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Liquid staking derivatives (LSDs) like Lido Finance, Ankr and Rocket Pool have emerged as one of the hottest new trends in the DeFi world, allowing investors to maximize their earning potential by validating transactions for the Ethereum network, without sacrificing liquidity. This is key as users can stake ETH tokens without locking them, meaning they can explore alternative ways to generate income at the same time.
Traditional Ethereum staking, conducted to validate network transactions and earn rewards for participating, would require users to deposit their finds in a wallet and leave them there for a period of time. As a result, these funds are effectively frozen, resulting in a loss of liquidity.
LSDs are therefore a revolutionary concept for DeFi, allowing users to lock their ETH into an LSD protocol and earn the standard rewards for it, while also receiving what is known as a “wrapped token”. Examples include stETH, cbETH, wstETH, frxETH, sfexETH, and so on, with the exact token depending on which LSD the user is putting their coins into.
The great thing about these wrapped tokens or LSD tokens is that they can then be used with supported crypto exchanges and traded normally or deposited into a range of compatible DeFi protocols that offer yield opportunities. In other words, they can be used to generate additional rewards on top of the basic rewards gained from staking. The potential returns can be astronomical, with various strategies offering returns of between 30% and 40%.
The other advantage of LSDs is that there is no minimum bet. Native staking on Ethereum requires users to deposit at least 32 ETH, which is around $49,000 at the time of writing. Of course, the vast majority of DeFi users are unable to raise such a large sum, meaning that LSDs are opening the doors to thousands of new investors.
More liquidity = higher value
One of the advantages of LSDs is that the more liquidity they attract, the more their value increases. However, the upcoming Shanghai upgrade to Ethereum has led some Twitter users to speculate that some interesting things are about to happen.
This is explained in a recent post on Decrypt, which notes that the main impact of Shanghai, when implemented in early April, is that it will allow users to finally withdraw the rewards they earn from staking ETH have (currently this is not possible). , so all these rewards have accumulated over the last few months).
Undoubtedly, with players finally being able to claim their rewards, staking becomes a much more appealing proposition as it means users can generate a nice passive income stream. Despite this, Ice v3 warns on Twitter that one consequence of this is that the LSD protocols may struggle to maintain their current liquidity. There are mutliple reasons for this. First, direct ETH staking will also generate higher returns as a result of the upgrade, making it more attractive than LSDs. Additionally, many users who have built rewards through the LSDs will likely be tempted to withdraw those earnings.
In order for LSDs to retain liquidity, they need to take some drastic steps, argues Ice v3. Most LSDs are already paying out massive amounts of so-called “bribes” to users, and these payments are likely to increase to ensure their protocols remain attractive to depositors.
If that happens as expected, that will be good news for alternative DeFi players like Aura Finance. Aura belongs to a new generation of “meta-protocols” that depend on another protocol – in this case, Balancer. Aura offers more incentives and rewards for liquidity providers on balancers by providing them with tokens that behave similarly to wrapped ETH. Aura allows users to earn generous AURA token rewards through a variety of staking and yield farming mechanisms.
LSDs may be able to leverage Aura and other similar protocols themselves as they actually support a number of LSD assets. Of course, if LSDs use aura to increase incentives, it will increase the value of AURA itself. At the same time, Aura and other meta-protocols can expect a large influx of users giving up LSDs altogether.
It remains to be seen if this theory will play out as expected as DeFi is an unpredictable industry at the best of times. What is clear, however, is that the LSD space is poised to experience extraordinary disruption, creating new opportunities for investors to maximize their profits. The combination of staking rewards plus additional income from LSD LPs and incentives from Aura promises to be an extremely lucrative opportunity worth pursuing.
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