Why Ethereum Bulls Are Turning To LSD

Decrypting DeFi is Decrypt’s DeFi email newsletter. (art: Grant Kempster)

The second week of the new year was a heady week for the coins, with Bitcoin, Ethereum and Solana making serious gains.

However, if we zoom in further, the market’s biggest gainers are none other than liquid staking tokens, also known as “liquid staking derivatives” (LSD).

The tokens behind projects like Lido Finance (+50.3%) and Rocket Pool (+23.3%) have surged in recent days. The reason? Ethereum developers are rolling up their sleeves for a major network upgrade: Shanghai.

Let’s break that down.

Since the merger last September, Ethereum has moved to a proof-of-stake (PoS) consensus mechanism. This means no more energy-guzzling mining machines, and so-called validators instead. Validators and miners basically do the same thing, verifying transactions and making sure there’s little mischief in the chain.

Still, validators are better distributed than miners because of their lower capital and maintenance costs. Instead of having to buy a multi-million dollar mining company somewhere in Siberia and hire a team of engineers to keep those miners working non-stop, all you need to become a validator is 32 Ethereum and the know-how to a single node that is always connected to the Ethereum network.

However, 32 Ethereum is still around $45,000 at the time of writing, so it’s a hefty amount. And that’s where these LSD projects come in.

They let you stake any amount of Ethereum you can afford. In return, they give you another token (Lido’s stake ETH token is called “stETH”, for example) that can be used elsewhere.

Today, according to DeFi Llama, you can earn as much as 301% if you stake your stETH in certain parts of the ecosystem. Its widespread adoption in DeFi is probably one of the reasons it is so popular; of this type of offering (excluding centralized, exchange-based equivalents), Lido controls more than 88% of the LSD market.

Beacon chain depositors over time. (Source: Dune)

Compared to centralized platforms like Kraken, Bitcoin Suisse or services like Staked.US, Lido still holds 28.9% of the market. Runner-up Kraken has only 5.57%.

What does this have to do with the Shanghai update?

Like the merger, Shanghai is another major upgrade to Ethereum. It will bundle several important improvements, but the main one is the one that will finally allow the aforementioned strikers to withdraw their positions from the network. Currently that is not possible (and last year there were a lot of people wondering if it would ever happen).

This meant that strikers who stormed into the Beacon Chain with their 32 Ethereum or a liquid-staking alternative with a smaller amount were effectively depositing money with only the promise that one day they could withdraw.

Now, however, that promise seems to be approaching reality (and significantly reducing the risks of strikers).

For more evidence of people rushing to try LSDs, look no further than Lido is overtaking DeFi’s unofficial central bank MakerDAO as the largest DeFi protocol.

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