Author: Pioneers of the Web3 World
This article provides an overall analysis of the LSD track from three dimensions: liquidity staking protocols, liquidity staking DeFi protocols, and decentralized solutions. It also provides a summary analysis of representative protocols, believing that the current three major narrative directions have basically formed and will explode with strong vitality in the upcoming industry cycle, presenting a thriving development trend.
Table of Contents
1. Three Major Narratives Leading the LSD Track
2. Opportunities and Challenges of LS Protocols
2.1. Lido’s Moat and Challenges
2.2.1 Moat: Timing, Location, and People
2.2.2 Challenges: Lido tending towards centralization
2.2. Chasers seeking opportunities through innovation
2.3. Liquidity Staking in Web3 Narrative
3. LSDFi Constantly Innovating for Application
3.1. Stablecoins: Lybra & CrvUSD
3.2. Lending: Alchemix & Instadapp
3.3. Advanced Derivatives: Pendle & Flashstake
4. Two Solutions Empowering Decentralized Staking
4.1. DVT Technology and SSV Protocol
4.2. Re-Staking and EigenLayer Protocol
5. Many Capital Favorites Ready to Erupt
01. Three Major Narratives Leading the LSD Track
After transitioning from PoW to PoS, the staking scale of Ethereum continues to rise. After the upgrade in Shanghai, the staked Ethereum can be redeemed, which has promoted the rapid growth of the staking scale dominated by liquidity staking and formed the situation of “three major narratives leading the development of Ethereum’s LSD track”.
The so-called “three major narratives” as shown in Figure 1-1 refer to the three closely related and focused ecological links and corresponding business forms formed around liquidity staking, or the three LSD branch tracks. Together, they form a relatively complete closed loop of liquidity staking business.
Figure 1-1: Three major narratives of liquidity staking track
Specifically, they are:
LS Protocols and LSD: The protocols that provide liquidity staking services and the derived liquidity staking vouchers LSD, such as Lido’s stETH/wstETH, Frax’s sfrxETH, Rocket’s rETH, Swell’s swETH, etc. Liquidity staking protocols lower the threshold for user participation in staking, improve the efficiency of staking, and create liquidity and returns for staked assets through LSD.
LSD Application Scenarios LSDFi: LSD is a strong consensus income-generating asset with programmability, composability, and free flow characteristics. It can be applied to various DeFi scenarios to meet investors’ different needs for capital liquidity, capital efficiency, return strategies, and risk management, thereby forming various LSDFi business forms. For example, by depositing stETH in Pendle, users can obtain PT (principal tokens) and YT (yield tokens), providing different income and risk strategies.
Decentralized Solutions: In view of the “centralization” trend and risks brought by the rapid development of liquidity staking protocols, currently there are two mainstream solutions to ensure the security and decentralization of blockchain networks. One is DVT technology, with related implementation protocols such as SSV.Network, Obol Labs, etc. The other is Re-staking, such as EigenLayer.
02. Opportunities and Challenges of the LS Protocol
Currently, most mainstream public chains adopt the PoS consensus mechanism, which requires staking tokens on the public chain to produce blocks, validate transactions, and provide security. Therefore, staking tokens on PoS public chains is a necessary application scenario, providing the necessary conditions for the emergence of the liquidity staking ecosystem in various public chain ecosystems. Compared to local staking, liquidity staking not only maintains stable risk-free returns but also provides capital liquidity and diversified returns, which provides sufficient conditions for the rapid development of the liquidity staking ecosystem.
Although the development of the liquidity staking ecosystem is spreading to other PoS public chains, the liquidity staking ecosystem on Ethereum is still the mainstream. It can be said that the development of Ethereum and its ecosystem largely reflects the current development status and trends of the cryptocurrency industry, making it the main target of observation.
Lido is the largest liquidity staking protocol in the Ethereum ecosystem, forming a strong fundamental and competitive pattern around it. On the one hand, for leaders like Lido, the challenge is how to use their existing advantages to maintain and expand market share, prevent share loss or being overtaken, and guard against industry countermeasures caused by excessive centralization. On the other hand, for followers, they need to seize the opportunity, play to their strengths, position themselves accurately, and make innovative breakthroughs in order to get a share of the staking cake or create new demands, expand their territory, and bring about new dynamics.
In the above, we have briefly summarized the cryptocurrency industry, the Ethereum public chain, and the competitive landscape within the Ethereum ecosystem. The purpose is to establish an industry background and fundamentals. This section will be based on these three aspects:
Lido becoming the leader in liquidity staking, even in the entire Ethereum staking, its advantages and challenges will become challenges and opportunities for other LS protocols;
Followers need to judge trends, capture innovative space, refer to Lido’s strengths and weaknesses, and formulate competitive strategies to play to their strengths, seek development opportunities through innovation;
Lido, taking advantage of Ethereum’s transition to PoS, has become the entry point for ETH staking flows. Will the grand narrative of Web3 bring long-term opportunities to liquidity staking protocols in other public chains, especially in the Polkadot ecosystem?
LianGuairt.2.1 Lido’s Moat and Challenges
2.1.1 Moat: Timing, Location, People
Timing refers to events or trends that have a significant impact on industry development.
For Lido, a major event is Ethereum’s transition from PoW to PoS, and a trend is the bull market cycle that started in 2020 and lasted for 1.5 years.
The former makes Ethereum staking a rigid demand, allowing the staking scale to continue to grow. However, staking locks up liquidity, but it creates conditions for the birth of liquidity staking. The latter helps accelerate the expansion of liquidity staking scale because compared to other staking models, Ethereum staked at high prices during a bull market can gain liquidity through liquidity staking, reducing opportunity costs and bringing higher returns, thereby attracting a large number of staking users to enter the liquidity staking market.
In December 2020, after a year of bottom oscillation, the cryptocurrency market started a vigorous bull market. On December 1, 2020, Ethereum began to transition to PoS by launching the Beacon Chain. On December 18, 2020, Lido Finance officially launched liquidity staking for ETH. It can be said that Lido seized the opportunity to enter the market and satisfied the two core needs of capital for liquidity and returns.
“地利” refers to Lido’s positioning, competition and development strategy, as well as network effects.
Figure 2-1 Competition pattern of the Ethereum staking market (July 2021)
The centralization of the node network contradicts the decentralized vision of Ethereum and may bring vulnerability to the Ethereum network. Decentralization is the future, and the industry calls for a “decentralized, trustless” staking pool. Lido appears as the “ETH2.0 decentralized guardian” and captures the hearts of investors in the process of continuous decentralization.
The road to Lido’s counterattack first lies in standing with the users, meeting the staking needs comprehensively, with the core being to lower the staking threshold, create staking asset liquidity, and increase returns. In this process, Lido has achieved accurate positioning as a decentralized, trustless liquidity staking service provider and stood out in competition with CEXs.
As shown in Figure 2-2, as of July 22, Lido occupies 31.8% of the overall Ethereum staking market and 74.22% in the liquidity staking market, winning the throne.
Figure 2-2 Percentage of Lido in overall Ethereum staking and liquidity staking
The correct positioning has given Lido development opportunities, but the key factors for winning the competition and achieving such impressive results should be attributed to the network effects brought by Lido’s staking derivative asset stETH, which includes market share, liquidity, and composability (integration) of stETH.
Reference to our analysis in “LSDFi Activates DeFi and May Gain 50x Growth Potential for Creating Liquidity-driven Returns”:
In terms of market share, Lido’s stETH and wstETH wrapped by stETH account for 88.25% of the entire LSD market, placing them in an absolute leading position.
In terms of liquidity provision, Curve has the largest stETH-ETH liquidity pool, holding 144,342 stETH and 142,547 ETH, with a TVL of $538 million; while Balancer has constructed the largest wstETH liquidity pool, holding 25,312 wsETH and 25,501 ETH, with a TVL of $102 million.
In terms of composability, composability means the possibility of obtaining higher returns and higher capital efficiency, and this is happening with stETH and wstETH. Both stETH and wstETH have gained support from DeFi protocols such as AAVE, Uniswap, Compound, MakerDAO, Lybra, etc. For example, Aave V2 lending pool has collateralized 911,108 stETH, with a TVL of $1.709 billion; MakerDAO wstETH-A has 314,500 stETH, with a TVL of $712 million; Lybra Finance has 201,200 stETH, and its stablecoin eUSD has a TVL exceeding $377 million… stETH and wstETH are widely used in various scenarios such as DEX, lending/CDP, yield aggregators, fixed income, risk-based grading management, leveraged pledging, etc., to meet the needs of users for capital liquidity, capital efficiency, diversified returns, and risk management, injecting vitality into DeFi and ultimately presenting network effects.
Renhe, refers to the joint efforts of the founding team, Ethereum community, and active investment institutions to promote the development of Lido. The founding members are early participants, investors, and entrepreneurs in the crypto industry, mainly from P2P Validator, a professional non-custodial staking platform with rich accumulation in this field.
Community support. Ethereum needs diversified staking models, especially the need for a decentralized, influential staking pool that competes with CEX without the need for trust, in order to balance the adverse effects caused by centralization. Lido has received strong support from Ethereum core developers and the community in the competition. However, when Lido’s market size is in an absolute leading position, the community also expresses concerns about its “centralization” and hopes that it will formulate improvement measures and strategies to guard against systemic risks to the Ethereum ecosystem.
Investment institutions. Lido has completed multiple rounds of financing, with a total financing amount of nearly $150 million. Its investors include almost all active Ethereum investment institutions and a considerable number of DeFi blue-chip founders. Investment institutions represented by LianGuairadigm not only provide strong financial support, but also vigorously promote Lido’s cooperation with numerous DeFi protocols, and guide Lido’s development in governance, decentralization, and development roadmap.
In short, both the founding team, the Ethereum community, and investment institutions have jointly promoted the development of Lido.
2.1.2 Challenges: Lido tends to centralization
Lido appeared as the “decentralized guardian of ETH2.0” and won competition with CEX and other platforms in the staking market, occupying 31.67% of the entire staking market. It has maintained a maximum growth rate of 2% over the past six months, as shown in Figure 2-3.
Figure 2-3 Distribution and growth of the Ethereum staking market
Lido is becoming the center of the staking market and continues to attract stakers to switch to Lido and maintain its dominant position in the market due to factors such as the deep liquidity of its derivative token stETH, its flexibility in composability, lower staking fees, and financial incentives. In addition, CEX has a market share of 18%, and the staking on the Ethereum network is trending towards centralization, which may pose systemic risks to the Ethereum network.
There have been calls within the industry for Lido to impose self-restrictions. Superphiz.eth, a security advisor to the Ethereum beacon chain community, stated that staking service providers should limit their validation ratio to below 22%, while Ethereum’s founder Vitalik Buterin suggested controlling it below 15%. However, the Lido community overwhelmingly voted against the self-restriction proposal in June 2022, with a majority of 99.81%.
The Lido team expressed their views that the core reason for creating the Lido protocol is to prevent centralized entities or exchange groups from dominating the Ethereum staking market. Without Lido, the market would be controlled by centralized exchanges that already have ecosystem power, leading to a worse situation. Lido is taking measures such as DVT technology to make its node operators more decentralized and to ensure their mutual supervision, thereby ensuring the security and decentralization of the blockchain network.
Section 2.2 Followers Seeking Opportunities in Innovation
After Ethereum transitions to PoS, as long as the network operates normally, there will be a permanent demand for staking, which provides a stable income staking market and has attracted many staking service providers to participate. So what are the differences between different service providers and how do they win the market?
Providing staking rewards with comparative advantages may be the most direct market expansion strategy. Therefore, we compared the staking rewards of different service providers. As shown in Figure 2-4.
Figure 2-4 Staking rewards rate and effectiveness ranking of various staking service providers
Comparing the staking rewards rate data of various LSD protocols, Staking Pools, and CEX during all time periods, the top 10 service providers do not have much difference, with an average level between 5% – 5.5%. Therefore, APR is not an important factor causing business differences.
In order to further understand the development of liquidity staking protocols, we selected five liquidity staking protocols from the top 10 market share for horizontal comparison (as of 2023-07-25), as shown in Figure 2-5.
Figure 2-5 Development of liquidity staking protocols
From preliminary analysis, the launch time of each liquidity staking protocol falls between 2020 and 2021, experiencing the same major events such as the transition from Ethereum PoW to PoS and industry cycle changes. However, compared to Lido, other liquidity staking protocols differ significantly in terms of staking market share and the TVL of LST. The possible reasons for such competitive patterns may include:
The decision-making and execution capabilities in response to major industry events and industry cycles;
Different positioning, innovation, and strategies, demonstrating different efficiencies, development stages, and development spaces;
The powerful force of industry capital, actively participating in and exerting important guidance and promotion effects on investment projects at this stage.
Liquidity Staking in the Web3 Narrative
Consider this question: Most current public chains are based on PoS consensus, and staking for each PoS public chain has started from the launch of their mainnet. Moreover, except for ETH, the average staking ratio of other mainstream public chains is above 50%, with staking market value ranging from $2 billion to $9 billion, as shown in Figure 2-6.
Figure 2-6 Data on staking in PoS public chains
But why did liquidity staking only become popular after Ethereum transitioned from PoW to PoS, becoming the mainstream narrative today?
Does it mean that other public chains do not have liquidity staking? Of course not! The Cosmos ecosystem has Stride, pSTAKE Finance, Quicksilverhe, etc. Polkadot has Acala, Bifrost, LianGuairallel, etc. The new public chain Aptos has Tortuga and Ditto, among others. However, the common characteristic is that whether it is the liquidity staking share or the TVL of liquidity derivatives, they are not on a large scale. One obvious reason may be that the DeFi in these public chain ecosystems has not yet developed, and there is a lack of application scenarios for LSD.
But this situation is about to change because, from the perspective of the development of the cryptocurrency industry, each stage has a mainstream narrative. In Bitcoin, it is decentralized digital currency; in Ethereum, it is decentralized finance. In Polkadot, it is Web3, corresponding to decentralized society and decentralized innovative digital economy. Bitcoin, Ethereum, and Polkadot are different public chains, but they also represent different stages of development in the cryptocurrency industry and the required infrastructure. The industry is forming a complete closed-loop from currency and finance to the economy.
Polkadot is built on the PoS consensus mechanism, and staking the native token DOT becomes a necessity for network operation to support various Web3 economic activities. This lays the foundation and provides development space for the development of liquidity staking. In other words, under the grand narrative of Web3, with the maturity and improvement of various aspects of the Polkadot ecosystem, such as stablecoins, DeFi, XCM/XCMP, liquidity staking may have its shining moment.
We also observe that in the Polkadot ecosystem, Bifrost is a scalable, non-custodial, decentralized parachain for full-chain liquidity staking. The concept and implementation of “full-chain” mean decentralization, shared security, and cross-chain interoperability, which align well with Polkadot’s own principles and mechanisms.
Currently, Bifrost has launched liquidity staking for DOT, ETH, FIL, and vGLMR, with a maximum annualized yield of 26.15%, as shown in Figure 2-7.
Figure 2-7: Liquidity staking of Bifrost
Bifrost’s mission is to aggregate staking liquidity from over 80% of PoS consensus chains through cross-chain derivatives and become a service provider for underlying liquidity in the Web3 innovative digital economy. With the development of Polkadot and Web3, Bifrost will also have continuous room for growth.
03, LSDFi constantly innovates for application
In section 4.2 of “Creating liquidity-driven income for strong consensus interest-bearing assets, LSDFi may achieve 50-fold growth,” we conducted a horizontal comparison of the top 10 LSDFi protocols. Here, we focus on analyzing the mechanisms and innovations of several LSDFi protocols in different application directions.
Figure 3-1: Top 10 LSDFi
Figure 3-1 shows the top 10 LSDFi protocols. Among them, Lybra, crvUSD, Raft, and Gravit are stablecoin protocols, accounting for 70.5% of the total market share. IETH and Alchmix are lending protocols, accounting for 12.47%. Pendle, an advanced derivative protocol, accounts for 7.56%. The rest are gambling and staking mining, accounting for 2.51% and 2.17% respectively.
It can be seen that stablecoin protocols dominate the LSDFi market, which is closely related to the wider application scenarios and better liquidity of stablecoins. Lending and advanced derivatives also occupy a considerable share. Next, we will focus on analyzing these three types of projects.
LianGuairt.3.1 Stablecoins: Lybra & CrvUSD
Lybra: Zero minting cost, fully integrated decentralized interest-bearing stablecoin protocol
Lybra Finance is an interest-bearing stablecoin protocol, characterized by zero minting cost and LayerZero full-chain integration. Currently, the Lybra protocol ranks first in LSD TVL, with $356.17m, and the value of ETH collateral is $14.24m. The total amount of eUSD/pUSD in circulation is $250m.
Zero minting cost. Users can deposit ETH or stETH as collateral, and in version 2, they can also deposit rETH, WBETH, and swETH. They can then borrow Lybra’s stablecoin eUSD with a collateral ratio of up to 170%. Lybra does not charge any eUSD minting fees or interest on borrowed amounts, and users can earn an annual percentage yield (APY) of 8% on the interest-bearing stablecoin eUSD.
LayerZero full-chain integration. eUSD can be converted back and forth with peUSD. peUSD is the full-chain version of eUSD supported by LayerZero’s homogeneous token (OFT) standard. This approach allows the eUSD liquidity pool to be full-chain oriented, eliminating the need to build separate eUSD liquidity pools on each chain and avoiding the problem of pool fragmentation. At the same time, it reduces the complexity of bridging and wrapping programs and related transaction costs. This means that Lybra can seamlessly integrate free full-chain functionality into its interest-bearing stablecoin product, and this ecosystem will inevitably move towards a full-chain model, demonstrating economic and technical efficiency.
In version V2, it also includes features such as Flash Loans, Dynamic Liquidity Provision (DLP), Stablecoin Peg Mechanism, Token Burn Mechanism, etc. For more details, please refer to: https://medium.com/@Lybra_Finance/a-simple-guide-to-lybra-v2s-market-leading-features-348068cc1e0
About the source of income. In addition to earning 8% interest by holding eUSD, users can also provide liquidity to the eUSD pool to earn income. They can leverage ETH by using eUSD to purchase more ETH. In addition, eUSD minters can receive Lybra’s governance token LBR incentives, and by staking LBR, users can participate in Lybra’s governance and earn a portion of the protocol’s revenue.
crvUSD: Native CDP Stablecoin based on Curve Finance’s LLAMMA
crvUSD is a decentralized Collateralized Debt Position (CDP) stablecoin protocol launched by Curve Finance, the largest stablecoin trading DeFi protocol, and its loan liquidation AMM algorithm (LLAMMA) plays a crucial role. The highlight of crvUSD as a stablecoin protocol is the LLAMMA algorithm.
When the value of the collateral begins to decline, LLAMA puts the position in a “soft liquidation” state and liquidates a portion of the collateral into crvUSD. As the value of the collateral rises again, crvUSD is converted back into the original collateral assets.
This mechanism is different from traditional liquidation. In traditional liquidation, if the value of the collateral falls below a threshold, the collateral will be liquidated all at once, and the borrower will be left with the remaining stablecoin instead of the collateral assets, resulting in unnecessary losses. But LLAMA’s gradual liquidation can avoid both of these losses.
This model of crvUSD reduces liquidation risk, minimizes liquidation losses, and can attract more liquidity providers, especially for users adopting leverage strategies.
In terms of income, LLAMA’s continuous rebalancing of user collateral will generate more trading volume in the Curve pool, thereby generating more revenue for the protocol and veCRV token holders. In addition, crvUSD loans may also generate borrowing fees, creating a new source of income for the protocol and its veCRV token holders.
Currently, crvUSD ranks 2nd in LSDFi, with a TVL of $85.25m.
LianGuairt.3.2 Loan: Alchemix & Instadapp
Alchemix: Non-Liquidating Self-Repaying Interest-Free Loans
Alchemix currently offers two types of synthetic assets: alUSD and alETH. alUSD is generated by collateralizing Dai, USDC, USDT, and FRAX, while alETH is generated by collateralizing ETH, rETH, stETH, and frxETH.
Alchemix’s implementation mechanism allows users to leverage their deposits to obtain tokenized value and automatically repay the borrower’s loan balance over time using the power of DeFi. Alchemix is considered a new tool for utilizing the time value of money.
Here’s an example to illustrate the principle: For example, when you deposit money in a bank, the bank pays you interest and gives you a credit card. This credit card allows you to spend 50% of your deposit without repayment, and your deposit interest pays for your credit card expenses.
Alchemix is currently deployed on the Ethereum mainnet, Optimism, and Fantom networks. It is currently ranked 10th in LSDFi, with LSD (alUSD and alETH) TVL at $13.52m and the total TVL of the protocol at $57.76m.
Instadapp Lite V2: Smart contract treasury that automatically executes DeFi strategies
Instadapp has three products: Avocado, Instadapp Pro, and Instadapp Lite. Avocado is a Web3 wallet with account abstractions, Instadapp Pro is a lending aggregation platform, and Instadapp Lite is a smart contract treasury that autonomously executes DeFi strategies, currently launched in V2 version.
Instadapp Lite V2 uses stETH as collateral and focuses on various treasury strategies related to stETH. Treasury strategies are supported by Instadapp’s smart contracts, which aim to execute DeFi strategies and earn profits, leveraging multiple lending protocols such as Compound, Morpho, AAVE, etc., to amplify returns.
iETH is the deposit certificate for stETH in Lite V2, so iETH can earn Ethereum staking rewards and also benefit from the powerful Instadapp Pro lending aggregation platform to earn more profits. iETH has higher annualized returns compared to stETH, as shown in Figure 3-2.
Figure 3-2 Comparison of iETH and stETH returns
Currently, Instadapp Lite V2 ranks 3rd in LSDFi, with LSD TVL at $78.37m.
LianGuairt.3.3 Advanced Derivatives: Pendle & Flashstake
Pendle: DeFi yield trading protocol through yield tokenization and AMM
Pendle Finance is a DeFi yield trading protocol deployed on Ethereum and Arbitrum chains. It provides users with more asset utilization and yield opportunities through innovative asset splitting and trading models.
Pendle splits LSD assets such as stETH into principal tokens (PT) and yield tokens (YT), achieving principal and interest separation and independent trading, bringing flexible yield and risk control strategies, such as purchasing assets at a discount to obtain low-risk fixed income or taking long and short positions based on expected yield rates.
Specifically, if the expected yield rate increases, PT can be sold to buy YT; if the expected interest rate decreases, YT can be sold to purchase PT. Alternatively, YT can be directly purchased to obtain staking income rights, eliminating the cost of purchasing principal and improving capital efficiency. Various hedging strategies can also be used to protect investors’ positions, such as future yield rate contracts.
At the same time, Pendle provides an AMM Pool to support the liquidity of PT and YT.
Currently, Pendle ranks 5th in LSDFi, with LSD TVL at $55.75m.
Flashstake: Immediately capture future earnings of invested assets at a fixed interest rate
Flashstake provides users with flexibility in earnings, allowing them to immediately receive prepaid earnings of deposited assets at a fixed interest rate within a set period. For example, if 100 stETH is pledged for 180 days, the Flashstake protocol will immediately give you approximately 2.82 WETH, with an annualized return of about 5.8%.
As shown in Figure 3-3.
Figure 3-3 Flashstake operating mechanism
The 2.82 WETH you receive doesn’t come out of thin air, it comes from the exchange of profits with regular staking mode users. In other words, regular staking users stake their profits at an annual rate of 5.8%, and you can immediately claim the profits from 180 days. As compensation, regular staking users will receive the profits from your assets for the next 180 days. Essentially, you are shorting the yield, while regular staking users are longing the yield. Flashstake brings flexible yield and risk management strategies.
Currently, Flashstake ranks 13th in LSDFi, with an LSD TVL of $3.37m.
In the above, we briefly summarize the LSDFi protocol in different application directions. It can be seen that this track has just started, and the players have already entered or are about to enter, but the bugle has sounded, and they need to win time.
Based on LSD innovation assets and its DeFi innovation, it is like the seeds after the rain in spring, with the vitality and strong tension to break through the soil. After experiencing an industry cycle, just like the arrival of summer and autumn, some sub-tracks will gradually take shape, and some LSD and LSDFi will win the market and establish their leading positions.
04, Two Solutions to Promote Decentralization of Staking
Liquid staking protocols present a situation where Lido is the dominant force, even to the point where two addresses (Lido and Coinbase) control over 45% of Ethereum transactions. This contradicts the goal of decentralization for Ethereum and may even pose security risks to the network.
This year, @DeFi_Taha, @superphiz, @scott_lew_is, and others have successively posted on Twitter, stating that Lido Finance poses a threat to the Ethereum network. The most direct evidence supporting this argument is that there are over 160,000 ETH stakers, but only 29 node operators (May data); moreover, Lido accounts for 30% of the total ETH staking, which means that a small number of entities control 30% of all PoS validators. If an entity exceeds a critical consensus threshold, such as 1/3, 1/2, and 2/3, it can be used to increase value extraction, control block timing, and weaken censorship resistance, posing a threat to the Ethereum network.
In response to the centralization of the staking network, two mainstream technical solutions have emerged in the industry. One is decentralized validation technology (DVT), and the other is Re-Staking.
LianGuairt.4.1 DVT Technology and SSV Protocol
DVT, Distributed Validator Technology, allows Ethereum Proof-of-Stake (PoS) validators to run across multiple nodes, collaborate in real-time to validate transactions, and build a distributed validator network.
The main advantage of DVT technology is that it can form a distributed network of validators, relying on a consensus mechanism (IBFT) to collectively execute the responsibilities of validators, and achieve diversity in Validator Clients, which improves fault tolerance and reduces the risk of validator single-point failures.
Currently, the main protocols that adopt DVT technology are SSV.Network, Obol Labs, etc. DVT technology, formerly known as Secret Shared Validator (SSV), was renamed DVT after the launch of SSV.network. SSV.network is the first practical solution based on DVT technology. Here we will focus on introducing SSV.network.
SSV.Network: Shaping the Future of Decentralized ETH Staking
SSV.network is a validator infrastructure that is trustless, permissionless, and available at all times.
Positioning: Public staking infrastructure. SSV.network is open and built for the public interest as a staking infrastructure. Whether it is developers, individual equity holders, institutions, or service providers, they can quickly and repeatedly use this staking infrastructure, making SSV.network a powerful platform for any staking use case.
Role: Promoting network decentralization. The SSV.network protocol is built on a node network and can distribute the operation of ETH validators among 4 to 13 nodes. This greatly improves the decentralization of the Ethereum validator layer.
Effect: Creating network effects. The reusability of the validator infrastructure saves users time and resources in building and maintaining infrastructure, simplifies development work, and ultimately accelerates innovation in the staking industry. At the same time, the openness and inclusiveness of SSV.network allow more participants to join the network, forming a stronger ecosystem.
Currently, SSV.network is being tested and adopted by multiple liquidity staking protocols. For example:
Lido V2: By integrating the SSV.network solution, Lido V2 will be able to add validators operated by both licensed and unlicensed participants, which is a significant improvement in the decentralization of Lido node operators. In addition, it can reduce the risk of penalties for staked ETH due to server downtime and mitigate related operational risks.
Stakewise V3: Stakewise V3 adopts the SSV solution in a new staking vault. With this solution, the system can distribute the validation workload among multiple nodes, minimizing the risks associated with single point failures or manipulation by a single entity. Through this upgrade, Stakewise V3 becomes a fully permissionless system. Anyone capable of running a node can create their own staking pool, building an open market where stakeholders can choose different operators according to their needs.
Rocket Pool: For Rocket Pool, adopting the SSV solution helps address maintenance and performance issues faced by individual stakers, allowing them to focus on securing the network and earning rewards instead of troubleshooting. At the same time, it provides a fairer competitive environment for individual stakers, bringing new advantages. For example, four distributed nodes can form a DVT cluster within a mini pool, with each node depositing 2 ETH, thereby reducing the staking cost to below 8 ETH requirement and improving capital efficiency.
LianGuairt.4.2 Re-Staking and EigenLayer Protocol
Re-Staking is the process of staking ETH again using the existing Ethereum trust network to protect other infrastructure and middleware layers. This is a new primitive for crypto-economic security and consensus. The representative project based on this concept is EigenLayer.
EigenLayer is an Ethereum-based protocol that introduces re-staking, allowing ETH to be reused on the consensus layer. Users who have staked native ETH or staked liquidity tokens (LST) can choose to join the EigenLayer smart contract to re-stake their ETH or LST, and extend the security of the crypto-economy to other applications on the network to earn additional rewards.
With EigenLayer, Ethereum stakers can re-stake their already staked ETH and choose from various services to ensure security and achieve collective security. At the same time, EigenLayer can reduce the cost of funds for stakers’ participation and significantly increase trust guarantees for individual services.
The protocol mechanism of Re-Staking in EigenLayer is shown in Figure 4-1.
Figure 4-1 Re-Staking protocol mechanism of EigenLayer
Re-Staking is expected to become the consensus security hub of the LSD track, but it also faces some economic and technical challenges.
Vitalik has published an article titled “Don’t Overload Ethereum’s Consensus” pointing out that re-staking is a set of techniques used by many protocols including EigenLayer, where Ethereum stakers can use their staked assets as deposits for another protocol. In some cases, if they behave improperly according to the rules of other protocols, their deposits may also be reduced… While there are some risks in the dual use of validator staked ETH, it is fundamentally fine, but attempting to “recruit” Ethereum’s social consensus for the purpose of the application itself is a different story.
EigenLayer’s founder, @sreeramkannan, also responded to this, stating that Vitalik’s warning aligns with what EigenLayer advocates, emphasizing that the EigenLayer protocol is built on the largest programmable decentralized trust network Ethereum, and splits the trust layer of Ethereum, allowing the components of the trust network to be reused for other purposes. This trust reuse involves economic trust, trust delegation, and ETH validator commitments. EigenLayer is a general platform that allows builders to mix and match these elements to create appropriate trust models.
05. Many Capital Favorites are Gathering Momentum
This article provides an overall analysis of the LSD track from three dimensions: liquidity staking protocols, DeFi protocols with liquidity staking, and decentralized solutions. It also provides a summary analysis of representative protocols, believing that the three major narrative directions have basically formed and will burst with strong vitality in the upcoming industry cycle, showing a vigorous development trend.
Because from the analysis, we can see several typical characteristics of this industry:
Long-term capital supports the formation of fundamentals and future space for real-world application scenarios: PoS public chains, mainly based on Ethereum, provide real and perpetual application scenarios for staking, with relatively stable, continuous, and secure staking rewards. This is the investment preference of long-term large capital and will form the industry’s investment fundamentals and development space. The current total staked amount on Ethereum has reached 47 billion, with a staking ratio of only about 20%, indicating significant room for growth.
Many LST tokens will become the new favorite of capital, and LST and LSDFi will strengthen each other through integration: Although there are many innovations in LST and LSDFi, they are still in the early stage, similar to when protocols like Uniswap and Compound were first launched. While they have driven industry development, the industry will enter the next stage only when they become infrastructure. In future development, many innovative LST assets such as stETH, rETH, vDOT, etc., will receive strong support from capital and become the new favorites of capital. They will integrate into a wide range of DeFi and Web3 application scenarios, forming network effects through factors such as free liquidity and composability. LST and LSDFi will strengthen each other through integration, leading to new competitive situations and development trends.
Innovation and new narratives will bring new prospects for industry development: Some innovations are just beginning and have not yet reached a stage of large-scale development. For example, Pendle tokenizes yield rates and creates yield markets in DeFi, potentially unlocking a huge derivatives market. In addition, under the grand narrative of Web3, Polkadot and its ecosystem will contribute to the development of the next generation of digital economy. Guided by innovation in the development of the next generation of digital economy, how should the LSD track position and develop itself? This may bring about a new landscape.