated yield strategies. These strategies include extending yield when anticipating an increase, acquiring assets at reduced prices, securing fixed yield on yield-generating tokens, and more.

The protocol achieves this by dividing each yield-generating token into two separate tokens: a principal token (PT) and a yield token (YT). For yield to be tokenized, its duration needs to be predetermined. For instance, consider stETH tokenized for an upcoming 3-month period. The YT enables its holder to collect the staking yield from ETH via Lido for these 3 months. These rewards are claimable anytime and can be transferred if the YT is sold. Conversely, the PT entitles the holder to the underlying ETH tokens after 3 months but doesn’t include the right to the staking yield during this period.

LSDfi-Pendle
TVL and Total Trading Volume on Pendle Finance. Source: analytics.pendle.finance

Pendle is currently one of the most prominent LSDfi projects, with a TVL of over 226 million USD, accounting for nearly 70% of the TVL of the entire LSDfi ecosystem. Additionally, the total trading volume on Pendle has reached approximately 280 million USD, making it the second-largest LSDfi project in terms of market capitalization according to CoinGecko.

CDP Stablecoins

Besides protocols that optimize liquidity and returns for LSTs, a new stablecoin minting mechanism with LSTs as collateral is also an important puzzle that LSDfi projects are focusing on and strongly growing recently.

LSDfi-Lybra Finance

Lybra Finance is a protocol offering an interest-earning stablecoin. It allows users to use either ETH or Lido Staked ETH (stETH) as security to borrow Lybra’s stablecoin, eUSD, with a collateral ratio up to 170%. Notably, Lybra does not impose fees for minting eUSD or interest on borrowed amounts.

Holding the eUSD token itself generates yield for users, originating from the yield on the underlying LSDs. This yield is then transformed into eUSD, sparing users the trouble of switching out of stablecoins to avoid ETH’s volatility.

In addition to simply holding eUSD, users can also profit from providing liquidity in eUSD pools or pursue ETH-leveraged long positions by using eUSD to purchase additional ETH. Furthermore, those who mint eUSD are rewarded with token incentives in LBR, Lybra’s governance token. By staking LBR, users gain a say in Lybra’s governance decisions and a share of the protocol’s earnings.

Lybra has emerged as a top performer in the LSDFi space, with its Total Value Locked (TVL) increasing more than tenfold in just the past two weeks. The value of the LBR token surged by over 2000% from its lowest point to an all-time high of $4.6352.

LSDfi-Gravita Protocol

Gravita Protocol, a rising contender in the arena of LSD-backed stablecoins, is set to make waves with its GRAI stablecoin. Users have the option to create a “vessel” on Gravita by putting in yield-bearing tokens such as Lido wstETH and then borrowing GRAI against this collateral. Notably, Gravita offers a notably high loan-to-value (LTV) ratio, reaching up to 99%, for LSD collateral on its platform.

Restaking and Liquid Restaked Tokens

The concept of Restaking and Liquid Restaked Tokens (LRTs) is making waves in the DeFi space.

One of the most prominent projects is EigenLayer. It allows ETH restaking across various Actively Validated Services (AVS), bolstering the security of multiple networks. However, a key challenge is the illiquidity of Liquid Staking Tokens (LSTs), which LRTs aim to address by unlocking liquidity and adding leverage for higher yields.

EigenLayer introduces two new concepts: Pooled Security Via Re-staking and Free-market Governance, to enhance Ethereum’s security for other systems and improve governance efficiency.

  • Pooled Security via Re-staking: EigenLayer enables users to re-stake ETH pledged on Ethereum within its platform, and these assets can be utilized for layers of data availability, oracles, middleware, and more. Validators can also be rewarded by providing verification and security services.
  • Free-market Governance: EigenLayer allows validators the freedom to choose which modules they participate in based on their risk appetite. However, the sole prerequisite for validators to earn returns is the need for security. EigenLayer’s governance model offers two benefits: firstly, it integrates strong underlying blockchain elements into fast and efficient systems; secondly, its optional validator model allows new modules to compete for resources among validators, aiming to better balance performance and security.

Despite the high-yield potential, the LRT model carries risks similar to the early days of DeFi, particularly in terms of market volatility and systemic failures. You should be wary of these risks while navigating the evolving landscape of LRTs and restaking practices.

4. Our Prediction On The Next LSDfi Summer

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The past quarter has witnessed a remarkable surge in the TVL of major LSDfi protocols, signaling a potential onset of what could be termed the next LSDfi Summer. The combined TVL of leading LSDfi protocols has notably surpassed $400 million, effectively doubling in just one month. This significant growth trend, particularly evident since mid-May, is a testament to the burgeoning interest and investment in this sector.

This uptick is largely attributed to the increased staked ETH post-Shapella, which has fueled greater participation in ETH staking and adoption of LSDfi protocols. LSTs holders are increasingly leveraging LSDfi protocols to maximize their yields. This growth trajectory, while impressive, aligns with broader market trends: over $26 billion in LSDs exist across all Proof-of-Stake chains, yet the total TVL of LSDfi protocols is around $412 million, constituting a mere 2% of the total.

The disparity suggests a vast potential for growth and expansion within the LSDfi space, setting the stage for what could be a transformative period for the sector. As these narratives continue to gain traction and popularity, we can anticipate further exponential growth in the LSDfi ecosystem, potentially reshaping the landscape of DeFi.

In Conclusions

LSDfi stands as the next wave in the DeFi space. It brings together the stability of staking and the dynamism of liquid assets, paving the way for more efficient and versatile yield-earning models built on liquid staking. As Ethereum and other Layer 1 blockchains continue to evolve and grow stronger, keeping updated to find investment opportunities with LSDfi protocols will bring lucrative rewards for DeFi participants.

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