ETH Liquid Staking Derivatives Primer

With Ethereum’s Shanghai hard fork scheduled for March, liquid staking derivatives (LSDs) have been at the forefront of the market. The Shanghai hard fork is the next step of the Merge, which began with Ethereum’s transition from PoW to PoS consensus. The Shanghai hard fork opens the exit queue for those who have been staking ETH since the start of the Beacon Chain, which previously had an unknown exit date. The implementation of a withdrawal process could encourage more ETH holders to stake their assets, putting upward pressure on the stake rate. On the other hand, we could see a decrease in staking demand as investors that locked ETH for the past two years will now be able to withdraw.

LSD protocols, such as Lido, Rocketpool, and Frax, enable participants to stake their ETH with the protocol instead of running their own validators. This reduces the barrier to entry for ETH staking and enables instant liquidity should participants choose to exit their positions. These LSD protocols have an effective business model: encourage ETH deposits, run validators as a service, collect MEV and tips, and charge a flat fee on the ETH rewards. For some protocols, this creates projectable cash flow, making LSD protocols some of the more investable projects in the industry.

Lido is the largest liquid staking protocol with 73% of the market share, but competition among LSDs enhances Ethereum's decentralization. Currently, the market share breaks down as follows: Coinbase 16%, Rocketpool 6%, Frax 1%, and the nine other providers combine for 4%.

While there are many options available for LSDs, each comes with its own architecture, fee structure, and governance token. It is important to understand both an LSD’s fundamental model and liquidity network before allocating capital.

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