Lido Finance — stETH Use Cases
DeFi space has experienced explosive growth since its inception. Several networks have contributed to the growth of this space with Ethereum being the leader. It built the foundation for the DeFi ecosystem with its smart contract functionality.
A key factor in the inexorable growth of DeFi has been interoperability. All platforms within the DeFi ecosystem are aware of the importance of collaboration, interaction, integration, and interoperability. In order to ensure the continued growth of DeFi, a new wave of projects is being built on top of the existing infrastructure. This includes projects designed to solve problems that hindered past protocols. Moreover, these protocols have reached an undocumented understanding to work together in order to enable the smooth accomplishment of tasks while utilizing innovative mechanisms for the overall betterment of the DeFi ecosystem.
Staking was born out of blockchains with the Proof of Staking consensus model where crypto assets are pledged to maintain the network. In the simplest of terms, it is the equivalent of locking your funds for yields/interest/rewards (mostly more crypto) and is hence an exciting revenue opportunity.
Ethereum as a blockchain started with the Proof of Work Consensus model. It was soon realized that the PoW model wasn’t sustainable for scalability and mainstream adoption. The solution led to a transition to Proof of Staking. Staking on ETH essentially involves locking money into the Beacon chain which is an upgraded version of the Ethereum blockchain running in parallel. The launch of the Beacon chain in Dec 2020 marked the start of Ethereum’s transition from Proof of Work to Proof of Stake consensus algorithm. Every PoS blockchain needs Validators and these Validators are chosen from the staking participants. The more crypto assets pledged, the more are the chances of the participant to be a Validator.
Problems to ETH 2.0 Staking
Staking ETH provides annualized yields in excess of 5%. However, running a validator node on the beacon chain has costs and complexities associated with it. Additionally, the following factors act as deterrents to enter the market -
- Capital required — 32 ETH minimum stake requirement. Basically, users can only stake in multiples of 32 ETH (which at the current price is equivalent to USD$120000 approx)
- Capital lock up — Funds are locked and cannot be unstaked until the current network merges with the beacon chain that is until transactions are enabled on ETH 2.0. Thus, making staked ETH non-transferable and illiquid.
- Complexities in computing — Apart from the hardware investment for running a node, this includes penalties from missed jobs or not maintaining uptime. For validators, there are three ways through which the staked balance can be reduced; penalties, inactivity leaks, and slashings.
To solve these barriers, staking protocols offer convenient solutions to stake. Lido Finance is one such solution that has a dominant market share of over 80%. It has emerged as the preferred DAO to stake ETH.
“Lido is a liquid staking solution for ETH 2.0 backed by industry-leading staking providers. Lido lets users stake their ETH — without locking assets or maintaining infrastructure — whilst participating in on-chain activities, e.g. lending. Our goal is to solve the problems associated with initial ETH 2.0 staking — illiquidity, immovability and accessibility — making staked ETH liquid and allowing for participation with any amount of ETH to improve security of the Ethereum network.”
Centralized exchanges like Binance and Kraken offer users the ability to pool their funds enabling them to stake and earn rewards with less than 32 ETH. However, what sets Lido apart is its solution to illiquidity. (More on this later)
Moreover, centralized exchanges are prone to slashing penalties and reduced rewards owing to validators’ malicious behavior resulting in their forced removal. LIDO mitigates this risk as it runs several nodes.
Lido’s stETH - An answer to Illiquidity, immobility, inaccessibility. What is stETH?
stETH is the token users receive on a 1:1 basis when depositing their ETH to the liquidity pool. stETH essentially represents staked ether in Lido. Designed to offset the limitations associated with staking directly on Eth2 deposit contract, Lido’s stETH is just like ETH, it can be traded, spent and since it is compatible to be used in DeFi, it can also be used as collateral for on-chain lending. When transactions are enabled on ETH 2.0, users will be able to redeem stETH for ETH.
Use cases for Lido’s stETH
The following section is going to focus on the use case of stETH and how it supersedes other staking derivatives on CEXs and other DEXs. A key component of Lido’s stETH is its ability for wide integration and use-cases across DeFi. Staking ETH with Lido for stETH helps circumvent all the associated problems of staking ETH with ETH2 deposit contract. Lido’s stETH has wide use cases that range from lending protocols, liquidity pools, yield aggregators and optimizers, derivatives, etc.
1. Liquidity Pools
One of the major deterrents with staking on the beacon chain is deposit lock up. Lido’s value proposition lies in its liquidity. Using AMMs (automated market makers) like Uniswap, Curve, etc. for liquidity pools with ETH can help mitigate the long waiting period.
stETH can be pooled together with vanilla ETH in a liquidity pool. This in turn allows users to indirectly unstake their ETH and receive their initial ETH deposit back via pool swaps, bypassing the time required to wait for transactions on Eth2 to be enabled if a user decides that they would like to unstake.
Additionally, liquidity providers who provide their liquidity to this pool will receive LP tokens in return. They can stake their LP tokens into the Curve gauge to receive trading fees in LDO and CRV.
For more information on stETH liquidity on Curve, click on this link.
Liquidity mining pools are also active on Balancer V2, Sushiswap, Bancor etc.
2. Lending Protocols
stETH permits users to borrow assets while simultaneously accruing Eth2 rewards while being staked as collateral on lending protocols.
How does this work?
To be used as collateral stETH must be wrapped, opening up an added layer of efficiency and DeFi composability in relation to yield farming and borrowing. Using stETH as collateral allows for advanced composable yield farming strategies where stETH can be used as collateral for ETH loan. The ETH can be swapped right back for stETH to add to the existing collateral as sort of leveraged position. Alternatively, borrowed ETH can be used for staking in Lido or depositing into other strategies or providing liquidity in a liquidity pool, etc.
Recently, Inverse Finance’s Anchor which is a money-market protocol similar to Maker, Compound, and Synthetix, but one that facilitates capital-efficient lending & borrowing via the issuance of synthetic tokens (eg. DOLA) & non-synthetic credit (eg. borrowing tokens such as ETH) passed a governance proposal to list Lido’s stETH . When supplying stETH as collateral into Anchor, users will be able to borrow assets based on their stETH up to a 70% collateralization ratio.
3. Flexible Yield Strategies
stETH enables Yield Aggregators (Yearn, Harvest, 1inch, etc.) to implement an additional yield layer on top of their existing yield farming. These strategies can be flexible and utilize a variety of other protocols as well as initiatives to generate high yields for users. Examples include- farming through liquidity mining incentives, earning yield through lending protocols, earning yield through native protocol staking, so on and so forth.
Ether-ETH group is an example of a strategy that makes use of the liquidity extraction rewards earned from providing liquidity in the Curve stETH-ETH pool to automatically compound into stETH — ETH used to bet back into the group. The possibilities are only endless especially with the addition of using stETH as collateral.
The derivatives sector is vast comprising several subsectors. This translates into varying use cases across multiple sectors making it difficult to elaborate on the specifics of each derivative platform that come with their own set of intricacies. Possible use and explanation of the derivative platform is given below.
Similar to the function of lending protocols Synthetic-issuing protocols may permit stETH to be used as collateral to mint synths. Minting a synthetic asset will enable users to trade or use the asset to track the performance of an asset that may or may not be related to DeFi assets (eg. Gold, Silver, TSLA). Since synthetics have infinite liquidity, synthetic ETH can be pooled with stETH to allow for low slippage trades between the two assets.
Insurance is another derivative use case. Lido partnered with Unslashed Finance to insure against a 5% validator slashing for stETH. It solves the problem of slashing for ETH staking which in turn reduces any loss and encourages more investment.
stETH may also extend to other derived financial products like put/call options.
5. Cross-Chain Integration with other blockchains
stETH can be bridged over as bETH on the Terra blockchain — in effect, allowing stakers from one blockchain to participate in another blockchain. This cross-chain integration creates innovative use cases where ETH stakers can collateralize their stETH (in the form of bETH) on the Anchor protocol.
Anchor’s bAssets or bonded assets are tokenized versions of staked assets of a PoS blockchain on Terra. Aside from Anchor’s stablecoin market, which only has UST (Terra’s native stablecoin), the bAsset market is only comprised of bLuna and bETH, both of which are Lido staking derivatives. bLuna is Lido’s Luna staking derivative (Luna is the native token on Terra), and bETH is the tokenized version of stETH on Terra. By moving ETH staking derivatives cross-chain, Lido is expanding both the utility and value for stETH holders.
bLUNA tokens can be used to farm ANC (Anchor’s native token), borrowing UST and earn ANC, deposit the borrowed UST back into Anchor to earn more ANC.
For more info, click on this link.
My two cents on Lido
Interoperability is critical for protocols to share solutions and for greater and more beneficial collaborations. Protocols can integrate and rely on one another which opens up endless possibilities for future innovations.
Dominating the Ethereum liquid staking market since its launch, Lido is a cross-chain liquid staking solution. Its operations and integration demonstrate liquid staking is a fundamental service required by a PoS chain.
Its advantages include
- stETH’s strong stability and liquidity
- DeFi composability and use cases
- Support from the community, Ethereum core developers, and the Ethereum orthodox fund
The scale at which Lido is operating and its success in a relatively short span of time is testimony to its offering. Moreover, its recent expansion to Terra has bolstered its growth. Its future plan of deploying to other chains (Solana, Polygon, Polkadot, and Kusama) and to DeFi protocols represents its ambitious desire to widen the uses cases of stETH.
I would like to conclude by mentioning no project/protocol/initiative is devoid of risk. Eth 2.0 is still being developed and as such is subject to errors and loopholes, which could result in the devaluation of stETH. To add to that there is the pledge penalty risk of improper node operation.