Cryptocurrencies like Bitcoin, Ethereum, Cardano and Dogecoin have made some impressive gains since the start of the year, but there are even bigger winners to be found in the weird and wonderful world of DeFi, where the tokens of “liquid staking derivatives” have exploded in value.
LSDs, as they’re called, have emerged as a viable alternative to the expensive proposition of becoming an Ethereum validator, which requires that users stake 32 ETH (around $50,000 at today’s prices) and set up and continuously run a node that stays connected to the network at all times.
With LSDs, users can instead stake any amount of ETH and earn rewards for validating the network. User’s funds are pooled until they’re big enough for that pool to run a node by itself, with the rewards shared between participants. However, there’s another big attraction to LSDs, as the user receives an additional token such as “staked ETH, or stETH” that can then be put to use elsewhere, earning yield in DeFi, for example. According to DeFiLama, the potential returns are massive, with some users earning as much as a 301% return on their original stake.
Considering this, it’s no surprise that the popularity of LSD tokens has exploded in recent weeks due to the coming deployment of a major upgrade to Ethereum, known as Shanghai, that will finally enable stakers to withdraw their deposits. It has resulted in some serious gains, with Lido Finance’s token up more than 50% since the beginning of the year, Rocket Pool up 23% and similar gains elsewhere. Lido remains by far and away the most popular LSD, with an 88% share of the overall market.
The Shanghai update is likely to propel the LSD market to even higher highs, as it will attract new depositors who may have held out until now due to the inability to withdraw their staked coins. However, it may well be that the real winners won’t be the LSDs themselves, but rather, alternative DeFi protocols like Aura Finance and Convex, which play a key role in enabling those massive returns for LSD token holders.
If you’re not aware of Aura Finance, it is what’s known in DeFi circles as a meta-protocol that’s dependent on a parent protocol, in this case Balancer. Rather than lock BAL tokens into one of Balancer’s liquidity pools, users can instead lock their BAL within Aura’s protocol. Doing this, they will receive auraBAL tokens instead of non-transferable veBAL, which can then be traded or staked elsewhere on Balancer to earn yet more rewards.
According to a tweet by Ice v3, a co-founder and “Lead Ape” of DAOJonesOptions, protocols like Aura Finance play a key role in generating the lucrative returns of LSD tokens, and demand will explode once the Shanghai upgrade is enabled.
Ice V3’s theory is that the Shanghai update will result in LSDs liquidity pools shrinking substantially, meaning they will struggle to find the liquidity they need to succeed. This is because Shanghai will result in single-staking ETH becoming more attractive, so LSDs’ liquidity pools will need to increase the amount of yield on offer to remain competitive.
What will likely happen then is that LSD protocols will massively increase the incentives for people to keep providing liquidity to their LPs, Ice V3 claims. And by far the easiest and most efficient way of doing so is through so-called Aura and Convex “bribes”.
According to Ice V3, the likes of Lido, Rocketpool and Frax are already tossing out “six figure bribes” to their users every two weeks for their LSDs, even while we remain in a bear market. Those bribes could well increase by ten-times in the wake of the Shanghai update, and if that happens, Aura and Convex will be the clear winners, as the value of their own tokens stand to make similar gains.