Cryptocurrencies

The Biggest Crypto Trend of 2023: Liquid Staking Derivatives (LSDs)

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Liquid Staking Derivatives are set to take off, thanks to Shapella. Here's how you can gain exposure as an investor. 

By James Edwards

Lido is now the biggest DeFi application on Ethereum, with around $12 billion worth of capital deposited on the platform.

It's part of a wider group of platforms that provide liquid staking for Ether (ETH).

Liquid staking platforms let you stake your ETH and earn yield but also provide you with a tokenized IOU for your staked ETH.

These tokenized IOUs are known as Liquid Staking Derivatives (LSDs). They can be sold, traded or used in DeFi applications similar to regular ETH — essentially allowing you to have your cake and eat it too.

LSDs were already big, but the recent network upgrade, Shapella, just added rocket fuel to the fire.

Here's how it works and how you can get in on the action.

The issue with staking 

Every transaction on Ethereum requires ETH to pay for gas fees, which you can think of like a road toll. This road toll is then paid to the validators who manage the network (you can think of validators as the construction workers who maintain the roads). 

Validators perform this service by staking — or locking up — their own ETH coins. In return, they earn an annual yield on their ETH, which is about 5% as of May 5, 2023.

But there's a catch — you need 32 ETH to serve as a validator. At today's prices, that's about $60,000. Plus, you need to operate some computer hardware, which can be a steep learning curve for some. 

This means you're locking away upwards of $60,000 of capital, and every seasoned investor knows that liquidity is key.

Enter LSDs — Bringing liquidity back to staking

Liquid staking derivatives (LSDs) allow stakers to earn yield without losing the liquidity of their staked assets.

LSDs are issued as an IOU when you stake your ETH and are intended to maintain a 1:1 value.

They automatically accrue yield as well, so you don't need to spend money on gas fees withdrawing your staking rewards. 

Better yet, they remove the 32 ETH barrier to entry, allowing anyone to stake any amount of ETH in return for yield. 

If you like, you can hold onto your LSD and earn yield, trade it, borrow against it, deposit it into a liquidity pool for additional revenue or simply sell it when you want to cash out.

Their utility has made them so popular that stETH — an LSD issued by Lido — is now the 8th largest cryptocurrency by market capitalization.

And it looks like they will grow even more popular, thanks to Ethereum's recent Shapella upgrade.

Why Shapella makes LSDs an even bigger deal

Last month, Ethereum completed a major upgrade called Shapella.

Shapella changed how staking on Ethereum works. Previously, any staked ETH could not be unstaked. It was effectively locked up and could not be withdrawn. This was the case for the past two years.

Following Shapella, users can now unstake their ETH as they please.

This means that approximately 10 million ($1.85 billion) previously unavailable ETH can now be redirected into the LSD market.

This isn't just a theory — on-chain analysis shows that staking via a liquid staking service is extremely popular. 

staking via a liquid staking service is extremely popular

4/9 of the largest staking depositors are from liquid staking platforms

Nansen.ai 

At the time of writing, there are approximately 19.8 million ETH staked, with about 50% of that done through liquid staking. 

That suggests the remaining 50% are through staking methods that do not offer LSDs. 

On-chain data shows that while nearly 1.3 million ETH was unstaked following Shapella, approximately 470,000 was staked into liquid staking protocols.

On-chain data shows that while nearly 1.3 million ETH was unstaked following Shapella, approximately 470,000 was staked into liquid staking protocols

ETH staking inflows since Shapella

Dune.ai 

This suggests that stakers are withdrawing their ETH to restake it with a liquid staking service to receive LSDs. 

And keep in mind that 440,000 of those 1.3 million withdrawals were done by the cryptocurrency exchange Kraken, which was forced to shut its retail staking service by US authorities.

It's not unlikely then that those retail investors will be looking for a new place to stake their ETH, with liquid staking services likely to look appealing.

How to speculate on the success of liquid staking platforms

Several LSD providers also have their own DAO or treasury token. 

Purchasing DAO tokens is a popular way to invest in a protocol by proxy in the hopes that any success will increase demand for the associated token.

Here's some of the most popular LSD providers and their DAO tokens, as well as the value proposition for each. 

Here's some of the most popular LSD providers and their DAO tokens, as well as the value proposition for each

If you believe that liquid staking has a bright future ahead, then you may want to research these tokens further before adding them to your portfolio. 

Keep in mind, though, that DAO tokens do not represent ownership or entitle you to profit-sharing. They are simply a proxy investment that could theoretically benefit from the underlying platform’s success.

Alternatively, you can participate in liquid staking by staking your ETH and receiving an LSD or simply purchasing an LSD like stETH or cbETH directly via an exchange, which saves you money on gas fees and provides all the same benefits.

Some platforms also reward you with DAO tokens as an incentive for staking with them.

How to stake ETH and get an LSD

The biggest LSD provider is Lido, an on-chain solution that issues stETH in return.

stETH is extremely liquid and accounts for over 70% of the LSD market. 

stETH is extremely liquid and accounts for over 70% of the LSD market.

Distribution of ETH across the largest LSD providers.

DefiLlama 

The next largest is Coinbase and Rocket Pool, which issue cbETH and rETH, respectively. 

Before you get started, brush up on how staking on Ethereum works and consider the risks involved.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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