Ethereum continues on its path to becoming fully PoS as it transitions to ETH2. If you intend to hold ETH for the long-term, you’ve likely had to decide whether or not to stake your ETH and help validate the network. While the staking yield prevents you from being diluted, since you would be earning a slice of new ETH emissions, there are a few caveats at the moment. The first is the technical hassle that comes with personally staking while the other is related to liquidity. Simply put, ETH2 staking is one directional at the moment. You can deposit / stake your ETH, but you can’t withdraw it yet. This lock up can be a major detractor for people and understandably so. Not only do they forgo the liquidity, but they also lose out on the utility of that ETH in the mean time. Want to borrow against your ETH to generate DAI? That would be tough to do if said ETH is locked up in staking.
Lido Finance, a liquid staking derivative platform, offers a solution. It gives participants who deposit ETH a 1:1 token known as stETH. This allows users to earn the staking yield from ETH2, reduces the technical burden placed on the individual since Lido handles staking on their behalf and, perhaps most importantly, stETH is liquid. Lido is the current market leader in the staking derivatives space and, as of now, the race isn’t very close. With that said, how has it fared recently and does its market position justify the valuation? Let’s dive into the data to see.
As seen above, Lido has gained significant traction on its liquid staking products, stETH and bLuna, amassing over $4.57 billion in TVL. On Terra, Lido’s bLuna has already captured over 18% of all circulating Luna after just 5 months. Lido plans to implement stSOL and stAAVE, expanding their reach to Solana and more Ethereum based tokens. There are also ongoing discussions around implementing staking derivatives for Polygon and Polkadot. This shows the scope of Lido’s total addressable market – essentially any stake-able asset at both the network and application level.
Lido currently represents 11.85% of all ETH staked in ETH2. On average, over the past 30 days, Lido has captured 51% of new inflows into ETH2. If this trend continues / accelerates heading into the merge, we could see Lido’s TVL balloon higher. This recent uptick in stETH can be partly attributed to Lido’s referral program, which was launched on July 19th. So far, it has attracted just over 125,000 ETH. The program rewards the referrer with 15 LDO tokens for every 1 ETH staked using their unique link. In addition, Lido has been gradually improving the utility of stETH by continuing to add new integrations. For example, Anchor, which is built on Terra, added stETH as collateral on August 10th, and has since attracted 51,000 stETH to its platform (stETH is called bETH on Terra). Other proposals are currently being worked on to implement stETH as collateral on platforms such as AAVE and Maker. This would let users borrow against their staked ETH while continuing to earn a projected base yield of 5.4% of ETH2 staking rewards.
Regarding that last point, let’s quickly note how the ETH2 validator queue impacts stETH yield. ETH2 staking rewards are currently 6%, but stETH is only earning 5%. Two factors impact this – 1) the 10% fee Lido takes as protocol revenue, and 2) the validator queue. Since a significant amount of stETH (60k in 6 days) has been created recently, this skews the staking APR down from 5.4% to 5%. Users start earning rewards on stETH within 24 hours, and thus, a situation arises where early stakers subsidize the yield of later stakers. This issue typically arises after large deposits but subsides once the new ETH is onboarded.
When looking at the competitive landscape, there are other liquid staking derivative providers that offer a similar product. However, Lido is currently the dominant provider, with an ~81% market share. Due to the liquidity and network effects of stETH, we expect Lido to maintain a leading position. Liquidity begets more liquidity, as many users will rationally opt for the most liquid and integrated token when dealing with these derivatives. A counterpoint to this would be the possibility for other liquid staking providers to offer higher staking returns by taking a smaller fee or subsidizing those returns with token incentives. Although this is a possibility, we believe that liquidity is the most important factor when dealing with these derivatives, especially as ETH2 withdrawals are not yet enabled.
The stETH/ETH curve pool is one of the most liquid pools in crypto, with a total value of ~$3.3 billion. Since withdrawals are currently not enabled in ETH2, no natural or set time-based arbitrage presents itself if the peg between ETH and stETH breaks. One must wait for the withdrawals to be enabled on ETH2, which could be months from now. So the importance of a deep and liquid pool for stETH can not be understated. Liquidity and peg stability are also very important for stETH integrations (i.e. AAVE, Maker, Anchor) given that it lowers the risk profile of the collateral they are accepting. The utility could continue to snowball until it reaches a point where it doesn’t make sense for would-be depositors to go with a less liquid alternative.
In late February and early March, we saw the stETH/ETH peg break down to roughly 0.96, as seen in the chart above. This was primarily caused by a decrease in the LDO token price from ~$3 to $0.70. This rapid fall in price led to a significantly lower APR for liquidity providers, causing some automated farming strategies to withdrawal ETH from the pool. Since then, the stETH/ETH peg has held up very well, even during the May 19th market crash. For more information on the peg and stETH stability, please read here.
The Lido community knows how important this peg is, so they incentivize the curve pool with LDO token rewards. 3.75m LDO tokens have been distributed to the Curve pool each month, currently translating to a 5.78% APR.
ETH2 rewards currently sit at 6%, which translates to stETH staking rewards of 5.4% (currently 5% due to the validator queue mentioned earlier). You could earn the 6% by staking yourself but you would be forgoing the liquidity and utility benefits we’ve highlighted throughout this report. For many people, the 10% fee that Lido receives is worth avoiding the headache. That 10% fee generates revenue for the protocol but the DAO does not have sole claim to it. 50% of revenue is paid to validators, meaning that the Lido DAO effectively earns 5% of staking yield. Total protocol revenue, as of writing, hovers around $3.2M and, therefore, cumulative DAO earnings are ~$1.6M.
As noted previously, there are clear network effects for being the leading staking derivative protocol. This naturally leads one to ask the question – what is the max fee that could reasonably be charged before users choose an alternative solution? If stETH dominates competitors and builds a liquidity/integration moat, we could see the 10% potentially moving higher. With that said, we typically see fee compression over time and, if a healthy level of competition emerges, Lido’s margins could move lower.
Lido is currently on an earnings run rate of ~$7.4 million per year, with ETH at $3000, as shown in the table above in green. This sensitivity table lays out various scenarios to play with that show the TAM and potential earnings to the Lido DAO. We’ve displayed a wide array of possibilities due to the impossibility of knowing what many of these variables will actually look like in the future. It is important to note that this table only accounts for ETH staking, and does not include revenue potential for other Lido integrations (stSOL, stAAVE, bLuna, and more stake-able assets in the future).
The current fully diluted P/E, shown above, is quite high at 610x. We believe this is due to two reasons – 1) the market attempting to price in LDO’s large potential TAM and 2) the low float of liquid Lido tokens sitting at just 2.85% of the total supply. Given Lido’s growth trajectory and current market position, we do not think it’s unrealistic for LDO to mature into its valuation at some point in the future, but it is still too early to tell.
Table assumptions not shown:
- ETH supply: 117 million
- Lido “Earnings” (to DAO): 5% of staking reward
- Lido Fully Diluted Valuation: 4.5 Billion (1 billion LDO * LDO Price of $4.5)
- ETH staking rate – Post merge, there will be many factors that go into this; please take a look at some of these resources if you would like to learn more: Look here and here for some ETH staking reward projections.
Lido’s more ‘centralized’ approach to start has played a key role in its recent growth but also represents a risk that users and investors should be aware of. Deposits made before July 15th, 2021 are managed by a 6/11 multi-sig, since then Lido has transitioned custody to a smart contract but cannot extend this to existing deposits yet. With that said, Lido has outlined its path to decentralization in this article here. Lido’s semi-centralized first approach has allowed Lido to capture the lions-share of “decentralized” staking derivative ETH inflows (and this rate is increasing). This go-to-market decision to opt for a step-wise path to decentralization is smart, especially with the potential network effects for the leading staking pool. Rocketpool, for example, opted to start more decentralized, delaying their launch and thus, hindering growth. In addition, structurally, being early in ETH2 is essential for validators. The validator queue can not handle mass inflows; as a result, Lido compounds their ‘first-mover’ advantage through queue priority.
If Lido monopolizes the staking derivative space, this is not necessarily bad for network decentralization (although it could be). As long as there is an equitable distribution of validators in the DAO (and fair withdrawal mechanics), a large staking pool could be fine for Ethereum network security. In the chart above, we have seen a healthy growth in validators onboarding onto the Lido DAO, as well as an equitable distribution of validator rewards – suggesting no single operator has outsized influence. A good sign as of now.
From what we can gather, Lido’s growth and market capture are both clearly impressive; however, the valuation, on a cash-flow basis, could be ahead of itself. With that said, with a TAM of this magnitude, the market is pricing in growth over current revenue. With a multi-chain future and the impending transition towards ETH2, there are strong reasons to see Lido as a leveraged bet on Ethereum, with an embedded call-option on all other staking-based chains gaining market share. This is to say, however, that Lido maintains its market lead over competing staking derivative players. Large unlocks, and low liquidity may dictate short-term price action now but, looking ahead, if metrics continue to flash strength, this should not be an issue.
Something important to highlight is Lido’s upcoming unlocks that begin on December 17th of 2021. Compared to the existing LDO float, these unlocks are very significant.