Written by: Sleeping in the Rain

LSD (Liquid staking derivatives) is the most mainstream narrative in the crypto market in the first half of 2023, or even the entire year. We can see that since January 10 this year, LSD-related tokens have started to lead the gains. The original intention of LSD is to liberate liquidity, that is, to issue liquidity certificates for the liquidity pledged by users, such as what Lido Finance is doing - users can obtain stETH liquidity certificates after staking ETH.

Why do we pay long-term attention to and are optimistic about the LSD-related ecosystem?

To make a simple analogy, if ETH is regarded as the "USD" in the crypto world, then stETH is a "USD treasury bond" with rigid redemption and its own yield. However, whether it is Lido Finance, Rocket Pool, or SSV.Network , they all aim to solve the pain points of Ethereum staking, such as difficulty in setting up nodes, high minimum pledge quantity threshold, low capital efficiency, etc. Until Frax Fiance launched new LSD-related products, the rate of return became a focus of everyone's attention .

frxETH hopes to increase user income through DeFi: users can choose to provide liquidity in Curve's frxETH-ETH liquidity pool, or they can pledge frxETH as sfrxETH to enjoy staking income. Its high income comes from two aspects. Frax Finance shares all the ETH asset staking income behind frxETH with sfrxETH pledgers, and it bribes Convex to make frxETH-ETH LP provide higher income (frxETH holders do not enjoy staking income dividends).

After Frax Finance, this kind of DeFi nesting doll trend is becoming more and more intense. In order to compete for users and funds, the LSD protocol must not only provide liquidity but also have a higher rate of return.

Next, we will focus on the three protocols of Yearn ($YFI), Pendle Finance ($PENDLE), and Aura Finance ($AURA).

Yearn

Yearn is an Ethereum-based DeFi yield aggregator launched by Andre Cronje in early 2020, dedicated to providing users with higher yields on ETH, stablecoins and other tokens.

On February 22 this year, Yearn officially announced that it will launch a new product "yETH", which aims to cover a basket of LSD assets in the form of yETH tokens, thereby diversifying risks and increasing returns.

According to the community's speculation, yETH launched by Yearn is built on first-layer LSD assets such as stETH and frxETH, and yETH can also enjoy the tilt of veCRV governance resources held by Yearn itself. In order to compare the benefits, Twitter @MStiive made a benefit calculation comparison as shown in the figure below.

In fact, as shown in the model in the figure, there is no direct competitive relationship between Yearn and Frax Finance, because the underlying supporting asset of yETH is not ETH, but LSD assets such as stETH and frxETH, and yETH will provide higher returns for stETH and frxETH holders, which will promote the emergence of a huge Ethereum staking flywheel or a new wave of nesting dolls.

Of course, the above are all speculations, and everything is subject to official news.

Pendle Finance

Pendle Finance is a DeFi protocol built on Ethereum, Arbitrum, and Avalanche that allows users to tokenize and sell future returns on certain assets.

How does it work?

Pendle will package the interest-bearing asset tokens into SY (standardized income tokens), and then divide SY into PT (principal tokens) and YT (income tokens). Because the income needs to be calculated, the time scale is involved. In fact, what Pendle is doing is to package SY with time and divide it into PT and YT.

YT is the income of PT in a certain period of time, and PT can be exchanged for SY at a 1:1 ratio after the given period ends. Users can also trade PT and YT through Pendle v2 AMM. v2 AMM adds a time decay factor to the traditional AMM model so that users can trade the income token YT of interest-bearing assets.

Will Pendle's split maximize the income potential from interest-bearing assets?

With Pendle, users can execute more advanced yield strategies, such as purchasing interest-earning assets at a discount - for example, $ETH at a 6.59% discount and $APE at a 20.85% discount.

Alternatively, users can lock up their interest-bearing assets, such as staking ETH in Lido, to obtain PT stETH and YT stETH tokens in advance, and cash out the income token YT stETH token in advance through v2 AMM.

In short, what the LSD protocol does is to help users stake ETH and seek the highest rate of return, while what Pendle does is actually to cash in the future returns provided by the LSD protocol to users in the present.

Currently, Pendle already supports the relevant LSD assets provided by Lido Finance, Rocket Pool, and Aura Finance.

Aura Finance

At present, stETH and cbETH have occupied most of the LSD market share. If smaller participants want to counterattack, the easiest way is to provide more incentives:

1. Higher yields

2. Increase liquidity

3. Integrate DeFi for stronger composability

Aura Finance can do this. It is an ecological income governance platform built on Balancer. Aura is to Balancer as Convex is to Curve.

According to Dune data, Aura holds 26.2% of $veBAL. Through $veBAL governance bribes, LP holders will receive higher returns. The advantage of the Balancer liquidity governance war is that it has a higher bribe capital efficiency than Convex, and Aura will benefit from it in the end.

In the above article, we have shown the results of Frax Finance and Yearn in the Curve liquidity governance war - Frax Finance has 20 million $veCRV, while Yearn has 50 million $veCRV. As time goes by, Lido Finance and Rocket Pool have begun to compete for Balancer's liquidity. As a veteran DeFi protocol, Balancer has a TVL (total locked value) of 1.1 billion US dollars, and Aura Finance will be the beneficiary of the Balancer liquidity war.

Aura Finance mentioned in a tweet that the LSD protocol will start with DeFi in order to increase the utility of LSD assets. For example, it will become a popular collateral type in CDP and currency markets. The reason why ETH can become a mainstream collateral type is that it has extremely strong liquidity, and the protocol can quickly liquidate ETH to ensure that no bad debts occur.

In order to ensure sufficient liquidity for LSD assets, a liquidity war will begin, and Aura Finance will be the leader of this LSD liquidity war on Balancer.

Through Aura Finance, LSD protocols will have the opportunity to start the liquidity flywheel of LSD asset USD trading pairs and altcoin trading pairs. If the flywheel is turned on, the liquidity network effect of LSD assets will occupy the market and become the default trading pair of the mainstream market.

At present, Aura Finance has reached cooperation with almost all mainstream LSD protocols, such as Lido Finance, Rocket Pool, Swell Network, Stakewise, Stader, Ankr and StaFi. It is foreseeable that these LSD protocols will also start the Aura governance war in order to ensure their own market share.

Rocket Pool is the first LSD player to participate in Aura Finance's liquidity incentives. According to official statistics, although the TVL of Lido stETH's altcoin liquidity trading pairs has exceeded 11 million US dollars, rETH's altcoin liquidity trading pairs, which have gained first-mover advantage, have obtained more than 27 million US dollars in TVL.

Frax Finance CEO Sam Kazemian also hinted in the community that he would accumulate AURA positions.

In essence, the war surrounding Aura Finance and Balancer is a battle for liquidity among various LSD protocols.

at last

In this LSD war, we might as well look at this emerging track from two perspectives.

From the user's perspective, the LSD protocol solves the minimum staking limit and higher yields for users. Representative protocols include Lido Finance and Frax Finance.

From the perspective of the LSD protocol, survival and expansion are the protocol's top priorities, which means that the LSD protocol needs to expand its market share to ensure its own survival and development. Yearn and Pendle are more like catalysts for the LSD protocol market. Their choice of the LSD protocol will have the opportunity to promote the corresponding protocols to expand their market share faster. Aura will have the opportunity to become the core protocol for the LSD protocol share competition, and its governance rights may become the object of competition among various LSD protocols.