Author: Arthur 0x; Compilation: Deep Tide TechFlow
Liquidity staking is one of the few protocols in the cryptocurrency field that has realized a unique market fit. The protocol addresses the capital efficiency problem faced by token holders of proof-of-stake (PoS) blockchains. This has led to the largest total value locked (TVL) in the decentralized finance (DeFi) space, reaching $22 billion. If the capital efficiency problem of PoS chains continues to exist, there will be a long-term demand for liquidity staking solutions.
As the value of the protocol services on chains increases, the size of the liquidity staking market also expands. Currently, the top five smart contract chains’ liquidity staking protocols generate over $800 million in revenue annually. Furthermore, due to its utility and low volatility, the profitability of this industry is superior to other DeFi sectors.
Due to Lido’s strong network effect around stETH, its reliable track record, and the adoption of decentralized validator technologies such as SSV and Obol, it is well-positioned to capture industry growth.
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We believe that in the medium term, Lido’s revenue has the potential to triple, primarily due to: 1) the increase in Ethereum’s market value, 2) the rise in Ethereum’s staking ratio after the Shanghai upgrade, 3) the increase in market share of decentralized liquidity staking protocols, and 4) Lido’s continued dominant position.
Due to the ability of liquidity staking protocols to address the capital efficiency problem faced by proof-of-stake validators, they have achieved a good market fit.
Currently, the top smart contract chains ranked by total value locked are all running PoS or PoS variants, such as delegated proof-of-stake and authorized proof-of-stake.
These blockchains allow users to stake their tokens in exchange for rewards that increase network security. However, the tokens staked by participants typically undergo a lock-up period, which varies depending on the protocol and usually ranges from a few days to several weeks. This presents a key capital efficiency problem for stakers.
Liquidity staking protocols have emerged to address this issue, allowing users to stake their tokens in exchange for a receipt token that represents their stake in the asset and corresponding staking rewards. These receipt tokens can be freely transferred and used for DeFi activities such as trading, liquidity pools, and lending.
Most importantly, liquidity staking protocols provide two key value propositions for stakers – the ability to generate income and the liquidity of staked assets – both of which solve the capital efficiency problem. As a result, the liquidity staking space has a total value locked of $22 billion, making it the highest TVL sector.
We believe that this product-market fit is unique to the liquidity staking track – if PoS chains are still popular, capital efficiency will remain an important issue, resulting in a long-term demand for liquidity staking solutions.
Liquidity staking protocols provide a sustainable source of income for a large market.
From a macro perspective, the potential scale of liquidity staking revenue is determined by four growth drivers: the market value of L1 tokens, the staking ratio of L1, the staking yield, and the market share of staking service providers.
In summary, these drivers have created an industry that generates millions of dollars in revenue annually. The top five PoS smart contract platforms alone generate $893 million in rewards each year, which belong to the liquidity staking protocols.
In addition, compared to other blockchain applications, the quality of this income stream is higher because it is repetitive. For example, the income of decentralized exchanges (DEX) is cyclical and highly dependent on market conditions. Generally, DEX trading volume is high during bull markets and gradually decreases during bear markets. This leads to unstable sources of income at the protocol level. Unfortunately, this is also the case for many other blockchain applications – NFT markets experience a decline in revenue during NFT bear markets, and revenue in the money market decreases with reduced demand for leverage. Therefore, we believe that in a volatile and fast-moving market, stable sources of income for the liquidity staking track are often overlooked advantages.
By comparing the monthly revenue of Uniswap and leading liquidity staking track Lido, the quality of this track’s revenue can be easily illustrated. Uniswap’s monthly revenue had two local peaks in May and November 2021, coinciding with the market tops of those two months. Subsequently, in the following bear market, monthly revenue gradually declined as trading volume and liquidity decreased.
In contrast, Lido’s revenue has remained stable over the past few years without significant fluctuations. This demonstrates the stability of staking income – as long as the blockchain continues to operate, liquidity staking protocols will continue to generate income regardless of market sentiment. We believe that an important implication of this phenomenon is that liquidity staking protocols should receive higher valuation multiples compared to protocols with cyclical businesses.
Lido is currently the market leader in the liquidity staking field with a total locked value of nearly $15 billion. In fact, it is also the DeFi protocol with the highest total locked value on-chain. Lido’s ETH receipt token stETH is also the most liquid staking ETH token and has the highest composability. We are confident that Lido will continue to grow and consolidate its market share by leveraging the network effects it has established.
When evaluating the advantages of a specific liquidity staking protocol, we also consider two additional parameters: 1) market share and 2) the proportion of rewards earned from staking. In the following section, we will explain the reasons for the growth of each driving factor and how they contribute to the continued success of Lido.
1. Growth of Layer 1 (L1) Token Market Value
Lido benefits from the growth of the underlying L1 chains it serves, as the total value locked (TVL) in USD is linearly correlated with the prices of these L1 tokens. Currently, Lido actively serves three chains – Ethereum (98.9% of TVL), Polygon (0.7%), and Solana (0.4%). If these chains continue to grow, their tokens should reflect these fundamentals. Therefore, even if the TVL in token terms does not increase, Lido’s TVL in USD terms will continue to expand.
It is worth noting that the growth of Ethereum has a significant impact on Lido’s fundamentals. Ethereum is the largest smart contract L1 chain to date, with a market value 6 times that of BNB Chain and 23 times that of Solana. ETH also accounts for the largest share of Lido’s TVL.
In this regard, we have a particularly positive long-term outlook on Ethereum. We have witnessed the successful implementation of major protocol upgrades such as the London upgrade (EIP-1559 – improving transaction fees and the user experience of ETH token economics), the Paris upgrade (PoS – reducing energy consumption and laying the foundation for scalability upgrades), and the Shanghai/Capella upgrade (ETH withdrawals). From an adoption perspective, Ethereum remains the preferred platform for secure L1 DeFi activities, with applications such as Aave and Uniswap enabling users to easily trade and borrow. At the same time, it continues to serve as a secure settlement layer for numerous scaling solutions, from zkRollups (Polygon zkEVM, zkSync, Starknet) to Optimistic rollups (Arbitrum, Optimism), enabling cheap and fast transactions and contributing to ETH transaction fees. Therefore, we believe that Lido will derive substantial benefits from this native advantage.
In addition, we view Lido’s multi-chain operations as a bullish option for alternative L1 chain growth. We believe that developers and users have different needs that can be met through other chains. From Lido’s perspective, providing services to these chains is a wise strategy for decentralized business.
2. Growth of L1 Staking Ratio
We believe that the staking ratio of Ethereum will continue to rise, especially after the recent success of the Shanghai/Capella upgrade. When Ethereum initially implemented staking on the beacon chain, early stakers did not have full assurance of the technical feasibility and withdrawal schedule of their assets when depositing ETH. Therefore, the staking ratio of Ethereum was relatively small compared to other PoS chains. With the completion of the Shanghai/Capella upgrade, this risk factor has been largely mitigated and has become a key driving factor for the growth of the staking ratio. In fact, the staking ratio of ETH has steadily increased from around 15% during the Shanghai/Capella upgrade to approximately 20% today.
We expect that the growth of the staking ratio will benefit the field of liquid staking, as users still face the same issue of capital efficiency even though the staking risk has been reduced. By converting to Lido’s stETH, ordinary ETH holders who occupy the majority of ETH supply can now enjoy the actual returns of ETH while retaining most of the on-chain composability.
3. Growth in Staking Rewards
We acknowledge that, under equal conditions, staking rewards will be compressed with an increase in the staking ratio. However, the current level of on-chain activity is pale in comparison to the bull market levels in history. Any increase in on-chain activity on Ethereum, such as the minting of NFTs and the surge in decentralized trading volume, will drive up transaction fees and MEV. This will help alleviate the compression of base rewards and contribute to the stability of Lido’s income.
4. Growth in Liquid Staking Market Share
We expect the field of liquid staking to benefit from the increased regulatory scrutiny on staking services provided by centralized participants. As of now, the top three centralized staking service providers have relinquished 9.6% of the market share, which has been partially absorbed by their decentralized counterparts. It is worth noting that Lido has been the biggest beneficiary of this trend, with a 2.9% increase in market share. We believe this indicates that stETH, due to its liquidity and composability in DeFi, remains the preferred choice for most stakers.
5. Growth in Lido’s Market Share
Driven by industry momentum, we believe Lido will continue to dominate the market share, thanks to the unique network effects it has established around stETH. Currently, Lido holds 86% of the market share for liquid staking ETH, nearly six times more than the second-largest decentralized participant (rETH).
This is due to the power-law dynamics formed around the liquidity and utility of the stETH token. stETH is the most liquid derivative of staked ETH on DEX. On Ethereum alone, the liquidity of stETH/wstETH is approximately $700 million (paired with WETH and ETH), eight times that of rETH. Therefore, it can be said that among all alternative solutions, Lido best achieves the primary goal of a liquid staking protocol – providing optimal liquidity for stakers.
With a substantial liquidity foundation established, the liquidity moat of stETH is further strengthened as more use cases for the token are unlocked. One example is using staked ETH in liquid staking as collateral in money market protocols. Liquidity is a crucial parameter for assessing whether an asset is suitable as collateral, and only with sufficient liquidity depth can asset liquidation be efficiently handled. Therefore, it is not surprising that stETH is also the most widely used staked ETH derivative as collateral in money market protocols.
6. Value Capture of Lido
Currently, Lido charges a 5% fee on staking rewards, which goes directly into the DAO treasury managed by LDO token holders. This allows us to easily understand the potential revenue of Lido under specific parameters.
Taking into account all the value-driving factors of Lido, we believe that there is still significant growth potential in the fundamentals of Lido in the medium term. Below, we have listed some rough numbers to illustrate the potential market opportunities for Lido.
We expect the staking ratio of Ethereum to reach 30% in the next 12 months as users start to digest the reduced risk of withdrawals.
In this case, the staking yield is expected to decrease to about 4%.
Over time, we also believe that Lido can capture 50% of the market for liquid staking protocols as users demand capital efficiency for their assets.
In addition, if ETH returns to its all-time high of $4,000 (with a market capitalization of $500 billion), it would mean an annual revenue of $3 billion just from the Ethereum liquid staking space.
Assuming Lido slightly increases its market share to 90% in the Ethereum liquid staking market, Lido DAO’s annual revenue could reach $135 million with a 5% fee.
This means that at the current fully diluted valuation of $1.8 billion, the forward FDV/Revenue ratio for Lido is 13.5x.
Once again, we are optimistic about the prospects of the liquid staking space as leading projects offer unique value propositions to a large and growing market. We further outline four key driving factors that support the growth of this industry and provide detailed explanations of how each metric can be expanded further.
We also argue that Lido will continue to dominate the market share, driven by the strong network effects built around stETH, which stem from the token’s liquidity and composability. If our view on the medium-term growth of this industry proves to be accurate, we demonstrate a 5x revenue growth opportunity for Lido from here.
In the short term, the market seems to have shifted away from the initial hype surrounding Shanghai/Capella. This can be seen from the increase in Lido’s total value locked (TVL) and revenue growth rates, and the compression of valuation multiples. We believe that this deviation between valuation and fundamentals will not last forever, and LDO now offers some of the best risk-adjusted returns.