Liquid Staking Derivatives (LSDs)

What are Liquid Staking Derivatives?

Liquid staking derivatives (LSDs) are tokens that represent staked cryptocurrencies. LSDs give users access to the liquidity of their staked tokens which otherwise would be locked in a staking smart contract. 

What is Liquid Staking and How Do LSDs Work?

LSD is predominately used when staking Ethereum (ETH). 

The process of ETH staking involves depositing ETH tokens in order to be eligible to run a validating node. Validators earn staking rewards typically at an annualized percentage return of 4%.

Since becoming a solo staker is out-of-reach for most individuals due to the high deposit requirement of 32 ETH (about $65,000 at the time of writing), many use staking pools to earn interest on their ETH tokens.

These pools allow users to earn rewards by delegating any amount of their ETH tokens to staking service providers.

What makes pooling solutions like Lido and Rocketpool popular is users receive LSD tokens on a 1:1 basis for their staked ETH.

How to Get LSDs?

There are two ways to get your hands on LSDs:

• You can get LSDs by staking your cryptos on liquid staking platforms. 
• You can buy LSDs on decentralized exchanges and centralized exchanges.

Example of Liquid Staking Derivatives

Let’s take the example of the two most popular liquid staking platforms – Lido and Rocket Pool.

When you stake ETH tokens on Lido and Rocket Pool, you get an equivalent amount of LSD called stETH or rETH, respectively.

These LSDs represent the staked ETH tokens on a 1:1 basis. 

The value of stETH and rETH are equivalent to the market price of ETH. So, you can use these LSDs on decentralized finance (DeFi) platforms for trading, collateral, and lending.

Meanwhile, your staked ETH tokens are deposited and earning interest on Lido or Rocketpool.

You can withdraw your staked tokens anytime you want. Upon withdrawal, your LSDs will be burned, and you will receive an equivalent amount of ETH tokens plus staking rewards.

Benefits of LSDs

• Liquidity: The process of staking cryptocurrencies would be an illiquid one without LSDs. At the time of writing, DefiLlama data showed that the value of total ETH staked on Lido and Rocket Pool stood at over $20 billion. LSDs minted on Lido and Rocket Pool allow billions of dollars to flow back into the crypto economy, creating value along the way, which otherwise would be locked in staking contracts.
• Ease of Staking: LSDs make staking more accessible by allowing users to stake any amount of crypto they want. Most liquid staking platforms do not impose any minimum staking amount.
• DeFi Use Cases: LSDs can be used like any other cryptocurrency. LSDs tend to hold the same market value as their underlying staked crypto, allowing users to use LSDs for crypto swaps, lending, collateral, and more.
• CEX Availability: The popularity of LSDs has seen tokens like Lido’s stETH get listed on centralized exchanges (CEX). CEX listing allows users to easily buy and sell LSDs. 

Disadvantages of LSDs

• Depegging: In the past, we have seen instances where the market price of LSDs has fallen below the market value of their underlying staked cryptos. There is no guarantee that the price of LSDs will always be pegged to their staked assets.
• Withdrawal Delays: Users face waiting time lasting 1 to 4 days when redeeming their LSD tokens on platforms like Lido and Rocket Pool.
• Fees: Conversion of LSD costs gas fees. Moreover, liquid staking platforms charge protocol fees of 5% to 2% of staking rewards. 
• Smart Contract Risks: Liquid staking platforms use smart contracts to receive staked cryptos and give LSD assets in return. Hackers can take advantage of smart contract bugs and vulnerabilities to steal staked cryptocurrencies from liquid staking platforms.
• Ethereum Centralization: Validators are critical members of any proof-of-stake (PoS) blockchain. The popularity of LSD protocols like Lido and Rocket Pool has created centralization risk as more staked ETH is now being controlled by larger staking service providers. The convenience provided by LSD protocols may discourage solo stakers.
• Network Risks: Any issues on the underlying blockchain network, such as transaction congestion and gas fee spikes, can impact the performance of LSD protocols.

What are the Top LSD Protocols?

Here are the top LSD solutions – based on total value locked (TVL) – that you can use to stake your cryptos:

The Bottom Line

The need for liquid staking derivatives came from Ethereum’s transition from a proof-of-work (PoW) blockchain to a PoS protocol.

Since this transition, LSDs have grown to become popular tools that DeFi users are leveraging to maximize their investment return.