The Dilemma and Future of LSDFi in PSE Trading

Since Ethereum transitioned to Proof of Stake (PoS), LSDFi has emerged as a new and notable track in the market. The reason LSDFi has become a focal point is due to its re-innovation based on Yield Bearing attributes of liquidity stake tokens. However, as the staking rate of ETH continues to rise and staking yields decrease, the market space is being squeezed, leading to a stagnation in LSDFi’s development.

Looking back, we have experienced three development phases in the LSDFi track: competition among liquidity staking protocols, the emergence of LST as a new, consensus-based circulating asset in DeFi, and the diversification and large-scale application of LST. Currently, we are in a clear development dilemma. This article attempts to clarify the current state of the LSDFi track through data analysis and explores the future direction of LSDFi by analyzing specific projects.

1. Current Status of the LSDFi Track from a Data Perspective

1.1 Growth Bonus Period Over, Track Development Stagnant, Decline in Yields Leading to Capital Flight

According to data from Dune, the net amount of staked ETH shows a flattening trend, and the number of validators waiting to enter is continuously decreasing, indicating the end of the aggressive staking growth period. Correspondingly, the total TVL (Total Value Locked) of the LSDFi track (currently at 839M) has been slowing down since September 26 of this year and even shows negative growth. It is predictable that without paradigmatic innovation, the LSDFi track will not see significant growth soon.

This situation may be due to two reasons. On the one hand, the lackluster growth in staking within the Ethereum ecosystem, coupled with the rise in Ethereum’s staking rate leading to a decrease in staking yields (as shown in the figure, the basic yield is only 3%+), has resulted in LSDFi protocols hitting a yield bottleneck. This reduces the track’s attractiveness to capital, leading to capital outflow. On the other hand, external environmental impacts, most notably the rising U.S. bond yields in a high-interest environment, have a siphoning effect on capital in the crypto industry. This leads to capital flight from LSDFi to higher basic yield U.S. bonds and DeFi-like U.S. bond derivatives.

Source: https://defillama.com/yields?category=Liquid+Staking&chain=Ethereum

1.2 Project homogeneity is serious, involution but insufficient innovation

Since the development of DeFi, two important parts are still shining as the cornerstones that generally maintain the operation of the entire DeFi system: lending and stablecoins. In the operating rules of LST, lending and stablecoins are also the most basic and feasible operating methods. Based on the interest-generating attributes of LST, the project directions of the LSDFi track can be roughly divided into the following two categories:

——LST serves as collateral for lending protocols or stablecoin protocols (represented by Lybra, Prisma, and Raft);

——Separation of LST principal and interest (represented by Pendle);

Source: https://dune.com/defimochi/lsdfi-summer

It can be seen from Dune’s data that among the top 12 TVL projects currently on the LSDFi track, 5 are stable currency protocols based on LST. Their basic mechanisms are almost the same: users use LST as collateral to mint or lend stablecoins, and when the price of the collateral drops, the collateral will be liquidated. The few differences are different stablecoins, different LTVs, and different supported collateral.

After Terra collapsed and BUSD was forced to be delisted due to regulatory risks, many gaps in the stablecoin market needed to be filled. The emergence of LST, which has interest-generating properties, can contribute to projects that are more in line with the needs of decentralization to the stablecoin market. It’s just that after the wave, the overall innovation of the track is weak, and they are just interfering with LTV, collateral types, and stablecoin yields (most of the yields rely on project token subsidies, which are essentially just air). If the latecomers do not have the differentiation points to challenge the earlycomers, going online means the end of the project.

Pendle is a unique presence in the entire LSDFi track. Its fixed interest rate products are naturally suitable for LST with interest-bearing attributes (taking stETH as an example, it can be split into ETH and pledge income parts), which is why Pendle has returned to the center of the market after Ethereum switched to PoS. Currently, Pendle is firmly holding on to its market share with product iterations, and there is no strong competitor of the same type on the market.

Pendle’s TVL reached a new high on November 1st https://defillama.com/protocol/pendle

1.3 Top Projects Lack Pricing Power, Long-Term Growth Not Guaranteed

For DeFi, we can say Aave is a leader in lending protocols, Curve is a leader in stablecoin DEXs, and Lido is a leader in Ethereum liquidity staking services. These projects have achieved pricing power in their respective fields. The pricing power I refer to here is the barrier effect formed by “monopoly + essential demand,” creating a certain monopolistic and brand effect in the market’s essential services (significantly leading market share).

What does having pricing power mean? I believe it implies two advantages: an excellent business model and guaranteed long-term growth. Simply put, the barrier of pricing power is the true barrier.

However, looking at the various projects in the LSDFi track, even Lybra Finance, the market leader, has not formed its pricing power barrier. In its V1 phase, Lybra quickly stood out from the crowd of LSD stablecoin protocols with a yield far exceeding Ethereum’s basic staking return (8%+), attracting a large amount of TVL. However, the V2 upgrade did not bring effective growth to Lybra; instead, it faced increasing market share pressure from later entrants like Prisma and Eigenlayer.

The inability of top track projects to have their pricing power is fundamentally due to Firstly, the technical difficulty at the protocol level is not high, especially since many LSD stablecoin protocols are direct forks of Liquity, meaning “low technical threshold” implies intense competition; Secondly, LSDFi projects are not LST issuers, essentially relying on ETH’s pricing power (staking yield) for liquidity redistribution; Lastly, the differences between each project are minimal, market shares are often influenced by protocol yields, and top projects have not formed their ecosystem to establish absolute pricing power within it.

The lack of pricing power means that the current prosperity might be temporary, and no one has found the key to long-term growth.

1.4 Token Subsidized Yields Unsustainable, Stablecoin Liquidity Lackluster

LSDFi previously attracted a large amount of TVL in a short time with high yields, but a closer look reveals that these high yields are subsidized by project tokens, leading to the premature depletion of the governance token’s value, making high yields unsustainable.

Take Raft as an example. Raft launched the Savings Module in V2, attracting $R holders with a 10% fixed APR, but the source of this 10% interest was not detailed (officially explained only as subsidized by protocol income). Considering the entire DeFi sector, projects offering 10% low-risk rates are few, raising doubts about whether the project is fabricating $R to create this seemingly beautiful APR myth.

It’s noteworthy that the current collateral borrowing cost (interest rate) for Raft is 3.5%, meaning users minting $R and depositing it in RSM can achieve at least 6.5% arbitrage.

The Official R Savings Rate is as high as 10%

For decentralized stablecoins, liquidity is a critical factor influencing their development scale. Liquity’s inability to expand and breakthrough in the last bull market was mainly due to its insufficient liquidity to meet user demands. Currently, DAI is indeed the decentralized stablecoin with the best liquidity. Likewise, most of the current LSD (Liquidity Sensitive DeFi) stablecoins also face liquidity issues, characterized by insufficient depth of their stablecoins, limited usage scenarios, and inadequate real user demand.

Taking eUSD, launched by Lybra, as an example, its current scale is 108M. However, its best liquidity pool is the peUSD pool on the Arbitrum chain (peUSD is a cross-chain version of eUSD). The depth of the eUSD-USDC pool on Curve is only 207k, indicating that exchanging eUSD with centralized stablecoins is highly inconvenient, which could significantly impact user adoption.

Source: https://defillama.com/yields/stablecoins?token=EUSD

2. Finding a Breakthrough in LSDFi Development Challenges from Specific Projects

Although the LSDFi track as a whole has entered a bottleneck period in development, there are still some projects that are striving for change. From them, we might gain some insights and inspiration for breaking through these development challenges.

2.1 Developing Ecosystems, Compensating for Economic Model Shortcomings, Establishing Pricing Power: Taking Pendle and Lybra V2 as Examples

Current LSDFi projects all face a seemingly unsolvable issue: using governance tokens to subsidize user returns, which leads to the continuous dilution of the value of governance tokens, eventually reducing them to worthless mining coins.

A feasible and instructive solution is to develop their ecosystems, leveraging the power of ecosystem projects to address flaws in their economic models, and establishing absolute pricing power within the ecosystem.

2.1.1 Pendle

Pendle is currently the most successful representative in practicing this method. Both Penpie and Equilibria are auxiliary protocols that enhance PENDLE LP (Liquidity Provider) yields based on the Pendle veToken economic model. LPs can obtain Pendle mining boost benefits without needing to stake Pendle. The business models are similarly different, with their primary function being to absorb some of the selling pressure of governance tokens for Pendle, facilitating healthier development for Pendle itself.

Source: https://dune.com/coumarin/pendle-war

2.1.2 Lybra Finance

After its V2 launch failed to achieve effective growth, Lybra Finance also began to intentionally build its ecosystem. On October 13th, Lybra officially announced the launch of the Lybra War, positioning it as the next strategic focus.

Lybra’s overt initiation of Lybra War is due to its recognition of several issues:

1) The high APR maintenance leading to high inflation of its governance token LBR, and the V2 mining activity causing excessive short-term selling pressure;

2) Intense competition in the same track (like Prisma, Gravita, Raft) resulting in stagnant growth, with Lybra lacking investors to rely on;

3) Insufficient liquidity for eUSD, and the promotion and usage of peUSD not meeting expectations;

4) Community consensus was shaken, especially during the V1 to V2 migration, where there were doubts about the handling of tokens that were not successfully migrated in time (the decision largely hinged on one individual, sifu, influencing the entire voting outcome).

Source: https://twitter.com/LybraFinance/status/1712505916363592011

The core of Lybra War focuses on the accumulation of dLP (decentralized liquidity provider tokens) and achieving a dynamic match between dLP and eUSD. In Lybra V2, users must stake a minimum of 2.5% of the eUSD value in LBR/ETH dLP to earn esLBR emissions. Therefore, second-layer protocols within the Lybra ecosystem must obtain more esLBR through yield boosting of esLBR and dLP. Additionally, the distribution power in Lybra War is concentrated on esLBR emissions among LSD (Lybra Synthetic Debt) pools, with the potential demand coming mainly from LST (Lybra Synthetic Token) issuers and major eUSD minters. The depth bias in Libra’s LSD pools is more conducive for small LST issuers to accumulate esLBR to increase their voting rights with esLBR.

Currently, the only significant player in Lybra War is Match Finance, and an effective competitive landscape has not yet formed. Match Finance primarily addresses two issues (without elaborating on the project mechanism here):

1) The problem where users minting eUSD without dLP cannot receive esLBR incentives;

2) The yield boosting of esLBR and the liquidity exit issue.

Match Finance Mechanism, Source: Match Finance Whitepaper

As protocol layers in the LSDFi track, both Lybra and Pendle are not issuers of LST, and hence, their initial strategy of accumulating substantial Total Value Locked (TVL) through high APR also planted a negative seed. For their future benign development, they chose to develop ecosystem projects to continuously support themselves. Any ambitious LSDFi-leading project will inevitably follow this path of development.

2.2 Micro-Innovations to Enhance Differentiated User Experience

For non-leading projects, the key to holding their ground in the competitive race is to find their unique differentiation. Even small-scale innovations can reach a specific segment of users. As long as these users are sufficiently loyal, the project holds the key to survival.

2.2.1 No Liquidation: Taking CruiseFi as an Example

While most projects are still competing over Loan-to-Value (LTV) ratios and collateral types, some have already introduced a “No Liquidation Mechanism” to attract traffic.

For instance, in CruiseFi, users can mortgage stETH to mint the stablecoin USDx. They can then swap USDx for USDC through the USDC-USDx pool on Curve. Lenders providing USDC to the Curve stablecoin pool can earn interest generated during the stETH mortgage period.

To ensure that a borrower is never liquidated, the following measures are taken when liquidation occurs:

1) The project side will lock a portion of the collateral (stETH), and then allocate the staking returns from the locked stETH to the borrower.

2) Positions exceeding the stETH returns will be suspended. This ensures that the staking returns always cover the loan interest, effectively preventing the borrower from being liquidated. However, a downside of this approach is that the returns from stETH may decrease as the overall staking rate of ETH increases.

3) For the suspended position, corresponding Price Recovery Tokens (PRT) are generated. These PRTs can be exchanged 1:1 for ETH (only when above the liquidation threshold) and can be freely traded in the secondary market.

The advantage of this approach is that it allows borrowers to extend the time before liquidation or avoid it altogether. Lenders can earn ETH staking returns, while PRT holders can benefit from the potential future growth of ETH. A “no liquidation” scenario can be particularly attractive in a bull market for users with a higher risk preference.

2.2.2 Combined Yield Rate: The Case of Origin Ether

In the world of DeFi (Decentralized Finance), yield rates are always the most attractive narrative, and this iron rule applies to LSDFi as well.

Origin Ether was launched in May 2023. It uses ETH and other LSTs (Liquid Staking Tokens) as collateral. The value of 1OETH is always equivalent to 1ETH.

Source: https://docs.oeth.com/origin-ether-oeth

The most significant difference between Origin Ether and other LSDFi projects is that its earnings come from a basket of LST assets such as stETH, rETH, sfrxETH, etc. Additionally, OETH enhances its yield by employing AMO strategies in the OETH-ETH liquidity pool on Curve and Convex and also supports strategies on Balancer, Morpho, and other ETH-denominated pools on Curve. Through a series of optimized liquidity strategies, Origin Ether can offer users a higher-than-average APYlso the reason why Origin Ether has rapidly accumulated a substantial Total Value Locked (TVL) in recent months, currently ranking seventh in market share in its category.

Source: https://defillama.com/protocol/origin-ether?medianApy=true

2.2.3 The Next Layer of Nesting: LRTFi Based on Eigenlayer

LSDFi, as a nested variant of LSD, has reached a developmental bottleneck. However, the emergence of the Eigenlayer is likely to lead to a new layer of LRTFi nesting in This not only represents another leveraged expansion for the enterprise but also an opportunity to return to the center of the market and expand outward.

Although Eigenlayer is still in a closed testing phase and not open to all users, the market enthusiasm has been very high, as indicated by the two previous staking events.

Eigenlayer TVL composition, source: https://defillama.com/protocol/eigenlayer

At the same time, several projects based on LRT (Liquid Restaking Token) have emerged, such as Astrid Finance and Inception. The core logic of these projects is not innovative; they simply include LRT in the collateral spectrum compared to LSDFi protocols. It is expected that this type of competition will intensify once Eigenlayer officially launches, and it is still in an early stage at present.

2.3 Support from Capital Forces, Bundling with Other Mature Projects, and Enjoying Benefits from Other Ecosystems: The Case of Prisma

If a later project wants to overtake its competitors in a race full of uncertainties but is unable to achieve paradigm innovation, then finding a strong backing, utilizing the benefits of other projects as its buff, will be an effective way to stand firm. We can call this approach ‘taking a shortcut’ or ‘finding a godfather’.

Prisma Finance is the most typical example of success in this respect. Compared to grassroots projects like Lybra Finance (community-started and without private equity funding), Prisma is akin to a rich second-generation born with a silver spoon. Even before launching any product, they had already caught the market’s attention with a dazzling PR article. The most valuable information revealed in the article was not how different its project mechanism was, but that its list of investors included not only DeFi OGs like Curve and Convex but also major institutions like OKX and The Block.

Subsequently, Prisma’s development path was as advertised. It bundled with Curve and Convex, secured their support, granted extra rewards to its native stablecoin mkUSD (in the form of CRV and CVX), and achieved a flywheel effect through the veToken model (which controls protocol parameters).

In the third month after its official launch, supported by Justin Sun’s one billion USD worth of wstETH, Prisma achieved an all-time high in TVL and surpassed Lybra to become the new leader in its field.

Source: https://defillama.com/protocol/prisma-finance

2.4 True Paradigm Innovation

In both large industries and specific niches, after experiencing rapid, unregulated growth, there’s inevitably a point where development hits a bottleneck. The fundamental solution to such predicaments is undoubtedly “paradigm innovation.” Although the development of LSDFi has not yet seen any groundbreaking innovations capable of changing the game, I firmly believe that as long as the value of Ethereum continues to be a strong consensus, there will eventually be a paradigm-shifting innovation that emerges to rekindle the blazing fire of LSDFi.

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