Three major trends in the LSD track decentralization, enhanced DeFi, and full chainization.

Three Major Trends in the Decentralization of LSD Tracks, Enhanced DeFi, and Full Chainization.

Author: 0xmiddle Source: X (originally Twitter) @0xmiddle

It has been half a year since the Shanghai upgrade, and the LSD War is still heating up. Due to the tremendous market value of billions, LSD has always been a competitive field.

There are old players like Lido, Rocket Pool constantly bickering, and new players like Puffer, Stader joining the table.

So what are the new trends and strategies in the LSD field? Where will the LSD track go? What kind of projects will gain a greater advantage in the competition? What is the endgame of the LSD track?

1. Decentralization: A politically correct banner

In July of this year, Lido launched an attack on Rocket Pool, pointing out that its contract has sudo permissions, allowing the team to make arbitrary modifications to key parameters, accusing Rocket Pool of not being decentralized enough. Then in August, Rocket Pool, together with 5 other Ethereum LSD protocols including StakeWise, launched an initiative in the name of maintaining Ethereum decentralization, limiting the staking shares of each LSD protocol to below 22%. This initiative specifically targets the industry leader, Lido, because only Lido’s staking shares exceed 22%.

Lido did not respond formally, but its community supporters argued that Lido should not be seen as a single entity, but as a coordinating layer.

Decentralization has always been one of the main narrative points for all DeFi protocols, including LSD protocols. In the crypto field, “decentralization” is a politically correct banner. Who can prove that they are more decentralized than their competitors can confidently claim superiority. This “atmosphere” has indeed promoted efforts in achieving decentralization in protocols.

In fact, Rocket Pool was the first protocol to implement a permissionless mechanism at the node level, while Lido has implemented Staking Router mechanism and dual-voting system in its V2 version. Both have made progress in terms of decentralization and are still working on it.

Decentralization of LSD protocols involves four levels:

  • The first level is the decentralization at the node itself, referring to technologies like DVT/SSV that allow multiple people to control a node;

  • The second level is the decentralization in the protocol’s choice of nodes, such as whether the protocol allows free access to nodes, how many nodes it can cover, and their geographical distribution;

  • The third level is decentralization in protocol governance. Who has the final say in the protocol, who decides the changes and upgrades of the protocol, and how to choose nodes? Do protocol developers have superpowers?

  • The fourth level is the diversification of LSD protocols. For a public chain, it is not a good thing if the majority of tokens are staked in a single protocol. Lido cannot be truly understood as a mere coordinating layer.

In the struggle between Lido and Rocket Pool, the author does not take sides, but only feels that this kind of competition and “supervision” actually promotes everyone’s development towards decentralization. Decentralization on four levels is beneficial.

2. DeFi Enhancement: The goal is to maximize yield

The basic yield carried by LSD assets depends on the staking rewards defined by the underlying blockchain and the distribution method defined by the LSD protocol (the distribution ratio between validators, protocols, and users). In this regard, most LSD protocols are similar, and some protocols will use various methods to subsidize (such as Frax Finance) to increase the basic yield, but it is definitely not sustainable.

From the user’s perspective, “yield stacking” is more important than the basic yield. The so-called yield stacking refers to the greater yield that can be obtained through certain DeFi combination strategies while controlling risks.

The most commonly used strategy currently is to use lending protocols for cyclic staking. For example, in Lido, staking ETH to obtain stETH, pledging stETH to borrow ETH in Aave or Compound, and then returning to Lido for staking. This operation can be repeated multiple times until the borrowing interest rate is equal to the yield of LSD. By cyclic staking, the yield stacking can far exceed the basic yield.

Essentially, this is a form of interest rate arbitrage and leveraging behavior. The risk of such operations is that as the number of cycles increases, the liquidation risk will be amplified.

Some protocols provide yield maximization strategy management tools for LSD asset holders (they can even manage the leverage rate, that is, the number of cycles, for cyclic staking). LSD holders can complete the process in one click through these protocols instead of manually performing cyclic staking. Representative examples include DeFiSaver, Cian, Flashstake, which provide diversified DeFi enhancement strategies for LSD and also offer Leverage Rate management tools.

In addition to cyclic lending, users can also use LSD assets for other interest-bearing activities. For example, providing liquidity in DEX or earning interest in index protocols and yield aggregating protocols. You can refer to this article: “Hidden “Seven-Fold Yield” of LSD, the Final Outcome of APR-War is a 10X Increase in TVL”

These protocols that are based on LSD assets are sometimes referred to as LSDFi protocols. In the future, LSDFi protocols and LSD protocols will merge and intertwine with each other. Some LSD protocols will launch their own LSDFi or integrate other LSDFi protocols to provide users with combined yield strategies on their own interface. On the other hand, LSDFi protocols will also integrate LSD protocols to support users in executing yield strategies with basic assets such as ETH in one click.

For the LSD protocol, we should not view the LSD War as an APR War on the basis of yield. Instead, we should try to list its LSD assets in more LSDFi protocols, so that they can be combined to achieve higher stacking yields and meet the needs of Yield Maximers.

3. Multi-chain: From multi-chain deployment to full-chain architecture

When discussing LSD, we often default to ETH LSD because of the huge market value of Ethereum, and the transformation of Ethereum’s PoS has facilitated the explosion of LSD. However, in reality, LSD is an ancient track. PoS-based public chains had LSD derivatives early on, but it was called “Staking Derivatives” back then.

In fact, early LSD protocols supported more than one chain, and even newer LSD protocols are continuously expanding to multiple chains to broaden their horizons.

Currently, Lido supports not only Ethereum but also Solana and Polygon. Users can mint stSOL on Solana or stMatic on Polygon through Lido. Stader supports 7 chains, including Ethereum, Polygon, Hedera, BNB Chain, Fantom, Near, and Terra 2.0. Ankr supports 7 chains, including Ethereum, Polygon, BNB Chain, Fantom, Avalanche, Polkadot, and Gnosis Chain. StaFi, an LSD protocol originated from the Cosmos ecosystem, supports 9 chains: Ethereum, Polygon, BNB Chain, Solana, Atom, HUAHUA, IRIS, Polkadot, and Kusama. Bifrost, an LSD protocol originated from the Polkadot ecosystem, supports 6 chains: Ethereum, Polkadot, Kusama, Filecoin, Moonbeam, and Moonriver.

Here, Bifrost’s multi-chain strategy is somewhat unique compared to other LSD protocols. Bifrost does not deploy the Bifrost protocol repeatedly on multiple chains. Instead, it adopts a completely new architecture.

Bifrost has its own chain called Bifrost LianGuairachain, which is a parachain of Polkadot. Bifrost only deploys the main protocol on Bifrost LianGuairachain and deploys a lightweight module that supports remote access on other chains. The LSD minted by the Bifrost protocol is called vToken. When users mint vToken on other chains, they will cross-chain access the main protocol of Bifrost LianGuairachain through the remote module. After the main protocol has minted vToken, it will be cross-chain transmitted back to the user’s chain.

What users experience is the minting of LSD completed locally, while the underlying process includes round-trip cross-chain transmission. According to Bifrost’s article “Taking Bifrost as an Example to Analyze the New Paradigm of Full Chain Applications,” Bifrost’s design is mainly based on the following two factors:

  • The global state of vTokens minted on all chains is on Bifrost LianGuairachain, not fragmented across different chains. Unified data brings better cross-chain integration. Any dApp on any chain can integrate with the corresponding remote module to integrate with vTokens on all chains, without needing to integrate different chains’ vTokens one by one. Users can also mint any vToken on any chain, such as minting vDOT on Ethereum.

  • All the liquidity of vTokens is on Bifrost LianGuairachain, so Bifrost does not need to guide liquidity on different chains. Users on other chains who want to exchange vTokens do so by accessing the liquidity pool on Bifrost LianGuairachain remotely. This avoids the problem of insufficient depth caused by liquidity fragmentation. If lending dApps on other chains integrate vTokens, they can also complete liquidation by accessing the unified liquidity pool on Bifrost LianGuairachain remotely. Since liquidity is not fragmented, the discount rate during liquidation will be smaller.

Bifrost refers to this architecture as “Full Chain Architecture”. Under this architecture, dApps are only deployed on a single chain, without being deployed on multiple chains. Users and applications from other chains can access and use the dApp through remote access, while still having the same experience as using a local chain application. Bifrost believes that this architecture offers better cross-chain composability and the advantage of unified liquidity.

The author believes that Bifrost’s “Full Chain Architecture” is undoubtedly the solution for multi-chain applications and may be a more universal form of application in the future. This architecture embodies a new thinking in application development, which takes multi-chain interoperability as a prerequisite and designs the dApp on different chains as a whole, rather than simply replicating a single-chain application on multiple chains.

With the outstanding cross-chain composability of the “Full Chain Architecture”, Bifrost can implement more complex DeFi yield strategies that span multiple chains with vTokens. Do readers smell a scent of “Intent-Centric” here?

However, this architecture requires higher requirements for cross-chain bridge infrastructure. There must be a secure and high-performance cross-chain protocol layer to support high-frequency cross-chain interoperability.

# Summary

In the culture-driven world of “decentralization” in the crypto space, LSD protocol will continue to evolve towards decentralization to obtain narrative points and impressions;

Users’ use of the LSD protocol is not limited to obtaining basic staking rewards, but they will formulate various DeFi combination strategies through activities such as circular lending to achieve higher yields. At this point, competition between LSD protocols also turns towards the competition of composability and stacking yields;

In order to expand their business scope, LSD protocols tend to be deployed on multiple chains, but there is also the option of the “Full Chain Architecture”, which enables “single-chain deployment, multi-chain access”. It offers better cross-chain composability and the advantage of unified liquidity, representing the future paradigm of multi-chain applications.

Competition and innovation in the LSD field are still ongoing. Currently, although the Top 5 LSD protocols account for over 80% of the LSD market, with Lido alone occupying over 70% of the ETH LSD share, seemingly unshakable, a strong wind starts with a tiny blade of grass. Users’ belief in decentralization, pursuit of stacking yields, and the expectation for a unified experience across multiple chains will definitely reshape the landscape of LSD.