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Did you know that the total amount of staked Ethereum is worth over 25 billion dollars. That’s more than the GDP of Iceland. But there’s no way of unstaking it yet. It’s completely illiquid. This problem has given rise to a solution called LSD. Now this sounds trippy, but it actually stands for Liquid Staking Derivatives. And in this video, we’ll explore how four different LSDs provide liquidity to staked Ethereum while also reducing the financial and technical barriers to staking and increasing yield. So why stake Ethereum in the first place? Staking provides network security and the yield is an incentive to secure the Ethereum network. As more ETH is staked, the yield goes down. As the price of ETH goes up, the dollar value of the yield also goes up. And if the level of activity on the blockchain goes up, yields are also likely to increase from MEV and transaction priority tips.

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While LSD providers have taken different approaches to solving the illiquidity problem, they all give the staker a new liquid token representing their staked ETH, to handle the operational work of running a node and allow small amounts of ETH to be staked at a time. Unlike the Ethereum protocol, which requires staking in multiples of 32 ETH. But they differ in how they distribute staking rewards. So what are the different types of LSD?

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Number one: Rebasing tokens. With Lido DAO, the biggest LSD provider, when you stake your ETH, you receive stETH 1:1 and every day at 12pm, the amount of stETH you hold goes up, or rebases.

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Number two: Reward-bearing tokens. With both Coinbase and Rocketpool. When you stake your ETH, you receive a token that increases its underlying value over time, but the amount of tokens you hold doesn’t go up.

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Number three: Base token + Reward token. With Stakewise, when you stake your ETH, you receive the base token. Every 24 hours you hold the base token, you receive the reward token, which can be exchanged for ETH, one to one.

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Number four: the Frax team came up with not one, but two solutions to the liquidity problem. When you stake your ETH, you receive Frax’s base token frxETH, which can be added with Ethereum to a liquidity pool. But instead of receiving ETH denominated rewards, liquidity providers receive Curve, Convex and Frax. frxETH can also be staked to receive sfrxETH, which is a reward bearing token. The clever part is, when ETH is staked in Frax, the majority of the ETH is sent to the Ethereum validators, but only staked Frax ETH earns validator yields, which means that it has an increased yield compared to other providers.

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Have my fingers always been this long? Though the yields are attractive, there are still some risks when using LSD. The yield for staking ETH is given as incentivization to take on risk. One of those risks is financial. As yield from staked Ethereum is still dependent on the price action of Ethereum. If the price of ETH stays the same, the yield will add additional value. But if the price of ETH goes down, the value of staked ETH will still go down. It’ll just go down slightly less. Of course, if it goes up, it’ll also go up slightly more, as yields are essentially a leveraged bet on Ethereum. When staking with an LSD, you will also take on the Provider’s Risk. If any of the providers are exploited, lose their peg or encounter a critical protocol bug, it would affect the ability to redeem their liquid staking token one to one. The biggest risk for LSD providers is centralization. When users stake their ETH with an LSD provider, they delegate their ability to build and validate blocks to that provider. The more ETH staked with one provider, the more power it has over the Ethereum network. With a significant stake a provider could abuse MEV extraction, manipulate block timing or even censor transactions.

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The critical thresholds when an LSD provider can launch increasingly severe attacks against Ethereum are at 33%, 50% and 66%. Here’s a quick look at the current market share that each provider has. Lido currently holds around 30% of all staked ETH, though it is decentralized across 27 node operators, it is still a way off from achieving trustless staking. Rocketpool is currently the most decentralized with 1906 operators. Coinbase is the second largest liquid staking provider, is a centralized entity and has no ability to decentralize. Although it has stated it would rather shut down its staking service and censor transactions. Frax and Stakewise both have single digit node operators but are moving towards decentralization in their future updates.

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LSD has solved the illiquidity problem in innovative ways and so has gained significant market share over staked Ethereum. After the Shanghai upgrade when staked ETH will be able to be withdrawn. It’ll be interesting to see if lower technical and financial requirements, increased liquidity and leverage yield are enough to sustain the rise of LSDs dominance. If you want to check out our projections for LSD providers and staked ETH, click on the link in the description below to read the full written research report this video was based on. If you enjoyed the video, give us a like and subscribe. Our next video will be out soon.

Staking Ethereum: Comparing LSD Mechanisms & Risks