What are liquid staking derivatives?
Liquid Staking Derivatives (LSDs) are a type of token on the Ethereum mainnet that offer a unique way to participate in staking, the process of validating and supporting the network by holding ETH. There are several main LSDs available on the Ethereum mainnet, including Lido’s stETH, RocketPool’s rETH, Stakewise’s SETH2, and Coinbase’s cbETH. Each LSD has its own mechanism, pricing and methods for generating secondary liquidity.
They work by letting users deposit their ETH into a smart contract, which in turn locks the ETH In the beacon chain with pre-selected validators. In return, the user gets a token: the liquid staking derivative. This token represents the underlying staked ETH and accrues value based on rewards in the network, acting as a sort of IOU on the staked ETH. When withdraws are enabled after the Shanghai fork, LSDs will be redeemable for the underlying ETH along with any additional ETH from staking yield.
Why use liquid staking derivatives?
The main advantage of LSDs is that they allow users to earn rewards from staking without having to lock up their funds for a long period of time. Further, they can also be used in DeFi for lending, trading and borrowing, providing users with more ways to generate yield.
LSDs are useful because they let all users access ETH staking rewards without needing to run validator nodes themselves. They provide users with the opportunity to earn rewards from staking while still retaining access to their funds, and taking advantage of price fluctuations in the market.
LSDs are also an important part of DeFi. Since staked ETH can’t be withdrawn, it is locked and not usable in various DeFi protocols. Instead, these liquid staking derivative tokens that represent the staked ETH are used.
Staked ETH now represents a large share of total value locked in DeFi as users have taken advantage of DeFi’s composabliity to spread the staked ETH throughout the market. Far more than just trading between the options, staked ETH derivatives are big parts of money markets like Aave and Euler, along with serving as base yield options in a number of protocols.
What are the different liquid staking derivatives?
stETH by Lido is the largest staked ETH token and has the largest market share and the most liquidity. However, there are some concerns about centralization and censorship with Lido as well. stETH is a rebasing token, meaning you continually get more stETH in your wallet over time, which lets stETH represent the growing quantity of underlying ETH represented by staking rewards.
rETH is considered the most decentralized liquid staking derivative. It also lets stakers source outside capital to run validator nodes with as little as 16 ETH instead of the usual 32. rETH is similar to stETH, but instead of rebasing, rETH is worth consistently more ETH over time.\
rETH is currently trading at a premium compared to other liquid staking derivatives. Because the supply of rETH is constrained by the number of validators the protocol can add, and it is currently full, the token has been bid up by farmers looking to capitalize on pools with heavy rewards.
Stakewise’s SETH2 is a smaller competitor in the liquid staking derivative market. They use a unique mechanism to pay out rewards in a separate token, which has kept the SETH2 peg close to 1:1 compared to the other tokens. Their next version will allow all validators access to mint a liquid staking derivative, improving the decentralization of the network. SETH2 is meant to be 1:1 with ETH, while rewards from validators are paid out in a second token RETH.
Stakewise has an ambitious plan to improve decentralization of validators. The Stakewise protocol Version 3 will allow solo stakers to spin up their own liquid staking derivative. In turn, they will be able to unlock the secondary market liquidity and DeFi composability previously reserved for professional teams creating liquid staking derivatives.
Coinbase’s cbETH is a centralized liquid staking derivative run by Coinbase. While one of the larger managers of staked ETH, cbETH is a newer entrant to the market and looks to take advantage of DeFi’s composability to add utility for cbETH holders. cbETH works like an interest-bearing token from Aave or Compound and is worth more ETH over time at an increasing exchange rate.
Coinbase is notable as one of the largest validators in the Ethereum network. Their move into the liquid staking derivative space brings a centralized counterparty option while still retaining the key benefits of LSDs in DeFi. Targeted incentives in the Cure and Balancer markets, make this an interesting choice for users not as worried about centralized coins.
FRAX’s sfrxETH is one of the newest liquid staking derivatives available on the market. Building on FRAX’s reputation for stablecoin assets, frxETH looks to be a stable asset pegged to ETH. In the background, FRAX deposits all ETH in the system to validator nodes and passes the yield back to holders of sfrxETH. The growth of frxETH has been admirable, as FRAX is using a good portion of their voting power in Curve and Convex to direct rewards onto the frxETH pools. sfrxETH is written as a vault contract and constantly gets worth more ETH over time.
What’s next for liquid staked derivatives?
In conclusion, LSDs are a new type of token on the Ethereum mainnet that offer a unique way to participate in staking while still retaining access to their funds. LSDs provide users with the opportunity to earn rewards from staking while still taking advantage of price fluctuations in the market. With several main LSDs available, users have the option to choose the one that best fits their needs and investment strategies.