Liquid Staking Derivatives - A Beginners Guide

What are Liquid Staking Derivatives?

Liquid Staking Derivatives (LSDs), also known as Liquid Staking Tokens (LSTs), is a new and innovative liquid staking solution within the blockchain world. In a sentence, they represent tokenized versions of staked assets within a blockchain network and offer investors the ability to "double-dip" their earning yields.

This means that while the original assets are locked and staked to secure the network, their tokenized counterparts can be freely traded or used in various DeFi protocols. This provides users with both liquidity and the potential to earn staking rewards.

Understanding the Basics of LSDs

In proof-of-stake blockchains, staking involves locking tokens as collateral to ensure the network's security. These tokens, once staked, become illiquid - meaning they can't be easily traded or moved and are generally locked up for a specific period of time.

Liquid staking derivatives address this limitation. When a user stakes their tokens, they receive an equivalent amount of LSDs, which can be traded or used in DeFi platforms. This system ensures that the staked assets remain productive even when they are locked.

Why are LSDs Gaining Popularity?

The primary advantage of using liquid staking derivatives is the ability to earn yields on assets like Ethereum without concerns about lock-up periods.

This flexibility is a game-changer for many investors as it allows investors to utilize additional DeFi applications for their staked tokens and earn additional yields, effectively "double-dipping" their earning yields.

Why use Liquid Staking Derivatives?

The benefit of using liquid staking derivatives like Lido or Rocket Pool is to earn a yield on your ETH without having to worry about lock-up time, which was previously a concern with previous staking. Liquid staking is now possible because you receive a token that represents the underlying ETH and any staking rewards it has earned.

With this token (e.g. Lido Staked Ether (STETH) you can earn extra yield by depositing it into a money market like AAVE, or borrowing collateral against it and effectively "double-dipping" your yield earnings.

Who Are the Key Players in the Ethereum Ecosystem

On the Ethereum mainnet, there are several notable liquid staking derivatives:

1. stETH by Lido: Currently the market leader in terms of market share and liquidity. However, there are concerns related to centralization with the Lido DAO.
2. rETH by RocketPool: Known for its decentralized nature, it allows stakers to source external capital for running validator nodes with a lower threshold.
3. SETH2 by Stakewise: A smaller player that distributes rewards in a separate token to maintain a close peg to 1:1 with Ethereum.

Other options like Coinbase’s cbETH and FRAX’s sfrxETH are also available. A comprehensive list can be found on platforms like Defillama.

LSDs Beyond Ethereum

While Ethereum is a major player, other blockchains also offer LSDs. Solana, for instance, has stSOL, and Avalanche boasts sAVAX. As the blockchain ecosystem grows, it's expected that most proof-of-stake networks, whether Layer 1, Layer 2, or app-chains, will introduce their versions of liquid staking derivatives.

Choosing the Right LSD

There isn't a one-size-fits-all answer here. While stETH offers high liquidity, rETH is prized for its decentralization. Newer entrants like cbETH provide a centralized counterparty option but retain the core benefits of DeFi LSDs. For those prioritizing yields, frxETH might be appealing, but it's essential to note that Frax Finance is relatively new, and due diligence is crucial.

What is the Best Liquid Staking Derivative?

There is no single "best" liquid staking derivative on Ethereum, as each has its own unique features and drawbacks and the one you choose should fit with your own investment style and risk tolerance.

stETH has the largest market share and the most liquidity, while rETH is considered the most decentralized and it also lets stakers source outside capital to run validator nodes.

There is also, cbETH which is a newer entrant to the market but brings a centralized counterparty option while still retaining the key benefits of LSDs in DeFi.

What is the Highest Yield Provider?

If you are looking for the highest and safest yields (~9% APY), you may want to check out frxETH. However, be mindful that Frax Finance is a relatively new protocol. Ultimately, the best LSD for a particular user will depend on your individual needs, risk tolerance and preferences.

Conclusion

Liquid Staking Derivatives are reshaping the landscape of staking in blockchain networks and offer a compelling blend of liquidity, flexibility, and additional yield rewards.

However, like all investments, they come with risks, especially concerning smart contract vulnerabilities. As this space continues to evolve, it's crucial for investors to stay informed and make choices aligned with their risk appetite and financial goals.