Take stock of the three major trends of LSD projects: decentralization, DeFi enhancement, and full chain

*Author:*0xmiddle

It’s been half a year since Shanghai’s upgrade, and the LSD War continues to heat up. Due to the huge market capitalization of 100 billion yuan, LSD has always been a highly competitive field. In the past, there were old players such as Lido and Rocket Pool, and then new players such as Puffer and Stader joined the table. So what are the new trends and new ways to play in the LSD field? Where is the LSD track headed? What kind of project will gain a greater advantage over the competition? What is the endgame of the LSD circuit?

Decentralization: A Banner of Political Correctness

In July of this year, Lido launched a bombardment of Rocket Pool, pointing out that its contract has sudo permissions, and the team can make arbitrary changes to key parameters, accusing Rokect Pool of not being decentralized enough. Then, in August, Rocket Pool joined forces with five Ethereum LSD protocols including StakeWise to launch an initiative in the name of maintaining Ethereum decentralization, and the staking share of each LSD protocol was limited to less than 22%, which was aimed at industry leader Lido, because only Lido’s staking share exceeded 22%.

Lido did not officially respond to this, but its community supporters countered that Lido should not be seen as a single entity, but as a coordination layer.

Decentralization has always been one of the main narrative points for all DeFi protocols, including the LSD protocol. In the crypto space, “decentralization” is a banner of political correctness, and whoever can prove that he is more decentralized than his opponent can be more justified than his opponent. This “ethos” has indeed contributed to the protocol’s decentralization efforts.

In fact, Rocket Pool was the first protocol to implement a permissionless mechanism at the node level, while Lido has already implemented a staking router mechanism and a two-tier voting system in its V2 release. Both have made some achievements at the decentralization level and are still working on it.

The decentralization of the LSD protocol consists of four layers
One is decentralization at the node level, which refers to technologies such as DVT/SSV, which allow multiple people to control a node;
The second is the decentralization of the protocol selection node level, does the protocol allow nodes to enter freely? How many nodes can be covered? What about their geographical distribution?
The third is decentralization at the level of protocol governance. Who has the final say on the protocol, who decides on protocol changes and upgrades, and who decides how to select nodes? Does the protocol developer have super permissions?
The fourth is the diversification of the LSD protocol, for a public chain, if most of the tokens are pledged in a protocol, it is indeed not a very good thing. Lido really can’t be understood as a mere coordination layer.

In the struggle between Lido and Rocket Pool, the author does not take sides, but feels that this kind of competition and mutual “supervision” is actually promoting the development of everyone in the direction of decentralization. All four levels of decentralization are beneficial.

DeFi Enhanced: The Goal is to Maximize Yield

The underlying rate of return carried by LSD assets depends on the staking rewards defined by the underlying blockchain and the distribution method defined by the LSD protocol (the distribution ratio between validators, protocols, and users). At this point, most LSD protocols are close, with some subsidizing in a variety of ways (e.g. Frax Finance) to increase the underlying yield, but certainly not sustainably. From the user’s point of view, more important than the base rate of return is the “additive rate of return”. The so-called stacked yield is a larger yield that can be obtained through certain DeFi portfolio strategies under the condition of controlling risk.

The most commonly used strategy is revolving staking through a lending protocol. For example, stake ETH in Lido to get stETH, stake stETH to Aave or Compound to lend ETH, and then return to Lido for staking. This operation can be cycled many times until the borrowing rate is equal to the yield of LSD, and with circular staking, the cumulative yield can far exceed the base yield. Essentially, this is a spread arbitrage behavior as well as a leveraging behavior. The risk of this operation is that the liquidation risk is magnified as the number of cycles increases.

Some protocols provide a yield maximization strategy management tool for holders of LSD assets (or even the Leverage Rate of revolving staking). Instead of having to manually recycle staking, LSD holders can do it with one click through these protocols. The more representative ones are DeFiSaver, Cian, and Flashstake, all of which provide diversified DeFi enhancement strategies for LSD, as well as Leverage Rate management tools.

Cian App Screenshot

In addition to revolving lending, users can also use LSD assets for other interest-bearing activities. For example, it can be put into a DEX to provide liquidity, or it can be put into an Index protocol or a yield aggregation protocol to earn interest. Here you can refer to this article “LSD Hides “Seven Returns”, APR-War Ends with TVL 10X Growth”

These LSD-based protocols are sometimes referred to as LSDFi protocols. In the future, the LSDFi protocol and the LSD protocol will converge and intertwine with each other. Some LSD protocols will launch their own LSDFi, or integrate with other LSDFi protocols to provide users with portfolio income strategies in their own interface. In turn, the LSDFi protocol will also integrate with the LSD protocol, allowing users to take underlying assets such as ETH to execute yield strategies with one click.

For LSD protocols, the LSD War should not be regarded as an APR War at the underlying yield level, but should try to promote its LSD assets to be LIstung out in more LSDFi protocols, so that they can be combined to achieve a better stacked yield to meet the needs of Yield Maximers.

Multi-chain: From multi-chain deployment to full-chain architecture

When we discuss LSD, in many cases, we default to ETH LSD, because Ethereum’s market capitalization is huge, and it is Ethereum’s PoS transformation that has contributed to the explosion of LSD, but in fact, LSD is an ancient track. The public chain that adopted PoS consensus earlier had LSD for a long time, but at that time it was still called “staking derivatives”.

In fact, the LSD protocol that developed earlier supported more than one chain, and even the later LSD protocol is constantly expanding to multi-chain to expand its territory.

Lido now supports Solona and Polygon in addition to Ethereum, allowing users to mint stSOL on Solana, or stMatic on Polygon.

Stader supports 7 chains, including: Ethereum, Polygon, Hedera, BNB Chain, Fantom, Near, Terra 2.0
Ankr supports 7 chains, including Ethereum, Polygon, BNB Chain, Fantom, Avalanche, Polkadot, Gnosis Chain.
StaFi, an LSD protocol originating in the Cosmos ecosystem, supports 9 chains: Ethereum, Polygon, BNB Chain, Solana, Atom, HUAHUA, IRIS, Polkadot, and Kusama.

Bifrost, an LSD protocol originating from the Polkadot ecosystem, supports 6 chains: Ethereum, Polkadot, Kusama, Filecoin, Moonbeam, and Moonriver.

Here, Bifrost’s multi-chain strategy is a bit peculiar and different from other LSD protocols. Instead of repeatedly deploying the Bifrost protocol across multiple chains, Bifrost has adopted an entirely new architecture.

Bifrost has its own chain, called Bifrost Parachain, which is a parachain of Polkadot. Bifrost only deploys the main protocol on Bifrost Parachain, and then deploys a lightweight module that supports remote access on other chains. When users mint vTokens on other chains, they will access the main protocol of Bifrost Parachain across chains through remote modules, and after the main protocol mints vTokens, they will be sent back to the user’s chain across chains.

What users feel is that LSD is minted locally, and the process behind it involves back-and-forth cross-chain transfers. According to Bifrost’s article “Taking Bifrost as an Example, Analyzing the New Paradigm of Full-Chain Applications”, the reason why Bifrost is designed is mainly based on the following two factors:

(1) The global state of vTokens minted for all chains is on the Bifrost Parachain, not split on different chains. The unification of data leads to better cross-chain integration. dApps on any chain can be integrated into vTokens of all chains by interfacing with the corresponding remote modules, instead of integrating vTokens of different chains one by one, users can also mint any vTokens on any chain, such as minting vDOT on Ethereum;

(2) The liquidity of all vTokens is on Bifrost Parachain, so that Bifrost does not need to channel liquidity on different chains. Users on other chains who want to exchange vTokens do so by remotely accessing the liquidity pool on Bifrost Parachain. In this way, the problem of insufficient depth caused by liquidity fragmentation is avoided. If the lending dApps of other chains integrate vTokens, they can also complete the liquidation by remotely accessing the unified liquidity pool on the Bifrost Parachain, and the discount rate at the time of liquidation will be smaller because the liquidity is not dispersed.

Bifrost calls this architecture a “full-chain architecture.” Under this architecture, the dApp is only deployed on one chain, not multi-chain, and users and applications in other chains use the dApp through remote access, but the experience is the same as that of using the local chain application. Bifrost believes that this architecture has better cross-chain composability and has the advantage of unified liquidity.

The author believes that Bifrost’s “full-chain architecture” is undoubtedly the correct solution for multi-chain applications, and may be a more general application form in the future. This architecture embodies a new kind of application building thinking, that is, taking multi-chain interoperability as a premise, and designing the parts of dApps on different chains as a whole, rather than simply replicating single-chain applications to multi-chains.

With the excellent cross-chain composability of the “full-chain architecture”, Bifrost can implement more complex DeFi yield strategies that span multiple chains for vTokens. Speaking of which, do readers ever smell an “Intent-Centric”?

However, this architecture has high requirements for cross-chain bridge infrastructure, and must have a sufficiently secure and high-performance cross-chain protocol layer to support high-frequency cross-chain interoperability.

Brief summary

Driven by the crypto world’s culture of “decentralization”, the LSD protocol will continue to develop in the direction of decentralization in order to obtain narrative points and impression points;
Users will not only use the LSD protocol to obtain basic staking rewards, but will also formulate DeFi portfolio strategies through various means such as revolving lending to obtain higher yields.

At this time, the competition between LSD protocols has also shifted to the competition of composability and stacked yields. In order to expand the scope of business, the LSD protocol tends to be deployed on multiple chains, but there is also a “full-chain architecture” that can achieve “single-chain deployment and multi-chain access”, which has better cross-chain composability and the advantages of unified liquidity, representing the future multi-chain application paradigm.

At present, although the top 5 LSD protocols account for more than 80% of the LSD market, and Lido alone accounts for more than 70% of the ETH LSD share, which seems to be unshakable, the wind starts at the end of Qingping, and users’ belief in decentralization, the pursuit of superimposed yields, and the expectation of multi-chain experience from fragmentation to unity will definitely reshape the LSD pattern.