PSE Trading: The Dilemma and Future of LSDFi
This article attempts to clarify the current state of the LSDFi track based on data and explores the future direction of LSDFi through the analysis of specific projects.Original Author: @Yuki, PSE Trading Analyst
Since Ethereum transitioned to PoS, LSDFi has emerged as a new and captivating track. The reason LSDFi has become the focus of the market is due to its innovative Yield Bearing properties based on liquid staking tokens. However, as the ETH staking rate continues to rise and staking yields decline, the market space is being increasingly squeezed, leading to stagnation in the development of LSDFi.
Looking back, we have experienced three development stages in the LSDFi track. From the competition among liquid staking protocols, to LST becoming a new consensus-based circulating asset in DeFi, to the diversification and large-scale application of LSTs. Now, we find ourselves in a clear period of developmental dilemma. This article attempts to clarify the current state of the LSDFi track based on data and explores the future direction of LSDFi through the analysis of specific projects.
1. Current State of the LSDFi Track from Data
1.1 The Growth Dividend Period is Over, Development is Stagnant, and Outflows of Funds Due to Declining Yields
According to Dune's data, in terms of the amount of net staked ETH, the overall trend has flattened, and the number of Validators waiting to enter is also decreasing, indicating that the aggressive staking growth period has passed. Correspondingly, the total TVL of the LSDFi track (currently at 839 M) has been in a state of significantly slowing growth since September 26 of this year, even showing negative growth. It can be expected that in the absence of paradigm innovation, there will be no significant growth in the LSDFi track as a whole in the near future.
There may be two reasons for this situation. On one hand, the internal staking growth of the Ethereum ecosystem is weak, with the rising ETH staking rate leading to declining staking yields (as shown below, the base yield is only 3% +), causing LSDFi protocols to hit a yield bottleneck, thus reducing the overall attractiveness of the track for funds and resulting in capital outflows. On the other hand, external environmental shocks have also impacted the situation, with the most severe effect being the continuous rise in U.S. Treasury yields in a high-interest environment, which has a siphoning effect on capital in the crypto industry, causing LSDFi funds to flow to U.S. Treasuries and DeFi derivatives with higher base yields.
Source: https://defillama.com/yields?category=Liquid+Staking\&chain= Ethereum
1.2 Serious Homogenization of Projects, Internal Competition but Insufficient Innovation
As DeFi has developed to this point, two important components still shine brightly, serving as the cornerstones that maintain the operation of the entire DeFi system: lending and stablecoins. In the operational rules of LST, lending and stablecoins are also the most basic and feasible operational methods. Based on the yield-bearing properties of LST, the project directions in the LSDFi track can be roughly divided into the following two categories:
LST as collateral for lending protocols or stablecoin protocols (represented by Lybra, Prisma, Raft);
Separation of principal and interest for LST (represented by Pendle);
Source: https://dune.com/defimochi/lsdfi-summer
From Dune's data, we can see that among the top 12 projects by TVL in the LSDFi track, 5 are stablecoin protocols based on LST. Their basic mechanisms are almost identical: users use LST as collateral to mint or borrow stablecoins, and when the collateral price drops, the collateral will be liquidated. The few differences lie in the different stablecoins, different LTVs, and different supported collateral types.
After the collapse of Terra and the forced delisting of BUSD due to regulatory risks, there are many gaps in the stablecoin market that need to be filled. The emergence of LSTs with yield-bearing properties can contribute projects that better meet the decentralized needs of the stablecoin market. However, after the wave, the overall innovation in the track is weak, merely competing over LTV, collateral types, and stablecoin yields (which mostly rely on project token subsidies, essentially just air). If newcomers do not possess differentiated highlights to challenge the predecessors, launching means the end of the project.
Pendle, on the other hand, is a relatively unique presence in the entire LSDFi track. Its fixed-rate products are naturally suitable for yield-bearing LSTs (for example, stETH can be split into ETH and staking yield), which is why Pendle has returned to the center of the market after Ethereum's transition to PoS. Currently, Pendle is firmly holding its market share through product iteration, and no strong competitors of the same type have emerged in the market.
Pendle's TVL reached a new high on November 1 https://defillama.com/protocol/pendle
1.3 Leading Projects Lack Pricing Power, Long-term Growth is Not Guaranteed
In DeFi, we can say that Aave is the leader of lending protocols, Curve is the leader of stablecoin DEXs, and Lido is the leader of Ethereum liquid staking service providers. These projects have achieved pricing power in their respective fields. The pricing power I refer to is the barrier effect formed by "monopoly + necessity," creating a certain monopoly effect and brand effect in the market's necessary business (with a market share far ahead).
What does having pricing power mean? I believe it means at least two advantages: one is an excellent business model, and the other is guaranteed long-term growth. In summary, barriers with pricing power are the real barriers.
However, looking at various projects in the LSDFi track, even the leading project with the largest market share, Lybra Finance, has not formed its own pricing power barrier. In the V1 phase, Lybra quickly stood out from a number of LSD stablecoin protocols with a yield far exceeding the basic staking yield of Ethereum (8% +), attracting a large amount of TVL, but the V2 upgrade did not bring effective growth to Lybra; instead, it was continuously squeezed by later-launched projects like Prisma and Eigenlayer.
The inability of leading projects in the track to have their own pricing power is fundamentally due to the following reasons: first, as a protocol layer, the technical difficulty of the projects themselves is not high, especially since many LSD stablecoin protocols are directly forked from Liquity; "low technical barriers" means that competition will be fierce; second, LSDFi projects are not the issuers of LSTs, essentially relying on the pricing power of ETH (staking yields) for liquidity redistribution; finally, the differences between various projects are minimal, and market share is often influenced by protocol yields, while leading projects have not formed their own ecosystems to establish absolute pricing power internally.
The lack of pricing power essentially means that the current prosperity may be temporary, and no one has found the insurance for long-term growth.
1.4 Token Subsidized Yields are Unsustainable, Stablecoin Liquidity is Weak
LSDFi previously attracted a large amount of TVL in a short time with high yields, but upon closer examination, we find that these high yields are subsidized by project tokens, which results in the premature overdraft of governance tokens' value, making high yields unsustainable.
Taking Raft as an example, Raft launched a Savings Module in V2, attracting \(R holders to deposit with a 10% fixed APR, but did not disclose the source of this 10% interest in detail (the official explanation is that it is subsidized by protocol revenue). Looking across the entire DeFi landscape, there are very few projects that can offer a 10% low-risk interest rate, which raises suspicions about whether the project team is minting \)R out of thin air to create this seemingly beautiful APR myth.
It is worth noting that the current collateral borrowing cost (interest rate) for Raft is 3.5%, which means that users can mint $R and deposit it into RSM to obtain at least 6.5% in arbitrage.
The official R Savings Rate shows as high as 10%
For decentralized stablecoins, liquidity will be the biggest factor affecting their development scale. Liquity failed to expand its scale and stand out in the last bull market because its liquidity could not meet user demand. Currently, DAI is indeed the most liquid decentralized stablecoin. Similarly, most LSD stablecoins now also face liquidity issues, as the stablecoins they launched lack sufficient depth, have limited use cases, and do not meet real user demand.
Taking Lybra's eUSD as an example, eUSD currently has a scale of 108 M, but its best liquidity pool is merely the peUSD pool on the Arbitrum chain (peUSD is the full-chain version of eUSD). The depth of the eUSD-USDC pool on Curve is only 207 k, indicating that the exchange between eUSD and centralized stablecoins is very inconvenient, which may affect user usage to some extent.
Source: https://defillama.com/yields/stablecoins?token=EUSD
2. Finding Breakthroughs in the Development Dilemma of LSDFi from Specific Projects
Although the LSDFi track as a whole has fallen into a developmental bottleneck, there are still some projects striving for change, from which we may gain insights and inspirations for breaking through the development dilemma.
2.1 Developing Ecosystems, Addressing Economic Model Deficiencies, Establishing Pricing Power: Examples of Pendle and Lybra V2
Currently, LSDFi projects share a common seemingly unsolvable issue: subsidizing user yields with governance tokens, leading to continuous dilution of the governance token's value, ultimately reducing it to worthless mining tokens.
A feasible and instructive solution is to develop their own ecosystems, leveraging the strength of ecosystem projects to improve their economic model deficiencies and establish absolute pricing power within the ecosystem.
2.1.1 Pendle
Pendle is currently the most successful representative of this approach. Penpie and Equilibria are auxiliary protocols that enhance PENDLE LP yields based on Pendle's veToken economic model, allowing LPs to earn Pendle mining boost rewards without needing to stake Pendle. The business models of both are not significantly different, with the main role being to absorb some of the selling pressure on governance tokens, allowing Pendle to develop more healthily.
Source: https://dune.com/coumarin/pendle-war
2.1.2 Lybra Finance
After Lybra's V2 launch did not achieve effective growth, it also began to intentionally create its own ecosystem projects. On October 13, Lybra officially announced the launch of Lybra War, positioning it as the next phase of focus.
Lybra's clear initiation of Lybra War is due to its recognition of several issues:
1) High inflation of the governance token LBR due to maintaining high APR, with V2 mining activities causing excessive short-term selling pressure;
2) Intense competition in the same track (such as Prisma, Gravita, Raft) leading to weak growth, with no investors behind Lybra to rely on;
3) Insufficient liquidity for eUSD, with the promotion and use of peUSD not meeting expectations;
4) Community consensus being shaken, with questions arising during the migration from V1 to V2 regarding the handling of "tokens that were not successfully migrated in time" (sifu determined the entire voting outcome based on one person's decision).
Source: https://twitter.com/LybraFinance/status/1712505916363592011
The core of Lybra War lies in the accumulation of dLP and the dynamic matching of dLP with eUSD. In Lybra V2, users must stake a minimum of 2.5% of the value of eUSD in LBR/ETH dLP to receive esLBR emissions, so the second-layer protocols of the Lybra ecosystem must obtain more esLBR through yield boosting of esLBR and dLP. Additionally, the distribution rights of Lybra War lie in the esLBR emissions among LSD pools, with potential demand primarily from LST asset issuers and large eUSD minters. The depth deviation of Lybra's LSD pool will be more suitable for small LST issuers to accumulate esLBR, thereby increasing esLBR voting power.
Currently, the only deep player participating in Lybra War is Match Finance, and an effective competitive landscape has not yet formed. Match Finance mainly addresses two issues (without going into project mechanics here):
1) Users cannot obtain esLBR incentives without dLP when minting eUSD;
2) Yield boosting for esLBR and liquidity exit issues.
Match Finance mechanism, source: https://match-finance.gitbook.io/whitepaper/
As protocol layers in the LSDFi track, neither Lybra nor Pendle are issuers of LSTs, so while they accumulated a large amount of TVL through high APRs early on, they also planted a negative seed. For future healthy development, they choose to develop ecosystem projects to continuously supply themselves with blood from these projects. Any ambitious leading LSDFi project will likely follow this developmental path.
2.2 Micro-Innovation to Enhance Differentiated User Experience
For non-leading projects, how to maintain their own territory in a fiercely competitive track and find their differentiated positioning is key. Even micro-innovations can reach certain vertical users, and as long as this user base is sticky enough, the project holds the cards to survive.
2.2.1 No Liquidation: Example of CruiseFi
While most projects are still competing over LTV and collateral types, some have directly launched a "no liquidation mechanism" to attract traffic.
Taking CruiseFi as an example, users can collateralize stETH to mint the stablecoin USDx, and then exchange USDx for USDC through the USDC-USDx pool on Curve, while lenders providing USDC to the Curve stablecoin pool can earn interest generated during the stETH collateralization period.
So how does it ensure that the borrower is never liquidated? When liquidation occurs:
1) The project will lock part of the collateral (stETH) and then pledge the staking yield of the locked portion to the borrower;
2) Positions exceeding the stETH yield will be paused, ensuring that staking yields can always cover borrowing interest, meaning the borrower will not be liquidated. However, the downside is that the stETH yield will decrease as the overall staking rate of ETH rises;
3) For the paused portion of the position, corresponding Price Recovery Tokens (PRT) will be generated, which can be exchanged 1:1 for ETH (only redeemable when above the liquidation line), and PRT can be freely traded in the secondary market.
The advantage of this approach is that borrowers can extend the time before liquidation or avoid liquidation altogether, lenders can earn ETH staking yields, and PRT holders can benefit from future growth in ETH. The "no liquidation" feature will be quite attractive to some high-risk-tolerant users in a bull market.
2.2.2 Composite Yield: Example of Origin Ether
In the DeFi world, yield is always the most attractive narrative, and this iron rule still applies to LSDFi.
Origin Ether was launched in May 2023, using ETH and other LSTs as supported collateral, with the value of 1 OETH always equal to 1 ETH.
Source: https://docs.oeth.com/origin-ether-oeth
The biggest difference between Origin Ether and other LSDFi projects is that its yield comes from a basket of LST assets such as stETH, rETH, and sfrxETH. Additionally, OETH utilizes AMO strategies in Curve and Convex through the OETH-ETH liquidity pool and supports strategies in other ETH-denominated Curve pools like Balancer and Morpho. Through a series of liquidity strategy optimizations, Origin Ether can provide users with an APY above the market average. This is also why Origin Ether has rapidly accumulated a large amount of TVL in recent months (OETH currently ranks seventh in market share in the track).
Source: https://defillama.com/protocol/origin-ether?medianApy=true
2.2.3 Continuing the Nested Structure: Example of LRTFi Based on Eigenlayer
LSDFi, as a nested structure of LSDs, has reached a bottleneck stage, but the emergence of Eigenlayer will lead to a new layer of LRTFi, which not only serves as another leverage for the entire LSDFi track but also provides an opportunity to return to the market center and expand outward.
Although Eigenlayer is still in a closed testing phase and not yet open to all users, the market enthusiasm has been very high based on the previous two staking situations.
Eigenlayer TVL Composition, Source: https://defillama.com/protocol/eigenlayer
At the same time, many projects based on LRT (Liquid Restaking Token) have emerged, such as Astrid Finance and Inception. The core logic of these projects has not innovated; they have simply included LRT in the collateral range compared to LSDFi protocols. It is expected that this type of competition will reach a fever pitch after Eigenlayer officially launches, and it is still in the early stages.
2.3 Support from Capital Forces, Bundling Other Mature Projects, Enjoying Other Ecological Dividends: Example of Prisma
If a later project wants to surpass its competitors in a volatile track but cannot achieve paradigm innovation, then finding a strong backing and leveraging the dividends of other projects as a buff will be an effective way to establish a foothold. We can call this behavior "taking shortcuts" or "finding a benefactor."
Prisma Finance is the most typical success story. Compared to grassroots projects like Lybra Finance (community-initiated without private fundraising), Prisma can be considered a rich second-generation project born with a silver spoon. Even before launching any products, they had already attracted market attention with a glamorous press release. The most valuable information revealed in the article was not how different their project mechanism was, but rather the presence of DeFi OGs like Curve and Convex, as well as large institutions like OKX and The Block in their investor list.
Subsequently, Prisma's development path unfolded as advertised, bundling with Curve and Convex to provide additional rewards (in the form of CRV and CVX) for its native stablecoin mkUSD, and achieving a flywheel effect through the veToken model (which can control protocol parameters).
In the third month after its official launch, Prisma achieved an all-time high in TVL with the support of Justin Sun's $100 million wstETH, surpassing Lybra to become the new leader in the track.
Source: https://defillama.com/protocol/prisma-finance
2.4 True Paradigm Innovation
From the industry level down to the track level, after experiencing wild growth, there always comes a bottleneck in development, and the fundamental solution to such dilemmas is undoubtedly "paradigm innovation." Although the development of LSDFi has not seen innovations capable of changing the game, I firmly believe that as long as the value of Ethereum continues to exist as a strong consensus, paradigm innovations that break the deadlock will eventually arrive, reigniting the flames of LSDFi.
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