After the Shapella upgrade: Yields, competition, and the long-term impact of LSD-Fi

Original Author: Lawrence Lee

***2023; Year; April; Month; 13; Day, Ethereum's; Shapella (execution layer; Shanghai; and consensus layer; Capella) upgrade was officially launched. This upgrade mainly supports pledge;ETH; Retrieve function. At this point, ETH;'s; PoS; process can finally be counted as "completed". In this article, we will discuss "ETH Staking; possible changes in the future rate of return, discuss; Staking; the competitive situation of subdivided tracks, and the potential impact of "LSDfi" on the "ETH Staking" ecology. ***

ETH Staking; past and present

Before we start, we still need to briefly review the "ETH" of "Staking". Unlike the vast majority of "PoS" public chains that are currently online, Ethereum's "PoS" does not support chain-native proxy entrustment, and also limits the maximum pledge size of a single node (profitable) to "32"; ETH. The benefits of this pledge method are obvious. It can minimize the possibility of a single entity controlling the Ethereum consensus directly by controlling a large node, and keep the Ethereum network as decentralized as possible. However, since the operation complexity of node operation is quite high for ordinary users, in addition to the "solo staking" pledged by users themselves, in practice, other "3" types of "Staking" methods have gradually appeared: staking pools , liquid staking; and; cex staking, the characteristics of these 4; pledge methods are as follows:

• Solo staking; that is, the way that pledge users handle all the pledge process and subsequent maintenance by themselves. The main drawback is the high requirements for equipment, funds, knowledge, and network
• Staking pools; to a certain extent, the pledge users are exempted from the need for network and hardware. Pledge users only need to pay a certain fee, and they can ask a professional pledge service provider to pledge the ;32;ETH; provided by themselves to obtain income. At the same time, this method can also ensure that the withdrawal private key is still controlled by the pledger himself, and the control over the funds is also relatively high. However, there are still high requirements for the funds and knowledge of the pledgers. In some classifications, this pledge method is also called; Staking as a service.
• Liquid staking; On the basis of "staas" outsourcing the specific operation of nodes to professional node operators, the pledge pool is used to collect users' "ETH" for pledge operations, so that users can pledge with any amount, and at the same time The pledge pool will issue a pledge derivative to the user; LSD (Liquid Staking Derivatives/ Tokens, we will use "LSD" to replace it below), LSD; has already had a wealth of use cases in "DeFi", and we will discuss it in detail later introduce. Of course, in the liquid staking; mode, essentially all pledged funds belong to the contract of the pledge pool. For pledge users, they need to trust the pledge pool. In some classifications, this pledge method is also called; Pooled staking.
• Cex staking; handles the entire pledge process by "cex;", also allows users to pledge any amount, and usually issues pledge certificates (such as "Coinbase"'s; cbETH, binance;'s; bETH) to users.

Bottom: ETH staking; historical changes in relative shares

*Source: *; (Note: Due to the complexity of statistics, the proportion of solo staking; is difficult to count. In most statistics of pledge classification, there will be a category of "unidentified" (; Unidentified in the above picture), According to the recent Rated; analysis, the current total pledge amount is;6.5%;provided by;solo staker;)

From the above figure, we can clearly see that, except for the 2; months when the beacon chain was just launched, until 2022; 4; months ago, due to the fact that "Cex" naturally has a lot of user managed; ETH, As a natural interest-generating channel, "CEX Staking" quickly became the leader of "Staking", and this situation is not what the Ethereum Foundation and community members want to see. Accompanied by "Paradigm" and other institutional investment; Lido, and "stETH" gradually built good liquidity and composability, Lido; developed rapidly, and subsequently led to the development of the entire "liquid staking" type. Up to now, "liquid staking" has been leading the way in the track.

After "Shapella" was successfully launched, the pledge share of CEX; showed a significant decline, and a considerable number of users who originally pledged "ETH" in "cex" began to switch to "liquid staking" and "solo staking (Unidentified).

According to the specific pledge entities, Lido currently occupies 31.8% of the total pledge market share, ranking from 3rd to 5th; the 3rd centralized exchange, ranking 6th It is another "liquid staking" service provider; Rocket Pool, and the ranking "7-10" is all "Staking pools".

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ETH Staking; future rate of return

The level of staking rewards is the decisive factor for ordinary users to participate in staking. We explore the future; the development of "ETH staking" requires an understanding of the composition of staking rewards and the future development trend. We know that after "Merge", staking Ethereum can not only get the rewards of the consensus layer, but also the rewards of the execution layer. The current "APR" for these two parts totals at "5.4%".

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The rewards of the consensus layer are issued by the Ethereum network; ETH, the release of its rewards rises with the increase in the total amount of pledges, but the pledged "APR" will decline with the increase in the total amount of pledged "ETH". The reward; APR; is; 3.4%;, the current market generally estimates that at the end of this year; ETH; the pledge rate will be around; 25-30%; when the pledge rate reaches; 30%;, the consensus layer's; APR; The reward is roughly at; 2.4%;. This reward is much lower than the rewards of most "PoS" chains, and it is also a manifestation of the Ethereum Foundation's "ETH; circulation minimization" principle.

The reward of the Ethereum pledge execution layer includes two parts,; 1; is the priority fee of the network (Priority fee), which is the part of the ;gas; paid by the user except for being destroyed; 2; is; MEV. The common feature of these two parts is that their income does not increase with the number of pledge;ETH;rise. This part is; ETH staking; the main variable of rewards, which we need to study further.

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*Source: *; Among them, CL_APR; represents the income of the consensus layer; EL_APR; represents the income of the execution layer

Flashbots; counted the total income of the proposer (ie; validator) since the Merge; Lido; also counted; Merge; since; Lido; consensus layer income and execution layer income; APR; ; for detailed analysis.

We can see that after the "Merge", the "APR" of the consensus layer is slowly decreasing with the increase of the total amount of pledges, while the "APR" of the execution layer has a relatively large change, with an average of about "1.5%", which makes the income of the pledge Can reach;5%;. And when the activities on the chain are frequent (such as; 5; months; meme season), the "APR" from the execution layer will even exceed the "APR" of the consensus layer, making the rate of return of pledged Ethereum close to; 10%;. Staking; income as the "risk-free rate of return" of the Ethereum network (see ***Mint Clips | How to define the native benchmark interest rate in the encrypted world? ***;), the attraction for "ETH; holders is huge of.

So how will executive revenue evolve in the future? We first need to understand the priority fee and "MEV" as a percentage of the pledger's executive layer revenue. We can refer to; MEV; data service provider; Eigenphi; for a detailed analysis of the income data of each role in the Ethereum execution layer ecology in the year of 2023: 1; month-2:

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We can see that in the "2" months, the priority fee and the "MEV" basically constitute the ether of the executive layer at a ratio of; 55%;:;45%; (4412; million:; 3472; million) Square pledge income (Validator fee).

We next explore the priority fee and; MEV; future trends.

The priority fee source of the Ethereum network:

In terms of priority fees, since the "EIP-1559" was launched, the current market has undergone a wave of bull-bear conversions. We can see that priority fees are closely related to market popularity. During the "21" bull market, daily The average priority fee can be close to 1000 million US dollars, and during the 22 year bear market, the average daily priority fee is around 800 thousand US dollars. In this year's May Meme Season, the daily average priority fee can be Reached; 300; million dollars or so. In the future, the priority fee will still change with market fluctuations, and this part of the income is based on "ETH" and will continue to fluctuate with the market in the future.

In terms of "MEV", it is more complicated. Except for "MEV" which cannot be fully analyzed from the chain, its composition mainly includes arbitrage, sandwich attack and liquidation. We have not found any information about "MEV" in "Merge". ; The latest trend data for the future. However, the Ethereum Foundation has long held a relatively negative attitude towards MEV. They proposed a PBS (Proposer-builder separation) plan "1; years ago, one of the purposes of which is to eliminate; MEV ; Impact on small staker returns. In the near future, the Research Institute of the Ethereum Foundation; Justin Drake; proposed a plan called MEV burn, which plans to destroy all of the "MEV" in the next; 3-5; years, as another force for Ethereum deflation. Although this plan is still in the planning stage and involves many interest trade-offs, from the perspective of Ethereum's successful transition from "PoW" to "PoS", they have "persuaded" key stakeholders in the ecology to abandon their interests, and Ability to implement the Ethereum roadmap.

Therefore, MEV, which accounts for about 20% of the current total pledge income, will probably shrink or even disappear in the medium and long term because it does not conform to the value orientation of the Ethereum Foundation.

Another notable marginal factor is L2. Driven by the "Rollup"-centered Ethereum roadmap, more and more transactions will be transferred from Ethereum L1 to L2, which will inevitably reduce the "MEV" and priority fees on the Ethereum mainnet. At present, L2's MEV/priority fee is handled by L2 itself, and has nothing to do with the pledgers of the Ethereum mainnet. Especially after the Cancun upgrade further reduces the cost of ETH L2, it may drive the further vigorous development of L2, and the overall handling fee + MEV that L1 can obtain may also be further reduced.

To sum up, in terms of the composition of "ETH staking" income, comprehensively considering the impact of "MEV burn" and L2, when "ETH; pledge ratio reaches; 30%;, the income of ETH; pledge will likely be reduced to; 3 %; level (including; 2.4%; consensus layer revenue and; 0.6%; executive layer revenue). This rate of return will have a significant impact on users' enthusiasm for staking.

Liquid Staking; will still be the mainstream of staking, and its concentration may be further improved

The Shapella; upgrade activates the withdrawal function of "ETH", which makes "Solo staking" and "Staking pool" pledged; "ETH;" also obtain liquidity. The reason why "Liquid staking" can develop rapidly in "21;-22" years is that the core factor is that the "liquid staking" agreement can provide liquidity to "LSD", thus realizing the withdrawal of pledge in disguise. Therefore, the "Shapella" upgrade obviously reduces the advantages of "liquid staking". Although "solo staking" still has a considerable operating threshold, the number of tools currently serving "solo staker" is increasing day by day, and the threshold of solo staking; will gradually decrease, and "solo staking" also maintains the decentralization of the Ethereum network The orthodoxy is strongly supported by the Ethereum Foundation.

Why do we still think that "liquid staking" will maintain its dominant position in the staking track, and even the concentration may be further improved?

The main reason is composability. LSD; has good composability, which means the possibility of obtaining higher returns/higher capital efficiency. Users who participate in "Staking" are naturally sensitive to income, and they tend to choose the pledge method with higher income. Due to the high combinability of "LSD", it actually provides higher returns for pledged users.

At the moment when the basic income of staking is 5.6%, LSD can easily obtain 10% APR. Take ;Lido;'s ;stETH; as an example:

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We can see that at present; stETH LP; can easily obtain; 50%; above; APR, taking into account the capital occupation of matching assets, the total; Coins in; Asymetrix (LSD; pool together) and; Ribbon (option protocol) are also available; 25%; above; APR (although may face some risks), in stack; stETH; itself; 5.6%; ;APR will allow users to make a total profit of staking through;lido;to reach;30%;.

In addition to high returns, stETH; is also widely integrated in DeFi; blue-chip protocols: Maker, Aave; and; Compound; all support; stETH (wstETH) as collateral, and there is no gap with; ETH; in terms of mortgage parameters Not much, in "Curve"'s "stETH-ETH" there is still more than; 1.1; billion dollars of liquidity, which makes holding "stETH" whether it is direct "swap" or mortgage lending can obtain liquidity more conveniently.

These advantages are not available in "solo staking" and "staking pools" through "staking pools". In particular, if the "ETH" pledge rate of return is reduced to only; 3%; as we mentioned above, considering the "solo staker" and; , time and effort, people will most likely choose a simpler and more profitable solution.

Ethereum community users are willing to maintain the decentralization of Ethereum, but they also need to consider the opportunity cost. “Maintaining decentralization of Ethereum is important and cool, but I still want to choose; 30%;”.

LSD; with; LSD-Fi

After the "Shapella" upgrade, many "LSDfi" projects have appeared in the market, and their common feature is to attract users to "LSD" deposits and various financial applications. Many thought we were going to meet one; LSDfi summer.

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We do not discuss the advantages and disadvantages of the specific "LSDfi" project in this article, because in my opinion, LSDfi; does not create a certain business category, but only allows "LSD" to be used as a collateral for many businesses. The business we do is still stable currency, income aggregation, Dex, and interest rate services. Whether their business can be successfully launched still depends on their understanding of the stable currency, income aggregation, Dex, and interest rate service markets. Among the "LSDfi" projects that have actually launched products, we have not seen projects that can get rid of "Fork" and pure "Yield farming" games. Of course, there are still more high-quality "LSDfi" projects that haven't been launched yet, and we expect more innovations based on "LSD" to appear in the future.

What we want to discuss is the impact of "LSDfi" on the entire "Staking" industry.

Holders of LSD; must have two characteristics: they hold; ETH; and have an understanding of "DeFi" on the chain; they are sensitive to yield (so they will pledge). And these two characteristics make them the target users of any DeFi entrepreneurs on the Ethereum network: hold on the chain; ETH, so they can operate on the chain, and they may also have an understanding of their business; they are sensitive to income , so the behavior of this part of users can be influenced through incentives. In fact, when "DeFi" has developed to today's relatively mature stage, there are still many "ETH" holders who only hold "ETH" on centralized exchanges.

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Based on this wave of "LSDfi;", there will be more and more "LSD;" projects initially launched, and they all have brand-new tokens, which means they have a brand-new market budget. What happened on "unshETH, Agility, Lybra" will be staged in "LSDfi" within 3-6 months in the future, and LSD will continue to appear far more than "ETH" on the chain ;APR, will likely form a self-reinforcing flywheel effect between ;LSD; ;LSD;more and more;LSD;will incentivize;DeFi;the agreement targets these users, and attracts these users by providing high returns so as to pass the cold start phase of the agreement.

In the end, all "DeFi" protocols may be called "LSDfi" in a broad sense, because they all support "LSDfi" more or less (in fact, except for a few stablecoin protocols, most of the "DeFi" protocols have been associated with ;LSD;). Apparently, LSD;can capture;LSDfi;of;beta. The popularity of LSDfi; will further promote the proportion of "liquid staking" in the "staking" of the overall track share.

The attitude of the Ethereum Foundation

On issues related to "staking", the attitude of the Ethereum Foundation is as follows:

1. Don't want too much "ETH" to enter; staking, too much "ETH; to enter; On the other hand, it will reduce the economic bandwidth of Ethereum (economic bandwidth, a concept proposed by "Bankless", refers to the liquid market value of "Layer; 1", which supports all "Dapp" operations on it. Base).

2. Negative view of;MEV; For every Ethereum pledger, MEV; is a huge reward that may fall from the sky at any time with a very low probability. Without intervention, it is easy to be forced to centralize (such as; BTC; and; ETH; in; PoW; Mining pool), thus building a new alliance (such as the current; MEV-boost) on top of the Ethereum consensus, resulting in unnecessary and not necessarily secure complexity at the consensus layer. In the medium and long term, the Ethereum Foundation will promote the destruction of; MEV; from the privilege of a few validators to a common reward for all; ETH; holders.

3. I don't want to see an overly powerful; LSD, powerful enough to "replace" ETH on the Ethereum mainnet. This will also bring more unnecessary security risks to "ETH".

The main line behind the idea of Ethereum is to maintain a decentralized consensus layer without affecting the characteristics of "ETH" itself as the main mortgage asset of the Ethereum network. The impact of the protocols built by workshops.

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stETH; is currently the largest non-native non-stable currency asset on the Ethereum network. Ranking higher than ;stETH;;USDT; and;USDC, their use cases are indeed very extensive, but they are essentially maintained by the credit of;Tether; and;Circle; Ethereum has a big impact, but does not consume Ethereum credits.

However, the special feature of "stETH" is that it has been integrated by almost all "DeFi" protocols as collateral similar to "ETH". We might as well do a thought experiment. If the contract of "Lido Finance" is attacked, all the private keys of "Lido" in the beacon chain will be controlled by hackers. So will Ethereum need a hard fork like the ;the DAO; event?

No one wants to see this, so we can understand why the Ethereum Foundation needs to work hard to support; solo staking, why the Ethereum community discusses whether to limit the scale of Lido; it is not difficult to understand why Lido Take decentralization as your next main task. But the problem is that the emergence of a large "liquid staking" service provider is not deliberately done by some evil centralized organization, but the natural result of market games. Even if the Ethereum Foundation/core community can control the scale of "Lido" in some form, there will be "Mido" or "Nido" appearing and becoming the Schelling point of that pledge.

There are two worlds before us:

1. One is what the Ethereum Foundation hoped to see in the original design: ETH; the proportion of pledge is not high enough to maintain security, most of; ETH; is still used as mortgage assets on the main network to maintain various; Dapp; The normal operation of , the main body of the pledge is; Solo staker;

2. The other is what we are actually likely to see: due to the presence of one (or several) powerful ;LSD; more ;ETH; Become the collateral of each; DAPP; to a large extent, this (or these several) LSD "becomes" ETH.

From the current point of view, the probability of the latter appearing is much higher.

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