Liquid Staking Derivatives Flow as Ethereum Community Eyes Shanghai

The crypto market is on a roll right now, and for Ethereum users it’s proving a particularly enjoyable trip. Liquid Staking Derivatives (LSD) are seeing massive in-flows from users who can’t get enough of that sweet, sweet yield. With the Shanghai upgrade, which would make staked ETH unlockable, looming, everyone’s on LSD.

DeFi Yields Give Way

2022 killed off many things in crypto, among them DeFi yields. Yield farming, which fueled the first great summer of DeFi, a plethora of food coins, and ominous warnings to stay away from pool 2, feels like a long time ago now. And so it was.

Last year, CeFi and DeFi yields were hammered from double-digit percentage points all the way down to zero. Without UST paying out 20% and DeFi protocols printing native tokens as if FDV was just a meme, there wasn’t much sustainable yield to be had. Given the paucity of farming opportunities, many Ethereans elected to lock their remaining ETH into the new PoS chain and hope that someday soon it would become unlockable. Their wish is about to be granted.

A Lot of ETH at Stake

Ethereum upgrade dates tend to be fluid and by that read they’re invariably pushed back. Nevertheless, it’s been promised that the network’s highly-anticipated Shanghai update will go live no later than September 2023. And when it does, all of the ETH that’s been locked into the Proof-of-Stake chain will become unlockable. When that occurs, stakers face a dilemma: sell their ETH at a loss to recoup some capital, or restake and wait for the market to recover?

The answer to that will depend in part on whether there are juicier yields to be obtained elsewhere. Assuming a new DeFi summer isn’t hitting its apotheosis in Q3 and everyone’s farming dubious memecoins, it may be the case that LSD platforms provide the safest risk-reward ratio.

More than 13% of the ETH supply is currently staked, with Lido accounting for one third of the total. Of the 33% of staked ETH that’s in LSD protocols, 29% is staked by Lido. It has dominated the LSD market so far, aided by its native LDO token that boosts the 4% in base rewards earned by ETH stakers.

LSD governance tokens have been outperforming the rest of the market this year – LDO is up 2x since the start of the month while Rocket Pool’s RPL is up 70%. All of which can be taken as a sign of confidence in Ethereum staking and, by extension, in Shanghai being implemented successfully.

From Shanghai to DeFi

Although the Shanghai upgrade will free up 16 million ETH, it’s likely that much of this will remain staked. Thanks to the creation of liquid staking derivatives such as STETH, stakers can have their cake and eat it. In addition to earning rewards for ETH staking, they can deploy their ETH derivatives in other protocols, providing a second yield boost.

Aura Finance, the incentivization protocol for Balancer LPs, is building a secure reserve layer for DAOs to deploy their treasuries, and this will include liquid staked derivatives. By abstracting the complexity of staking LP tokens into Balancer, Aura makes it easier to obtain Balancer gauge deposits. The ability to accumulate AURA rewards, meanwhile, provides an additional incentive layer. Expect to see more such initiatives that make use of liquid staking derivatives, as the LSD market matures.

More than $10 billion of ETH is now locked into LSDs. Lido’s 73% dominance of the LSD sector is followed by Coinbase Wrapped Staked ETH, Rocket Pool, StakeWise, and Frax Ether. Loading up on the native tokens of LSD providers has proven a profitable move so far this year; Frax’s FXS is up 88% and most other LSD assets are also deep in the green.

When the market was bleeding out last year, access to locked up ETH couldn’t arrive fast enough. Now the LSD market is flourishing and DeFi protocols are dispensing yield on staked ETH, however, Shanghai no longer seems so urgent.