MIX Capital: LSDFi Project Research Report

Author: MIX Capital

1. Definition of LSDFi

1.1 What is LSDFi

LSD stands for Liquid Staking Derivatives, which is a product that allows users to stake related underlying assets in a contract to provide liquidity for the relevant ecosystem and earn rewards. It sounds similar to what we currently understand as Stake to Earn. However, the focus of LSD is that the staked assets can still be flexibly used by the staker in some way, leading to a series of financial derivative plays that develop from this.

1.2 How does LSDFi work?

Since independent node validators require at least 32 ETH, and before the Shanghai upgrade, the process of validators adding new blocks to the blockchain, processing transactions, and storing data carries certain risks. Technical issues can easily lead to losses of staked assets or rewards, and the high threshold keeps many ordinary users out.

The LSD protocol allows ordinary users to participate in staking and earn rewards without the need to maintain staking infrastructure, and the design of the note assets also releases the liquidity of ETH during the staking period. This has quickly attracted a large number of users and assets, developing into an independent track.

Coincidentally, in the English context, LSD also stands for "lysergic acid diethylamide," a semi-synthetic hallucinogen and stimulant. This drug became synonymous with American youth and hippies in the 1940s, symbolizing the avant-garde and the enchanting. Similarly, the latest interpretation of the DeFi concept, which represents the core of Web3 development, is also avant-garde and enchanting.

The original intention of LSD is to liberate liquidity. For those who want to stake tokens but do not want to be constrained, liquid staking derivatives can change the game. These derivatives represent the staked assets of token holders and confirm the staker's participation in the staking pool.

Excitingly, these tokens can be used for borrowing, trading, and collateral in the decentralized finance world. This means users can enjoy the benefits of staked tokens without giving up their usage rights. It is a win-win situation, providing unprecedented flexibility and efficiency.

The LSD project aims to create returns higher than the base yield, making it a hot topic this year. The market has responded positively to the expectations of this upgrade, as seen in the recent sector trends. Currently, staking solutions based on DVT technology can redistribute nodes, improving the stability of validating nodes, and are widely discussed.

1.3 What types of LSDFi are there?

The LSDFi ecosystem includes some mature DeFi protocols that have already incorporated LSD as part of their diversified product offerings, as well as some new projects primarily based on LSD and major types of LSD.

1. DeFi Liquid Staking Providers: DeFi providers that enable users to participate in staking and earn LSD as a reward.

2. CEX Liquid Staking Providers: Centralized exchanges ("CEX") that offer liquid staking services.

3. CDP Stablecoins: Protocols that allow users to use LSD as collateral to generate stablecoin debt positions ("CDP").

4. Index LSD: Tokens representing a basket of LSD shares.

5. Yield Strategies: Protocols that enable users to access additional yield opportunities.

6. Money Markets: Protocols that facilitate borrowing and lending activities using LSD.

1.4 Development Stages of LSDFi

Phase One: Liquid Staking Protocols

Entering 2023, LSD providers like Lido and Rocket Pool have become some of the hottest projects in the cryptocurrency space. As you may know, these protocols allow users to lock their ETH in smart contracts and then stake it to help secure the network.

In return, users receive LSD, such as stETH or rETH, which represent liquidity tokens for their staked ETH. The result is a liquidity token that can be traded and lent while still accumulating staking rewards in ETH itself.

By maintaining the liquidity of staking tokens, LSD providers play a crucial role in encouraging users to confidently stake their Ether. However, the protocols issuing this wave of LSD are not the only ones benefiting. If we view these staking protocols as the primary beneficiaries of LSDFi, we can delve deeper into several layers.

Once LSD was introduced, it logically became necessary to find a way to keep it anchored to its underlying assets. The last thing we want to see is a repeat of last summer's situation, when the largest ETH LSD—stETH—depegged due to forced selling by institutions like 3AC. Therefore, protocols like Curve and Balancer saw significant inflows into liquidity pools related to ETH LSD, amplifying their total locked value (TVL).

Phase Two: LSD as Collateral

The second phase of LSDFi involves a series of projects with similar fundamental concepts: users lock LSD in CDPs and then issue and lend stablecoins against it.

You may be tired of hearing about new LSD-supported stablecoins, but don't let the sheer number of protocols using this model overshadow its importance. Personally, I believe the reason so many protocols are doing this is that it is an incredibly compelling use case.

This not only further expands the utility of LSD but also provides much-needed decentralization to the existing stablecoin market. Additionally, by definition, LSD earns returns generated by its underlying assets by performing certain tasks (such as providing security for PoS blockchains). The annualized staking yield is usually higher than most money markets pay on deposits (unless there are high incentives), so you are already at an advantage. Essentially, using yield-bearing tokens as collateral turns each CDP position into a self-repaying loan.

So far, the biggest beneficiaries of the second phase include Lybra, Curve, and Raft.

As LSDFi evolves, more LSD will gain market share.

In fact, I wouldn't be surprised if by the end of 2024, stETH's dominance drops below 50%. After all, only 17% of the ETH supply is currently staked, and less than half of that is through LSD providers. Therefore, this game is far from over.

Phase Three: Diversification of Collateral

If the first phase was about a large amount of LSD and the second phase was about lending backed by LSD, what new developments can we expect in the third phase?

Given that the fundamental trend throughout the process has been based on the second-largest asset in cryptocurrency, ETH, the natural direction of development will be further expansion through other composable assets. This can be achieved through the use of LP tokens, stablecoins, money market deposits (such as Aave's aUSDC), and more.

Looking ahead, a partial reserve system in DeFi is necessary as it can achieve more functionality with less capital.

Moreover, unlike traditional finance (TradFi), DeFi is inherently composable, making it easier to integrate new forms of assets and utilize these assets in various use cases.

2. Quality LSDFi Projects

2.1 Ion Protocol

Ion Protocol is a CDP protocol built on Ethereum staking positions. The protocol aims to accept different types of liquid staking collateral tokens (LST) and deposits supported by EigenLayer collateral assets, collectively referred to as allETH, and uses vaETH to track the returns of allETH. The goal of the protocol is to integrate all Ethereum liquid staking derivatives and complete yield aggregation.

2.2 unshETH

unshETH is an LSDFi protocol that promotes decentralized Ethereum staking validation through liquidity incentives. unshETH introduces two concepts: validator decentralized mining (vdMining) and validator domination options (VDOs).

2.3 vdMining

vdMining can be understood as a liquidity incentive nested structure; pure nesting cannot achieve sustainable mining, so vdMining introduces the concept of decentralized incentives. In simple terms, vdMining sets an ODR (Optimal Decentralization Ratio) through governance, and the closer the CR (Current Ratio) is to the ODR, the more mining rewards all users in the pool receive. This approach is designed to incentivize users to stake ETH into more decentralized LSD protocols, thereby promoting the overall decentralization of the Ethereum staking track.

We mentioned the concept of ODR above, and the LSD asset holders who dominate the ODR can write VDOs for the corresponding LSD assets, while non-dominant LSD holders can purchase them through the unshETH DAO. My personal understanding is that VDOs represent your right to exercise on the expiration date, and profits and losses depend on the CR; the closer the proportion of LSD assets is to the ODR on the expiration date, the more profitable it is.

This provides an additional revenue channel for non-dominant LSD asset holders. The ultimate goal of VDOs is to better adjust the CR value by adding a secondary market. Of course, this is just my personal understanding, and everything is subject to the final product situation of the protocol.

2.4 Lybra

Lybra is an over-collateralized stablecoin protocol. Unlike the conventional over-collateralization, liquidation, and arbitrage seen in MakerDAO and Liquity, Lybra mints yield-bearing stablecoin eUSD by collateralizing yield-bearing assets like stETH. Lybra converts the interest generated by stETH into eUSD and distributes it to eUSD holders and Lybra token stakers.

Essentially, Lybra captures the yield from Ethereum staking through the stablecoin eUSD. The secure staking rate for eUSD is 160%, with an APY of 7.2%. If calculated under ideal conditions (1.6 dollars of stETH minting 1 dollar of eUSD), the profit efficiency of eUSD is slightly less than that of stETH. However, eUSD is a liquid asset, and holders can earn more profits through eUSD in DeFi protocols, providing higher capital efficiency for stakers in the Lybra protocol.

2.5 Raft

Raft is a lending and stablecoin issuance platform for cryptocurrency holders. It allows users to generate R tokens using liquid staking tokens as borrowing capital, maintaining a stable peg to the dollar, thus providing an efficient lending method. The project focuses on providing deep liquidity and stable pegging for R tokens to meet the stablecoin demand in decentralized ecosystems.

At the same time, it improves capital efficiency and fee flexibility, optimizes liquidation and incentive mechanisms, and is committed to providing a better user experience and incentive structure. Overall, the Raft project encompasses lending, stablecoin issuance, liquidity provision, and improvement mechanisms, aiming to bring more financial opportunities and benefits to cryptocurrency holders.

LSDFi Projects Yet to Issue Tokens

Obol Network

Official Website: https://obol.tech/

Twitter: https://twitter.com/ObolNetwork

More Information: https://app.vedao.com/projects/

Project Introduction: Obol Network is a protocol that promotes trust-minimized staking through multi-operator validation. Obol focuses on expanding consensus by providing permissionless access to distributed validators (DV). Distributed validators will and should constitute a significant portion of the mainnet validator configuration. To prepare for the first wave of adoption, Obol Network is currently implementing middleware that uses distributed validator technology (DVT) to enable the operation of distributed validator clusters, which can retain the current client and remote signing infrastructure of validators.

Obol believes that in the future, distributed validators will occupy a significant portion of the mainnet validator configuration, thus aiming to expand consensus by providing permissionless access to distributed validators (DVT) as a core building block for various Web3 products.

Funding Situation:

Currently, Obol Labs has raised a total of $19 million.

In September 2021, Lido provided a $100,000 LDO grant to Obol to continue research and development of the protocol.

In October 2021, Obol completed a $6.15 million funding round, with investors including ConsenSys, Acrylic Capital, Coinbase Ventures, IOSG Ventures, Blockdaemon, Delphi Digital, Stakefish, Figment Fund, Chorus One, Staking Facilities, and The LAO.

On January 17, 2023, Obol completed a $12.5 million funding round, co-led by Pantera Capital and Archetype, with follow-on investments from Coinbase Ventures, Nascent, BlockTower, Placeholder, Ethereal Ventures, Spartan, and IEX, as well as direct participation from top validators such as Stakely, Cosmostation, Kukis Global, Swiss Staking, Swift Staking, Blockscape, and DSRV.

Ether.Fi

Official Website: https://ether.fi/

Twitter: https://twitter.com/ether_fi

More Information: https://app.vedao.com/projects/

Project Introduction: Ether.Fi is a non-custodial liquid staking platform that allows users to maintain control of their keys while delegating Ethereum validator operations to node operators. Each validator generated through its protocol will be represented as an NFT. Ethereum stakers who deposit at least 32 ETH will hold an NFT representing the economic interests of the validator. Once the liquidity pool and protocol fund management smart contracts are implemented, this NFT can be split.

Funding Situation:

On February 28, 2023, Ether.Fi completed its first funding round, raising $5.3 million, with investors including Chapter One, North Island Ventures, Arrington XRP Capital, Maelstrom, Node Capital, Version One, and Purpose Investments.

EigenLayer

Official Website: https://www.eigenlayer.xyz/

Twitter: https://twitter.com/eigenlayer

More Information: https://app.vedao.com/projects/

Project Introduction: EigenLayer is a set of smart contracts on Ethereum that allows ETH stakers to choose to validate new software modules built on the Ethereum ecosystem. Stakers choose to join by granting EigenLayer smart contracts the ability to impose additional slashing conditions on their staked ETH, thereby allowing for the expansion of cryptoeconomic security.

EigenLayer introduces a Re-staking model: the protocol creates an optional middle layer that allows users to deposit staked ETH into smart contracts, agreeing to grant EigenLayer additional execution rights. In other words, it transfers the management rights of staked ETH to EigenLayer to earn more returns.

Such a network can be seen as a voluntary subset of the network of numerous Ethereum stakers and validators that choose to join Re-staking, sharing security with Ethereum. The opt-in nature of this network will yield many results: for example, providing additional validation services will allow for extra validation rewards. A token's role is multifaceted; it can serve as both a staking token and a validation token.

Funding Situation: As of now, EigenLayer has completed two funding rounds:

In August 2022, EigenLayer completed a $1.45 million seed round, with participants including Polychain, Ethereal Ventures, Figment Capital, dao5, Robot Ventures, P2P Validator, Anthony Sassano, Viktor Bunin, Mara Schmiedt, Tim Beiko, Marc Bhargava, Zaki Manian, Joe Lallouz, and Jon Charbonneau.

On March 28, 2023, EigenLayer completed a $50 million Series A funding round at a $500 million valuation, with investors including Blockchain Capital*, Coinbase Ventures, Hack VC, Electric Capital, Polychain, Bixin Ventures, IOSG Ventures, and Finality Capital Partners.

Tenderize

Official Website: https://www.tenderize.me/

Twitter: https://twitter.com/tenderize_me

More Information: https://app.vedao.com/projects/

Project Introduction: Tenderize is a staking derivatives protocol that allows users to collateralize loans and trade tokens while maintaining their staked asset positions. With this increased flexibility, the company believes it can unlock the full utility potential of staked assets, with the ultimate goal of achieving permissionless liquid staking. Currently deployed on ETH/Arbitrum, the liquid staking protocol supports liquid staking for four assets: $MATIC, $GRT, $AUDIO, and $LPT. To date, Tenderize has achieved a total value locked (TVL) of up to $1.68 million, with annualized yields reaching as high as 24%.

Funding Situation: On July 7, 2022, Tenderize completed a $3 million seed round, with investors including Eden Block*, TRGC, Figment Capital, Encode Club, Daedalus, and Syndicate.

Other LSD Project Reference List: https://docs.google.com/spreadsheets/d/1JVCzecdr4xShnl7qUrKOulxLnLq8mDAy5pGV6TtizVQ/edit#gid=0

3. Development Trends of LSDFi

3.1 Prospects

In the future, how LSDFi can truly leverage staking mechanisms to empower the long-term health of public chain ecosystems while ensuring no systemic risks arise, as well as the evolution of its competitive landscape, are all issues worth exploring in depth.

To achieve the long-term healthy development of LSDFi, it is first necessary to design a more simplified staking process to lower the barriers to user participation and improve user experience. A simplified staking process will attract more participants to join the LSDFi market, promoting liquidity provision and increasing funds.

At the same time, introducing security measures is also crucial, such as validator deposits, liquidity limits, and self-collateralization mechanisms, which can effectively prevent malicious behavior and systemic risks. These security mechanisms will provide users with confidence and enhance the stability and reliability of the market.

Furthermore, strengthening governance and consensus mechanisms is key to achieving the long-term healthy development of LSDFi. Through community governance and consensus mechanisms, the rights and interests of stakers and validators can be protected, reducing potential disputes. The healthy development of public chain ecosystems requires a balance and coordination of interests among all parties, and good governance and consensus mechanisms will provide a stable operating environment for the LSDFi market.

3.2 Risks

It is worth noting that LSDfi is a relatively young market, and like all emerging technologies, people should be aware of the risks involved in interacting with such projects, including general risks associated with liquid staking.

Slashing Risk: If validators fail to meet certain staking parameters (e.g., going offline), they may face penalties, and LSD holders may be exposed to these slashing risks.

LSD Price Risk: The price of liquid staking tokens may fluctuate due to market forces and may differ from the underlying tokens. This could expose users to price volatility and potential liquidation risks if used as collateral.

Smart Contract Risk: Interacting with each smart contract introduces new levels of smart contract vulnerabilities.

Third-Party Risk: Some projects may use other dApps (e.g., yield strategies) as part of their normal operations. In such cases, users may be exposed to additional counterparty risks.

Moreover, the above factors do not account for the different specific project risks among various projects. Users should conduct thorough due diligence before participating.

3.3 Opportunities

Based on the above understanding, the future competition of LSDFi may focus on two significant opportunities: secure aggregate mining and the development of "LSDFi+". By combining these two aspects, a safer, more efficient, and value-added LSDFi ecosystem can be created.

The multi-chain nature of LSD business is an inevitable trend; theoretically, as long as there is a POS mechanism, LSD can be created from any chain. However, based on the cases of the projects mentioned above, the vast majority of LSD projects should start from a specific chain or ecosystem before expanding to other public chains.

In summary, as an essential component of public chain ecosystems, the future development of LSDFi needs to achieve long-term healthy empowerment through simplifying staking processes, introducing security mechanisms, and strengthening governance and consensus.

At the same time, market decentralization, the rise of innovative solutions, and cross-chain cooperation will characterize the competitive landscape of LSDFi. These trends will drive the prosperity of the LSDFi market and provide users with more choices and better experiences.

4. Conclusion

In 2023, LSDFi experienced astonishing growth, with total value locked (TVL) increasing by 58.7 times. This indicates investors' interest and demand for higher yield opportunities through staking ETH.

Many LSDfi protocols have opened new opportunities for yield-seeking LSD holders.

By providing additional use cases for liquid staking tokens, LSDFi incentivizes staking participation and has the potential to accelerate the growth of liquid staking. Considering that this industry is in its early development stage, it will be interesting to further observe innovations in this field and the adoption of LSDFi.

At the same time, the LSDFi market encompasses multiple areas and projects, offering a rich variety of solutions and functionalities. Market share, TVL, and staking ratios are important indicators for assessing competitiveness. As time goes on and the market evolves, the LSDFi market will continue to change, bringing new competitive landscapes and opportunities.

During the data organization process, many LSD projects have very poor UI experiences, and many projects have numerous use cases for LSD but do not inform users how to use them, resulting in an overall poor UX experience.

CEX is a factor that cannot be overlooked; as the largest traffic entry point for Web3 and a gathering place for various tokens, for example, Coinbase alone brings in over $10M in trading volume from CBETH-ETH, which, in addition to liquidity, will also affect speculators' attention to the LSD track.

In conclusion, LSD has become a core narrative in the crypto market. The market size for LSD still has significant growth potential. While there are concerns about selling pressure from ETH unlocked after the Ethereum Shanghai upgrade, the overall LSD track is still expected to perform better in terms of data.

If you want to lay out in the LSDFi track, it is recommended to prioritize the high-quality LSD Alpha mentioned above that has not yet issued tokens.