The new frontier of DeFi: re-staking, liquidity staking, and LSD tokens

Author: Conor Compilation: vernacular blockchain

Since Ethereum transitioned to PoS, anyone willing to stake ETH has been able to earn roughly a 4% yield.

However, for veteran DeFi folks, it’s not enough to sit on tokens for steady income** and a number of protocols are emerging that allow stakers to earn income from their staked assets and re-stake their tokens. **This could be a huge growth area for DeFi, and there are already many approaches available depending on the type of staking being made.

You can split staking activity on Ethereum into 2 camps by running a validator or using liquid staking derivative tokens.

If you run a validator on the Ethereum network, you lock up a denomination of 32 ETH and run the consensus layer and execution layer clients yourself. For this, you will earn staked ETH rewards deposited directly into your Ethereum wallet.

1.LSD token

Liquid Staking Derivatives (LSD) tokens are tokens issued by services to which you can delegate your ETH and they will stake your ETH. In return, you will receive a token that tracks the value of your staked ETH and can be redeemed 1:1 at any time.

The advantage of the LSD token is that it provides the liquidity of staking ETH, which means additional income opportunities for most DeFi users.

Imagine if you could put your money into a bank savings account and the bank would issue you an equivalent denomination of funds to spend as you wished? This is actually what the LSD token offers you.

**The two most popular LSD tokens are Lido’s stETH and RocketPool’s RETH. The output of both is similar, but implemented differently. **

For stETH, proceeds are paid directly to wallets holding stETH, so from a tax perspective, income tax may be payable. Whereas with RETH, staking rewards are accumulated through the increase in token value, so cumulative rewards are only calculated when tokens are sold.

In order to obtain stETH or RETH, users can deposit ETH through the Lido or Rocketpool websites, or simply exchange ETH for these tokens through a DEX such as Uniswap.

Alternatively, you can directly stake with Rocketpool with a denomination of 16 ETH, not only can you get additional ETH staking rewards, but you can also get Rocketpool’s governance token RPL.

Lido currently limits staking to a limited number of participants on its network. Although they plan to open to the public in the future, this centralized staking service model is the main point of criticism.

2. LSD Yield

Offering yield opportunities is where DeFi has gotten a lot of attention lately, and LSD tokens are a relatively nascent asset class, and services are accelerating to meet their needs. These services offer yields in LSD tokens in addition to the underlying staking yields they already benefit from.

Curve Finance is a popular venue for yielding LSD tokens, and it provides liquidity pools for these tokens, such as stETH/ETH and RETH/ETH, that can be used to earn yield. Liquidity pool rewards on the curve can then be boosted using Convex Finance.

Frax Finance is providing a DeFi ecosystem (stablecoin, DEX, and lending) that also caters for LSD tokens. These Frax stablecoins are fully crypto-collateralized and none of them use fiat currencies like USDC.

On top of that, you also have Origin Protocol’s OETH, which provides a convenient way to earn benefits from many of these DeFi services by simply depositing ETH or LSD tokens into their app.

These DeFi platforms and other LSD tokens offer yield opportunities no different than other stablecoins, as their investors provide liquidity for DeFi services such as automated market making.

**However, mechanisms to re-stake funds are on the horizon, and Eigenlayer is at the forefront of this new DeFi infrastructure. **

3. Related pledge

Eigenlayer provides stakers with income opportunities in the form of resets. Restaking Eigenlayer involves acquiring existing staked assets to secure additional services such as rollup, bridging, and data availability networks.

With Eigenlayer, teams building core services will no longer need to bootstrap trust to secure their systems. Historically, when a blockchain network is launched, a token is required to secure it, while ensuring that the token has sufficient value to prevent malicious attackers from taking a majority stake.

Eigenlayer solves this problem by enabling stakers to re-stake their staked ETH. These restakers can then choose to protect themselves by allocating a proportion of their staked assets to new services launched using the feature layer.

As far as I know, Eigenlayer is unique in the Ethereum ecosystem and will no doubt inspire many new services to launch using their infrastructure as a backbone.

They haven’t launched on mainnet yet, but intend to not only support LSD tokens RETH and stETH, but also allow ETH stakers to deposit their staking rewards directly into the protocol’s smart contracts for staker distribution.

4. Related risks

Ethereum didn’t finalize its transition to proof-of-stake until April, when withdrawals of staked ETH became possible. While Lido, Rocketpool, and other LSD projects have been around for a while, they are still in their infancy compared to other parts of the DeFi ecosystem such as lending, DEXs, and fiat-backed stablecoins.

When you consider acquiring an asset that yields 4% and then reinvesting it for another 4%, and possibly another yield, the returns can be very attractive. However, each reinvestment will exacerbate your overall risk profile.

While this has not happened to LSD tokens so far, we all know that smart contracts get hacked sometimes, or the token value can go to zero. I’m certainly more comfortable with staking ETH at 4% yield, while the overhead of depositing it into a protocol could be more than double that, but it’s not proven compared to the Ethereum network itself.

There are also social factors to consider, such as Vitalik discussed recently.

He argues that if you end up restaking a large portion of the Ethereum validator set who are vulnerable to the social consensus of the applications they help secure, they could end up potentially Affects decisions on the Ethereum mainnet. **This could cause changes in Ethereum as decisions made by completely independent applications running on a network secured by Ethereum re-funding.

It’s also important to remember that in the event of a real liquidity crunch on the Curve Pool or LSD protocol, **can you ensure that you will be able to line up first to withdraw funds safely? **

Restake and LSD protocols are really starting to take off and are important areas of DeFi growth. The sustainability of the current string of projects remains to be seen, but this is an exciting time because it’s only just getting started.

What are your thoughts on double staking and the LSD scheme? Are they the next big thing in DeFi?