POS dividends disappearing? Analyzing the challenges and future of LSDFi from a data perspective

Are POS Dividends Disappearing? Analyzing the Challenges and Future of LSDFi from a Data Perspective

Author: @Yuki, PSETradingAnalyst

Since the transition of Ethereum to PoS, LSDFi has emerged as a new and exciting track. The reason LSDFi has become the focus of the market is because it has innovatively utilized the Yield Bearing property of liquidity staking tokens. However, as the Ethereum staking rate continues to rise and the staking yield keeps declining, the market space is being squeezed, and the development of LSDFi has reached a stagnant state.

Looking back, we have gone through three stages of development in the LSDFi track. From the competition of liquidity staking protocols to LST becoming a new consensus circulation asset in DeFi, and then to the diversification and large-scale application of LST. And now, we are in an obvious period of development dilemma. This article attempts to clarify the current status of the LSDFi track from the data perspective, and explore the future direction of LSDFi through the analysis of specific projects.

1. The current status of the LSDFi track from the data perspective

1.1 The growth dividend period is over, track development is stagnant, and the decline in yield leads to capital outflow from the track

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According to Dune’s data, the overall net staked ETH amount is leveling off, and the number of Validators waiting in line is decreasing, indicating that the violent staking growth period is over. Correspondingly, the total TVL of the LSDFi track (current total TVL is 839M) has been slowing down since September 26th this year, and even showing negative growth. It can be expected that without paradigm innovation, the LSDFi track as a whole will not experience significant growth in the near future.

There may be two reasons for this situation. On the one hand, the lackluster staking growth within the Ethereum ecosystem and the rise in Ethereum staking rate have led to a decline in staking yield (as shown in the graph below, the base yield is only 3%+), causing LSDFi protocol to encounter a yield bottleneck. The attractiveness of the entire track to capital has declined, resulting in a capital outflow. On the other hand, it is also affected by external factors, with the most severe impact being the continuous increase in US Treasury yields in the high-interest environment in the United States, which has a siphoning effect on funds in the cryptocurrency industry. LSDFi funds are flowing out to US Treasuries and DeFi-related US Treasury derivatives that offer higher base yields.

1.2 Serious Homogeneity, Insularity but Insufficient Innovation of Projects

Since its development, DeFi has two important parts that still shine, as they are the foundational pillars that sustain the entire DeFi ecosystem: lending and stablecoins. In the operating rules of LST, lending and stablecoins are also the most fundamental and viable methods of operation. Based on LST’s interest-bearing properties, LSDFi’s project direction can roughly be divided into the following two categories:

• LST as collateral for lending protocols or stablecoin protocols (represented by Lybra, Prisma, Raft);
• LST interest separation (represented by Pendle);

From the data provided by Dune, we can see that among the top 12 TVL-ranked projects in the LSDFi track, there are 5 stablecoin protocols based on LST. Their basic mechanisms are almost identical: users use LST as collateral to mint or borrow stablecoins, and when the price of collateral falls, the collateral will be liquidated. The few differences lie in the different stablecoins, different LTVs, and different supported collaterals.

After the collapse of Terra and the forced delisting of BUSD due to regulatory risk, there are many gaps in the stablecoin market that need to be filled. The emergence of LST, which has interest-bearing properties, can contribute projects that better meet the decentralized demand of the stablecoin market. However, after the wave passes, there is a general lack of innovation in the track, with projects only competing in terms of LTV, collateral types, and stablecoin yields (most of which rely on project token subsidies, essentially being air). If newcomers do not possess differentiated highlights that challenge previous players, going live will mean reaching the end of their projects.

Pendle, on the other hand, is a relatively unique presence in the entire LSDFi track. Its fixed-rate product naturally suits LST with interest-bearing properties (taking stETH as an example, it can be split into ETH and staking income parts). This is also why Pendle has returned to the market center after Ethereum’s shift to PoS. Currently, Pendle is firmly holding its market share through product iterations, and no strong competitors of the same type have emerged yet.

1.3 The head projects have no pricing power and long-term growth is not guaranteed

For DeFi, we can say that Aave is the leader in lending protocols, Curve is the leader in stablecoin DEXes, and Lido is the leader in Ethereum liquidity staking services. These projects have all achieved pricing power in their respective fields. When I talk about pricing power, I mean the barrier effect formed by “monopoly + strong demand” that creates a certain monopoly effect and brand effect in the market’s strong demand business (leading market share).

So, what does having pricing power mean? I believe it means at least two advantages: excellent business models and guaranteed long-term growth. In summary, a barrier with pricing power is a real barrier.

However, when looking at various projects in the LSDFi sector, even the market-leading project LybraFinance, has not formed its own pricing power barrier. In the V1 stage, Lybra quickly stood out from the crowd of LSD stablecoin protocols with its much higher yield (8%+) compared to Ethereum staking returns, attracting a large amount of TVL. However, the V2 upgrade did not bring effective growth to Lybra and instead, its market share was continuously squeezed by later-launched projects like Prisma and Eigenlayer.

The fundamental reason for the inability of head projects in this sector to have their own pricing power is: first, as protocol layers, these projects are not technically difficult, especially as many LSD stablecoin protocols are directly forked from Liquity. “Low technical barriers” means fierce competition is inevitable. Secondly, LSDFi projects are not issuers of LST themselves; they essentially rely on ETH’s pricing power (staking yield) for liquidity redistribution. Lastly, the differences between projects are minimal, and market share is often influenced by protocol yields. However, the head projects have not formed their own ecosystems to establish absolute pricing power within the ecosystem.

The lack of pricing power actually means that the current prosperity is likely only temporary, and no one has found the key to long-term growth.

1.4 Unsustainable token subsidy yields, stagnant stablecoin liquidity

LSDFi previously attracted a large amount of TVL in a short period of time due to high yields. However, upon closer examination, we will discover that behind these high yields, project tokens are used for subsidies, which results in the premature overdraft of the governance token’s value and the unsustainability of high yields.

Take Raft as an example. Raft launched the Savings Module in V2, attracting R holders to make deposits with a 10% fixed APR. However, the source of this 10% interest is not clearly disclosed (the official explanation is that it is subsidized by protocol revenue). Looking at the entire DeFi sector, projects that can offer a 10% low-risk interest rate are few and far between, which raises doubts about whether the project team simply created R out of thin air to create this seemingly beautiful APR myth.

It is worth noting that the current staking loan cost for Raft (interest rate) is 3.5%, which means that users can earn at least a 6.5% arbitrage by minting $R and depositing it into RSM.

For decentralized stablecoins, liquidity will be the biggest factor affecting their development and scale. Liquity, for example, failed to expand its scale and make a breakthrough in the last bull market because its liquidity could not meet user demand. Currently, DAI is indeed the most liquid decentralized stablecoin. Similarly, most LSD stablecoins currently face liquidity issues, with insufficient depths, limited usability, and insufficient real user demand.

Take eUSD launched by Lybra as an example. The current scale of eUSD is 108M, but the most liquid pool is only the peUSD pool on the Arbitrum chain (peUSD is the full-chain version of eUSD). The depth of the eUSD-USDC pool on Curve is only 207k, which indicates that the conversion between eUSD and centralized stablecoins is extremely inconvenient and will to some extent affect user usage.

2. Looking at specific projects to find breakthroughs in LSDFi’s development predicament

Although the overall LSDFi industry is currently facing a bottleneck in its development, there are still some projects that are striving for change. From these projects, we may gain some insights and ideas on how to overcome the development predicament.

2.1 Developing the ecosystem, addressing the deficiencies in economic models, and establishing pricing power: Examples of Pendle and LybraV2

LSDFi projects currently all have a seemingly unsolvable problem: subsidizing user earnings with governance tokens, which leads to continuous dilution of the value of governance tokens, ultimately rendering them worthless coins.

A feasible and meaningful solution is to develop their own ecosystem, leveraging the power of ecosystem projects to improve the shortcomings of their economic models and establish absolute pricing power within the ecosystem.

2.1.1 Pendle

Pendle is currently the most successful representative of this method. Penpie and Equilibria are both auxiliary protocols that improve PENDLELP earnings based on the Pendle veToken economic model. LPs can earn Pendle mining boost without staking Pendle. The business models of the two are not significantly different, and their main role is to absorb part of the governance token selling pressure for Pendle, making the development of Pendle itself healthier.

2.1.2 LybraFinance

After the lack of significant growth upon the launch of Lybra V2, Lybra also started to actively develop its own ecosystem projects. On October 13th, Lybra officially announced the launch of Lybra War, which serves as the focal point of the next phase.

Lybra’s clear intention to launch Lybra War is due to its recognition of several issues:

1) The high inflation of the governance token LBR caused by maintaining a high APR, with the V2 mining activities leading to excessive short-term selling pressure;

2) Intense competition in the same sector (such as Prisma, Gravita, Raft) resulted in weak growth, without any investors to rely on behind Lybra;

3) Insufficient eUSD liquidity and lower-than-expected adoption of peUSD;

4) Community consensus shaken during the migration from V1 to V2, where there were doubts about the handling of “tokens that were not successfully migrated in a timely manner” (sifu single-handedly decided the entire voting result).

The core of Lybra War lies in the accumulation of dLP and the dynamic matching between dLP and eUSD. In Lybra V2, users must stake a minimum of 2.5% of the value of LBR/ETH dLP holding eUSD to receive emissions of esLBR. Therefore, second-layer protocols in the Lybra ecosystem must obtain more esLBR through yield boosting of esLBR and dLP. Additionally, the allocation power of Lybra War lies in the emission of esLBR between LSD pools, with the main potential demand coming from LST asset issuers and large eUSD minters. A deviation in the depth of Lybra’s LSD pool would be more suitable for small LST issuers to accumulate esLBR, thereby increasing their esLBR voting power.

Currently, the only deep player participating in Lybra War is Match Finance, and an effective competitive landscape has not yet formed. Match Finance primarily addresses two issues (not elaborating on the project mechanics here):

1) The problem of users not receiving esLBR incentives when minting eUSD without dLP;

2) Yield boosting of esLBR and liquidity withdrawal issues.

As protocol layers in the LSDFi sector, Lybra and Pendle are not issuers of LST, thus they both accumulated a large TVL through high APR in the early stages, while also planting a negative seed. In order to facilitate positive future development, they chose to develop ecosystem projects to sustain themselves. In fact, any ambitious LSDFi leading project would follow this development path.

2.2 Micro-Innovations to Improve Differentiated User Experience

As a non-head project, the key to holding on to your own piece of land in a fiercely competitive race is to find your differentiated positioning. Even micro-innovations can reach some vertical users, as long as these users have high stickiness, the project has the chips to survive.

2.2.1 No Liquidation: CruiseFi as an Example

While most projects are still caught up in LTV and collateral categories, some projects have already directly launched “no liquidation mechanisms” to attract traffic.

Take CruiseFi as an example, users can collateralize stETH and mint stablecoin USDx, then exchange USDx for USDC through the USDC-USDx pool on Curve. Lenders providing USDC to the Curve stablecoin pool can earn interest generated during the stETH collateral period.

So how do you ensure that borrowers are never liquidated? When a liquidation occurs:

1) The project will lock a portion of the collateral (stETH) and pledge the locked portion’s stETH yield to the borrower;

2) Positions exceeding the stETH yield will be suspended, ensuring that the pledge yield will always cover the loan interest, meaning the borrower will not be liquidated. However, the downside is that the stETH yield will decrease as the overall ETH collateral rate increases;

3) Regarding the suspended positions, corresponding Price Recovery Tokens (PRT) will be generated. These PRT can be exchanged 1:1 for ETH (only when the liquidation threshold is surpassed). PRT can be freely traded on the secondary market.

The advantage of this approach is that borrowers can extend the time before liquidation or avoid being liquidated altogether. Lenders can earn ETH pledge yield, and PRT holders can receive future growth benefits of ETH. “No liquidation” will have considerable appeal to riskier users during a bull market.

2.2.2 Composite Yield: Origin Ether as an Example

In the DeFi world, yield is always the most attractive narrative, and this iron rule still applies to LSDFi.

Origin Ether was launched in May 2023 and uses ETH and other LSTs as collateral, with 1 OETH always equaling 1 ETH in value.

The biggest difference between Origin Ether and other LSDFi projects is that its sources of yield come from a basket of LST assets such as stETH, rETH, sfrxETH. In addition, OETH uses AMO strategies on Curve and Convex through the OETH-ETH liquidity pool, and supports strategies on Balancer, Morpho, and other ETH-based Curve pools. Through a series of optimized liquidity strategies, Origin Ether is able to provide users with APYs above the market average. This is also the reason why Origin Ether has rapidly accumulated a large amount of TVL in recent months (OETH currently ranks seventh in market share in the race).

2.2.3 Continuing the Nesting: Taking LRTFi based on Eigenlayer as an Example

LSDFi, as a nested version of LSD, has reached a bottleneck stage in its development, but the emergence of Eigenlayer will result in another level of nesting with LRTFi in the future. This is not only another leverage for the entire LSDFi track, but also an opportunity to return to the market center and expand outward.

Although Eigenlayer is currently in a closed testing phase and has not been made available to all users, the market interest has been very high based on the two previous open staking situations.

At the same time, many projects based on LRT (Liquid RestakingToken) have already appeared, such as Astrid Finance and Inception. These projects do not have innovative core logics, but they include LRT in the range of collateral compared to LSDFi protocols. It is expected that this type of competition will reach a white-hot stage after the official launch of Eigenlayer, but it is still in the early stages.

2.3 Capital Support, Bundling with Other Mature Projects, and Enjoying Other Ecological Dividends: Using Prisma as an Example

If a later project wants to surpass competitors in a track full of variables but cannot achieve paradigm innovation, then finding a powerful backer and using the dividends of other projects as their own buff advantage will be an effective way for them to gain a foothold. We can call this behavior “taking shortcuts” or “finding a daddy.”

PrismaFinance is the most typical success case. Compared to grassroots projects like LybraFinance (community-driven and without private funding), Prisma can be considered the rich second generation with a silver spoon. Even before their project was launched, they had already attracted market attention with a lavish press release. The most valuable information revealed in the article is not how different their project mechanism is, but rather their investor list, which includes both DeFi OGs like Curve and Convex, as well as major institutions like OKX and TheBlock.

Subsequently, Prisma’s development path followed as advertised. By bundling with Curve and Convex and obtaining their support, they provided additional rewards to their native stablecoin mkUSD (in the form of CRV and CVX) and achieved a flywheel effect through the veToken model (which controls protocol parameters).

In the third month since its official launch, Prisma achieved an all-time high TVL and surpassed Lybra to become the new track leader with support from JustinSun, worth $100 million wstETH.

2.4 True Paradigm Innovation

From industries to individual racing tracks, after experiencing rapid growth, they always encounter bottlenecks in their development. The fundamental way to solve such dilemmas undoubtedly lies in “paradigm innovation.” Although LSDFi’s development has not witnessed innovative breakthroughs with game-changing capabilities, I firmly believe that as long as the value of Ethereum continues to exist as a strong consensus, there will eventually be paradigm innovations that will reignite the roaring fire of LSDFi.

Reference

1. https://foresightnews.pro/article/detail/38534

2. https://foresightnews.pro/article/detail/28437

3. https://www.panewslab.com/zh/articledetails/o0rocg16.html

4. https://match-finance.gitbook.io/whiteLianGuaiper/

5. https://docs.oeth.com/origin-ether-oeth

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