LSD Track Investment Research Report

Introduction

In 2023, Liquid Staking Derivatives (LSD) undoubtedly became one of the hot topics in the market. As we explore the latest developments in the Ethereum ecosystem, LSD has become an essential consideration.

With the transition of the Ethereum network from Proof of Work (PoW) to Proof of Stake (PoS), LSD provides an innovative staking solution that not only enhances the network’s security but also brings unprecedented flexibility and profit potential to users.

1. Track overview

1.1 Definition and background

The full name of LSD is Liquid Staking Derivatives, which refers to derivatives based on liquidity staking. Staking operates on the mechanisms of Proof of Stake (POS) and Delegated Proof of Stake (DPOS), requiring users to prove ownership of a certain quantity of digital currency. Users only need to lock a specific amount of cryptocurrency in a crypto wallet or exchange for a period to generate profits. These profits include block rewards generated by smart contracts. Additionally, if utilizing smart contracts with lending capabilities, investors acting as lenders earn interest income when others need to borrow certain cryptocurrencies.

The emergence of LSD is closely related to Ethereum’s transition from a Proof of Work (POW) mechanism to a Proof of Stake (POS) mechanism, indicating that the switch in Ethereum’s consensus mechanism has spurred the development of the LSD track.

Ethereum’s protocol upgrades are divided into four stages: Frontier, Homestead, Metropolis, and Serenity. “Serenity,” also known as “Ethereum 2.0,” primarily aims to transition to Proof of Stake and develop second-layer scalability solutions. This upgrade is divided into three phases: Berlin, London, and the Merge.

• December 1, 2020, the beacon chain required for Proof of Stake went live, allowing for staking but not yet withdrawals.
• 2021, Ethereum underwent the Berlin and London hard forks, upgrading the beacon chain, and controlling the total supply through fee burning and reducing block rewards.
• September 15, 2022, the Ethereum mainnet merged with the beacon chain, transitioning from PoW to PoS.

Since then, Ethereum has officially bid farewell to the era of large-scale mining rigs. Holders can now mine by staking ETH (requiring 32 ETH per validator node), marking Ethereum’s entry into the 2.0 era.

LSD (Liquid Staking Derivatives) emerged as a DeFi derivative product with the upgrade to Ethereum 2.0. They provide stakers with a new way to participate in network maintenance while maintaining asset liquidity.

In traditional Ethereum staking models, participants need to lock up at least 32 ETH to become validators, which somewhat restricts capital liquidity and flexibility. The advent of LSD allows users to convert staked ETH into tradable assets, enabling them to contribute to the network while unlocking capital for participation in other DeFi activities.

1.2 Development history

ETH announced the transition to PoS

Before 2018, the ETH team had planned to transition from Proof of Work (PoW) to Proof of Stake (PoS), laying the foundation for the emergence of LSD.

ETH 2.0 Phase 0 Launch

In December 2020, ETH 2.0 Phase 0 was launched, introducing the Beacon Chain, marking the start of staking ETH, and the subsequent increase in demand for LSD.

Introduction of Liquidity Staking Platforms

On January 26, 2021, with the growing demand for staking, the first liquidity staking service platform, Lido Finance, was launched, marking the beginning of a new era in DeFi, where staked assets could be converted into liquid and tradable tokens.

Expansion of the LSD Market

In the first half of 2021, with the rise of DeFi and expectations for the ETH network upgrade, the liquidity staking derivatives market began to expand rapidly, with other projects like Rocket Pool also launching their own LSD products.

ETH London Upgrade

On August 4, 2021, ETH underwent the London upgrade, with the EIP-1559 proposal changing the transaction fee mechanism (introducing base fees and burning mechanisms, as well as adjustments to miner tips), impacting the entire Ethereum ecosystem and the LSD market.

ETH Merge

On September 15, 2022, the ETH 2.0 mainnet merged with the beacon chain, completing the full transition to the PoS mechanism. Users can stake ETH and earn approximately 3-6% annualized returns, but they still cannot withdraw staked ETH.

Shapella Upgrade

On May 5, 2023, the Ethereum network underwent the Shapella upgrade (a combination of the Shanghai and Capella upgrades, with Shanghai focusing on the Ethereum Virtual Machine (EVM) and Capella on the consensus layer), allowing users to withdraw their staked ETH, providing new growth opportunities for the LSD market and avenues for investor participation.

LSD (Liquid Staking Derivatives) was considered one of the top DeFi trends in 2023, with Lido becoming one of the largest DeFi applications on the ETH chain. This demonstrates the increasingly important role of the LSD track in the entire cryptocurrency and DeFi ecosystem. With technological advancements and increased market participation, LSD is expected to continue being an indispensable part of cryptocurrency investment and financial strategies.

1.3 Technical route and characteristics

In the LSD track, there are various development paths, including centralized service providers and decentralized protocols. However, at least the following development routes should be included:

Decentralized Staking

Represented by Lido, this method maintains decentralization while enhancing liquidity. Users can stake their tokens on platforms like Lido and receive derivative tokens representing their staked shares. These derivative tokens are usually pegged 1:1 to the original asset and can be traded on various decentralized finance (DeFi) platforms. Additionally, other projects like Rocket Pool provide decentralized staking services, allowing users to become node operators by staking ETH.

Centralized Staking

Common examples include staking services provided by centralized exchanges like Coinbase, Kraken, and Binance. Centralized services typically offer a simpler and more direct user experience, where users stake tokens on the platform and earn rewards through the platform. This type of service provides more stability, trustworthiness, and potentially higher staking rewards. However, compared to decentralized services, users have lower control over their assets. There is also the development of staking pools, which allow multiple stakers to pool their assets to achieve higher returns and lower risks. Large staking pools can effectively diversify validator performance risks and often have more professional asset management capabilities.

Re-Staking

Re-staking, as exemplified by EigenLayer, involves using already staked ETH or liquidity staking tokens (such as Lido’s stETH or Rocket Pool’s rETH) on the Ethereum blockchain for additional staking. Re-staking allows users to leverage these assets for additional rewards and enhance network security without needing to unstake their existing positions. The benefits of re-staking include increasing potential earnings and enhancing the overall security of the system by using already staked assets to reinforce network security. EigenLayer is optional, meaning users can decide whether to participate in this additional security protocol. However, this may introduce additional risks, such as different protocols having their own penalty mechanisms.

1.4 More LSD solutions

Although LSD was initially designed for Ethereum, other public chains supporting the PoS mechanism have also begun developing their own LSD solutions. These solutions have different technical characteristics and economic models to adapt to the characteristics of their respective chains. Some projects may offer higher returns but come with higher risks, while others may prioritize fund security and stable returns, such as:

Solana

Solana is a high-performance public chain that supports various DeFi applications and LSD projects. Marinade is a popular LSD service on Solana, allowing users to stake SOL and receive mSOL, which can be used within the Solana ecosystem and earn additional rewards.

Polygon

Polygon provides a framework for the Polygon network, supporting the construction and connection of Ethereum-compatible blockchain networks. On Polygon, users can participate in LSD projects by staking MATIC to obtain various derivatives, and utilize these derivatives for trading and earning profits within the Polygon ecosystem.

Frax Finance

Frax Finance is a stablecoin platform deployed on Ethereum and other public chains. Frax Finance has introduced two tokens, frxETH and sfrxETH, representing different staking strategies. frxETH represents ETH that does not earn beacon chain rewards from staking, while sfrxETH includes all staking rewards. This design allows users to choose different staking methods according to their preferences.

Ankr

Ankr offers a multi-chain solution, supporting multiple blockchains including Ethereum, Polygon, Avalanche, Binance Chain, Fantom, and Polkadot. Ankr’s services allow users to stake assets through its platform and receive corresponding liquidity tokens, which can be used in Ankr’s DeFi products.

Stakewise

Stakewise is another LSD solution focusing on Ethereum and Gnosis chains. It provides a user-friendly interface, allowing users to easily stake their ETH and receive tokens representing their staked shares.

These different technological routes and types of LSD solutions contribute to the diversity and complexity of the LSD track. Each solution has its unique characteristics, as well as facing different challenges and opportunities. As the cryptocurrency market evolves and matures, we can expect the LSD track to continue evolving, possibly introducing new innovative technological routes and service models.

1.5 Competitive Landscape

LSD (Liquid Staking Derivatives) track faces intense competition as it involves managing the liquidity of staked assets in blockchain networks, which is a high-demand area. Currently, in the DeFi market, different LSD solutions are competing for users, staked assets, and brand influence in the existing incremental market. Major players like Lido, Coinbase, Rocket Pool, etc., collectively hold over 80% of the market share. The key points of competition among these LSD platforms include:

Liquidity and Capital Efficiency

Users tend to choose LSD platforms that offer high liquidity and capital efficiency. High liquidity means users can easily enter or exit staking, while capital efficiency ensures that their assets can earn maximum returns.

Security and Decentralization

Security is a crucial factor when users select LSD platforms. Decentralization is also key as it reduces reliance on single points of failure and increases system robustness.

Improvement of User Experience

Intuitive, user-friendly interfaces, and seamless trading experiences can attract more users to choose specific LSD platforms. In the current market, some LSD tokens may trade slightly differently from their anchored assets, reflecting the market’s demand for liquidity and instant convertibility.

Policy Compliance and Regulation

As the LSD track develops, compliance and regulatory challenges have become important topics. The market continues to focus on how to regulate these emerging financial products, which may affect the operation of LSD platforms and user confidence.

Overall, the competition in the LSD track is fierce, with platforms striving to offer better liquidity management, security, user experience, and compliance with regulations to attract and retain users and assets.

2. Data overview

2.1 Market share

The current total market value of the LSD (Liquid Staking Derivatives) track is approximately $5.188 billion USD ($5,188,456,158). According to the latest data from Delphi Digital, the staking rate for Ethereum is at 23792%, with the quantity of staked ETH nearing the target of 28.78 million, representing approximately 24% of the total ETH supply. This level of staking is considered excellent for ensuring network security.

The adoption of LSD (Liquid Staking Derivatives) has also seen significant growth, with approximately 44% of all staked ETH currently existing within these protocols. Compared to other LSD solutions:

• Lido’s stETH offers outstanding practicality, providing it with a significant competitive advantage.
• Frax has demonstrated stable growth, with ETH staking volume expected to increase from 38K to 233K in 2023.
• Mantle has introduced the mETH product, leveraging the ETH held by its protocol to generate revenue for Mantle and enhance liquidity on DEX platforms.
• ether.fi and Renzo have implemented native liquidity re-staking on EigenLayer.

The LSD industry on Ethereum has matured, become highly competitive, and saturated. Many LSDfi projects have lost their attractiveness due to diminishing incentives-driven high yields. Re-staking (EigenLayer) may be the fastest-growing area within staking protocols in 2024.

2.2 On-Chain Data

According to the latest data from Token Terminal:

The total market value of circulating assets in the LSD (Liquid Staking Derivatives) field has surpassed $4.08 billion USD, marking a growth of 7.4% compared to previous figures. Lido Finance remains the dominant player in the market, capturing 61.7% of the market value share.

The total value of staked assets is approximately $31.65 billion USD, showing a growth of 6.0%. Among them, Lido Finance holds the largest share with 69.1%.

In the past 24 hours, the total fees amounted to $2.5 million USD, showing an increase of 12.8%. Lido Finance dominates this area with an absolute advantage of 92.8%.

The total revenue in the LSD field over the past 24 hours amounts to $233,000 USD, showing a growth of 9.4%. Lido Finance almost monopolizes this metric, capturing 99.7% of the share.

The daily active users have decreased by 25.1%, totaling 4,080, with EigenLayer being the most popular service, accounting for 40.5% of all users.

Currently, there are 127 core developers working in the LSD field, showing a slight increase of 0.8%. Lido Finance employs 29.1% of these developers.

3. Track Ecology (Case Study)

Lido

Lido provides liquid staking solutions for Ethereum, Solana, and Polygon networks simultaneously. On Ethereum, it allows users to participate in staking for ETH2.0 and other blockchain networks without the need to meet traditional staking requirements (owning 32 ETH). Users stake their assets through Lido and receive equivalent liquid tokens (such as stETH), which can be used throughout the DeFi ecosystem while continuing to earn staking rewards.

To sustain operations, Lido charges a certain percentage of staking rewards as service fees, which are used to pay network validators, protocol maintenance, and new feature development. The governance token of Lido, LDO, enables holders to participate in protocol decisions, influencing key parameters and future development directions.

Lido holds a significant share in the market, capturing 61.7% of the total market value in the LSD track. In terms of market share, Lido Finance occupies 77.27% of the market share in the liquidity staking domain. In November, the unique number of stakers exceeded 200,000, and the Total Value Locked (TVL) grew by 18.61%, surpassing $20 billion USD. However, as a decentralized project, it may face security challenges and regulatory risks. Compared to more decentralized or security-focused projects like Rocket Pool, Lido may need to continuously enhance its security measures to remain competitive.

In the future, Lido plans to build a fully permissionless and minimally risky staking solution:

The first improvement is the gradual adoption of Distributed Validator Technology (DVT).

The second improvement is to create Node Operator Scores (NOS) compiled based on different metrics and allocate stakes according to this score.

From a technical perspective, the RSI indicator for the LDO token shows a current value of 35.53, indicating that LDO may be in an oversold condition, suggesting a potential rebound in the short term. This may attract some short-term investors to enter the market in search of quick profits.

From a market sentiment analysis, being one of the top five DeFi protocols with the highest revenue in 2023, Lido demonstrates a strong position in the DeFi space. This could positively impact investor sentiment, increasing their confidence in Lido. Additionally, the collaboration between Hashnote and Lido to launch liquidity staking solutions for institutional users on Ethereum indicates that Lido is expanding its service offerings and attracting institutional investors. This is a positive signal that could increase market optimism about Lido, supporting a potential rise in its token price.

Marinade

Marinade Finance aims to simplify the staking process on Solana by optimizing staking rewards through automation. Users can stake their SOL tokens through Marinade and receive mSOL, a liquidity token pegged 1:1 to the original SOL token. mSOL has strong market liquidity and is listed on exchanges such as Coinbase and Kraken. Marinade has also received investments from well-known Czech venture capital firms Miton and Big Brain Holdings.

Marinade monitors all Solana validators and delegates tokens to the validators with the best performance to maximize returns. As of 2023, Marinade has been utilized by over 107,548 accounts. However, due to Marinade’s current focus primarily on the Solana blockchain, it may not offer the same level of diversity as other cross-chain LSD platforms like Ankr or StakeWise.

Marinade Finance currently maintains a dominant position in the Solana liquidity staking market. Since its launch in 2021, Marinade has experienced peak Total Value Locked (TVL) exceeding $1.5 billion during market highs. Despite some fluctuations compared to its peak, Marinade continues to hold the top position in TVL rankings within the Solana ecosystem, with over 5.47 million SOL staked. With a project TVL reaching $1.156 billion and a monthly growth rate of 78%, Marinade not only demonstrates its significant influence in the Solana ecosystem but also indicates promising potential for future development.

From a technical perspective, the RSI (Relative Strength Index) indicator for the LDO token shows a current value of 43.38, indicating a relatively balanced market state with no clear overbought or oversold signals. This level may suggest weak price momentum for the asset, lacking significant upward or downward trends.

In terms of market sentiment analysis, Marinade, as the top DeFi protocol by TVL in the Solana ecosystem, demonstrates a strong position on the Solana chain. This could positively influence investor sentiment, reflecting confidence in Marinade’s dominance within the Solana ecosystem.

Jito

Once users delegate SOL to validation nodes, they receive JitoSOL as liquidity tokens, whose value increases with the accumulation of node validation rewards. Jito Labs’ early positioning in the Solana MEV (Maximal Extractable Value) field enables Jito to distribute MEV income to delegators, thereby enhancing overall staking rewards.

Jito was launched amidst FTX’s collapse, which led to significant liquidity outflows in the closely related Solana ecosystem. Initially, Jito’s Total Value Locked (TVL) failed to significantly increase due to a lack of market confidence and liquidity demand. However, as the Solana ecosystem gradually recovered in the latter half of 2022, especially in August, Jito introduced incentive programs encouraging users to participate in Jito staking, hold JitoSOL, engage in DeFi activities, and refer new users. This strategy significantly boosted Jito’s TVL growth, rapidly making it one of the top two LSD protocols on Solana.

Compared to Marinade, the gap between Jito and Marinade in terms of ecosystem composition, decentralization, and staking model singularity is gradually narrowing. Jito’s core competitive advantage in capturing and distributing MEV value is expected to continue expanding with the prosperity of the Solana network. Therefore, we hold extremely optimistic expectations for Jito’s future development, as it is poised to become the largest LSD protocol in the Solana ecosystem.

Rocket Pool

Rocket Pool is a pioneering decentralized Ethereum staking protocol aimed at broadening the participation in Ethereum’s Proof of Stake (PoS) consensus by reducing the minimum staking requirement from the standard 32 ETH to a more accessible 0.01 ETH. This approach democratizes Ethereum staking, enabling individuals with smaller holdings to contribute to the network and benefit from it.

Established on the Ethereum blockchain, Rocket Pool is a non-custodial staking protocol founded by David Rugendyke and launched in 2021. RKT token holders own and govern the protocol, extracting a portion of the total investment return as revenue. Rocket Pool’s economic model is designed to reward node operators participating in network maintenance, with the rETH token providing liquidity for stakers while maintaining a 1:1 peg with ETH, and the RPL token used for protocol governance and as collateral for node operators.

Rocket Pool holds a certain market share within the LSD (Liquidity Staking Derivatives) arena, although the specific proportion varies with market dynamics. In terms of user numbers, it has attracted a large number of users who wish to participate in Ethereum staking but are unwilling or unable to run their own nodes.

4. Potential analysis

4.1 Stage progress (current situation)

The LSD market is expanding rapidly, especially with the increased demand and recognition following Ethereum’s transition from Proof of Work (PoW) to Proof of Stake (PoS). As more institutions begin to pay attention to and participate in this field, investors and financial institutions view LSD as an innovative addition to the realm of crypto asset staking, providing beneficial supplements to traditional staking mechanisms. Some institutional investors may also be considering incorporating LSD into their portfolios to diversify risks and enhance returns.

Overall, the LSD arena is rapidly evolving, injecting new vitality into the realm of cryptocurrency staking by providing additional liquidity and returns. However, this track still faces challenges such as regulatory hurdles and market volatility. For investors, understanding the operation and potential risks of these emerging products is crucial.

4.2 Advantages & Potential

Liquidity Staking Derivative (LSD) holds significant advantages and potential in several aspects:

Reasonable Revenue Structure

Users can earn not only staking rewards through LSD but also utilize their derivatives in various decentralized finance (DeFi) scenarios such as providing liquidity and borrowing, thereby generating additional income.

Vast Market Potential:

With the advancement of blockchain technology, particularly mainstream public chains like Ethereum transitioning to Proof of Stake (PoS), the staking market is rapidly expanding. LSD allows users to maintain their assets in a staked state while obtaining derivatives representing these staked assets, enabling asset liquidity without unstaking. Serving as a bridge between PoS and DeFi, LSD exhibits enormous market potential.

High Ecosystem Attention

The LSD arena attracts a plethora of developers, creating diverse financial products while also drawing numerous users to form a robust network effect. As the LSD market matures, more institutional investors are beginning to pay attention to this field, providing financial support and market recognition, further driving the development of the LSD market.

Transparent Community Governance

Many LSD projects employ decentralized autonomous organization (DAO) models for governance, enabling community members to directly participate in project decision-making processes, enhancing transparency and credibility.

In conclusion, LSD stands out as one of the most prominent innovative directions in the cryptocurrency domain, leveraging its unique advantages and immense potential. With ongoing technological advancements and improvements in market conditions, it is expected to continue attracting more capital, users, and developers participation.

4.3 Problems & Difficulties

User threshold and market risks

Compared to other application products, LSD is relatively complex, requiring users to have a certain level of blockchain knowledge and financial understanding. User education is a challenge in promoting LSD products; additionally, the high volatility of the market may affect users’ confidence in staking and LSD products, leading to the withdrawal of funds during downturns, thereby affecting the liquidity and stable operation of LSD platforms.

Fierce competition and pressure

With the introduction of staking services by industry giants such as Ethereum, the LSD track may face intense competition. Large-scale projects typically have more resources and a wider user base, putting significant pressure on smaller or emerging projects.

Model stability remains to be tested

The robustness of the revenue model needs to be verified over time. LSD, as an economic model that can attract users to participate in staking while ensuring liquidity and returns, must remain stable during market fluctuations to avoid financial bubbles caused by excessive revenue commitments. Designing mechanisms to optimize capital utilization and reduce user costs is a concern for LSD platforms.

Uncertainty in regulatory environment

The cryptocurrency market is influenced by policy regulations from various countries worldwide. As an emerging financial product, LSD may face unclear or unfavorable regulatory environments. For example, differences in regulatory attitudes towards DeFi and derivatives across different countries may affect the development of LSD. Therefore, LSD platforms need to closely monitor changes in regulatory policies and take appropriate measures to ensure compliance.

4.4 Trend prediction

LSD, as a novel financial product, the security of smart contracts will be an ongoing concern that the industry needs to address, as any vulnerabilities could result in significant asset losses. There will inevitably be more technological innovations to address the security and efficiency issues currently facing LSD.

With the continuous maturation and popularization of blockchain technology, traditional capital and users may flood into the LSD market in a new cycle, bringing more funds and liquidity to the market. Under these conditions, LSD products will become more diverse to meet the needs of different users, and there will be more cooperation models, such as partnerships with traditional financial institutions and integration among different LSD platforms.

The regulatory environment for the global crypto market is gradually improving and maturing. As an emerging financial product in the crypto industry, LSD may undergo strict regulatory scrutiny, especially in terms of compliance and anti-money laundering. However, in the long run, regulatory authorities may formulate clearer and more friendly regulatory frameworks.

5. Summary

The LSD liquidity staking derivative (LSD) sector has experienced rapid growth in the past two years, with Lido emerging as the dominant player in the field. It has become the leader in liquidity staking and even Ethereum staking as a whole. Over the past year, Lido’s financial department has been one of the few departments that have accumulated substantial value from operational income. Competitors need to analyze trends, capture innovative opportunities, and refer to Lido’s strengths and weaknesses to formulate competitive strategies, capitalize on strengths, and mitigate weaknesses while seeking development opportunities through innovation.

However, as the market enters a new cycle, staked assets may flow out due to significant market fluctuations, leading to market instability. Moreover, the relatively high barriers to entry and the stability of the revenue model in the face of cyclical market fluctuations will be important factors affecting the LSD ecosystem.

The liquidity advantages and diversified revenue potential of LSD have attracted more user and capital attention to the ecosystem. As long as LSD continues to manage contract security effectively and with advancements in technology, product innovation, and a gradually clearer regulatory environment, the LSD sector is expected to achieve sustained growth. It may occupy a crucial position in the future blockchain finance industry.

All the above views are not intended as investment advice. If there are any inaccuracies, feel free to leave comments for clarification or correction.

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