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DeFi Activity and the Emergence of Liquid Staking Derivatives
While Ether’s DeFi activity has seen a dip in the recent bear market, a new trend is brewing within the space involving liquid staking derivatives (LSD) tokens. This new trend has the potential to rejuvenate Ethereum’s network activity and could be a catalyst for a new bull market.
Currently, Ethereum’s yearly staking reward of 4% poses competition to DeFi, as pointed out by Glassnode analysts. DeFi protocols' gas consumption has also seen a decrease from 34% in 2020 to the current 8%-16%, with NFTs taking up the majority share of 25% to 30%, as per Glassnode's recent report.
Challenges Facing DeFi Tokens
The supply-weighted price index for DeFi in USD and ETH by Glassnode has noted a 90% decline since early 2021. Furthermore, the renowned DeFi "Blue-Chips," a selection of governance tokens from leading DeFi protocols like Uniswap, MakerDAO, Aave, Compound, Balancer (BAL), and SushiSwap, have experienced an 88% reduction in their market capitalization from the peak of $45 billion in May 2021.
The performance of DeFi blue chip tokens during bullish market periods has been less impressive than ETH and their decline during the bear phase has been more severe. As staking of ETH now provides a yield of 4%, this sets a new benchmark rate for ether investors that token returns will need to outperform.
The Attraction of Staking
Lending protocols like Aave and Compound presently offer yields between 2-3% on lending stablecoins and ether, which falls short of the yield from ETH staking. Additionally, DeFi protocols like Aave and Compound carry smart contract risks that are mitigated with proof-of-stake (PoS) validators.
Post the Shapella upgrade in April 2023, staking has gained significant traction among Ethereum investors as it permitted redemptions from the staking contract. By the close of May, Ethereum users had staked 21.63 million ETH, worth $40.021 billion, representing 18% of Ethereum’s total supply.
The Rise of LSD Platforms and LSDfi
LSD platforms, including Lido and Rocket Pool, constitute one third of this enormous market. These platforms provide tokenized representations of staked ETH, permitting investors to benefit from the staking yields without compromising on liquidity.
An emerging trend in the Ethereum investment space is LSD-fi, or LSD financialization, which aims to employ the liquidity offered by LSD tokens within DeFi applications. LSDfi essentially harnesses the liquidity of LSD tokens for higher yields by deploying them into DeFi lending protocols and liquidity on exchanges.
Could LSDfi be the Game-Changer for DeFi?
With a considerable amount of ETH staked on LSD platforms, LSDfi could potentially breathe new life into DeFi activity. A Dune analytics dashboard by data analyst Defimochi highlights that the total value locked (TVL) in LSDfi protocols has soared to $411 million since mid-May. Some of the significant players in the sector include Pendle Finance, Lybra Finance, Curve Finance, and Alchemix Protocol.
While new applications like Lybra Finance and Pendle Finance are capitalizing on the liquidity provided by LSD tokens, investors should tread carefully. As seen previously with DeFi, these protocols can carry smart contract risks and the possibility of rug pulls, underlining the inherent risks associated with the higher returns that LSDfi offers.
