Ethereum’s centralized and decentralized liquid staking providers are fighting for supremacy

Liquid shakers have offered investors a way to earn passive income while maintaining control of their tokens.

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What happened

After Ethereum started the transition to proof-of-stake, liquid staking platforms have allowed users to earn revenue by delegating their ether (ETH) to a validator while receiving a tradable staking token , which represents a claim on the underlying staked ETH.

Liquid staking products have seen significant traction in recent months, with two of the largest liquid staking pools, Lido and Rocket Pool, gaining the largest market share among decentralized staking pools. Decentralized staking pools allow users to delegate their assets while keeping their private keys, while their centralized offerings require users to move their assets to a centralized platform first. Lido and Rocket Pool’s respective native tokens, LDO and RPL, are up 115% and 80% year-to-date, respectively, indicating increasing interest in the platforms.

Coinbase, the largest centralized US-based exchange, is a recent entrant to the liquid staking space, quickly climbing to second place with its staking service and associated wrapped staking token, cbETH. According to Dune Analytics, decentralized staking protocols Lido and Rocket Pool have a 76% and 3.5% market share in terms of ETH deposited on their platforms, while Coinbase quickly gained 17% market share.

Lido and Coinbase are the two largest liquid staking pools

dune analysis

broader context

Ever since Ethereum’s beacon chain was launched in December 2020, initiating the first phase of the network’s transition from a proof-of-work consensus mechanism to a proof-of-stake alternative, individuals have been able to stake their ETH and act as validators for processing and securing transactions serve the network. Individual stakers need specialized hardware with high internet availability and at least 32 ETH (~$49,000) to run nodes themselves. In return for this service, stakers receive compensation in the form of block rewards (new ETH edition), tips, and minimum extractable value (MEV) paid out in ETH. The staking yield drops as more validators come online, and the current yield is ~5.5% APR on a total of 15.9 million ETH stakes.

Ethereum completed its transition to proof-of-stake when the merge upgrade took place in September 2022. Although the network has completely moved away from its energy-intensive proof-of-work consensus mechanism, stakers will not be able to withdraw their assets until the Shanghai upgrade is implemented, which is expected to take place in March of this year.

Enter fluid staking.

Although the underlying ETH is locked until the Shanghai upgrade is complete, liquid staking providers are issuing a derivative token backed one-to-one by the assets staking on the platform. Lido depositors receive stETH and Rocket Pool depositors receive rETH, which update their balances daily to reflect users’ token rewards. These tokens provide users with liquidity for their underlying staking positions, allowing them to sell their positions or use these tokens to earn returns through various DeFi strategies or access credit. Even if the upgrade allows withdrawals, the staked ETH still needs to be locked during the staking process to ensure liquid staking protocols continue to be used after the upgrade.

As Lido, Rocket Pool, Stakewise, Coinbase and other liquid staking providers went online, the amount of ETH staking in pools increased by 2,470% from 265,000 ETH in early 2021 to over 6.8 million ETH now.

Liquid staking providers have seen a dramatic increase in usage

dune analysis

It’s worth noting that the price of ETH and its derivative liquid staking tokens has constantly diverged, with the staking tokens often trading at a slight discount. There are several reasons why staking tokens are trading at a discount to ETH, such as delays in withdrawals.

With withdrawals enabled, the gap should close and the tokens should trade at par with ETH. As shown below, stETH, cbETH, and rETH are currently trading at a ratio to ETH of 0.992, 0.989, and 0.962, respectively.

Liquid staking ETH tokens traded at a slight discount to underlying ETH

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key stats

Currently, 42.7% of all ETH staked participates in liquid staking pools, or 6.9 million ETH (~$10.7 billion). Ethereum’s circulating supply is approximately 120.5 million ETH, so the amount staked in pools accounts for 5.6% of the network’s total supply.

Outlook and Impact

Both centralized and decentralized staking providers have gained popularity because they remove the technical complexity from the staking process and allow users to stake with no minimum requirements, lowering the entry barrier for everyday users to participate.

Decentralized liquid staking providers like Lido, Rocket Pool, and Stakewise have also created Decentralized Autonomous Organizations (DAOs) to provide governance and reward different stakeholders of the protocols. The native tokens of these platforms are used to compensate node operators, provide oracle price data (i.e. provide real-time ETH prices), vote on matters like staking fee parameters, and use funds for protocol development (i.e. Lido charges a fee). of 10 %). via staking rewards shared between node operators and the DAO treasury), adding and removing node operators, and other operational issues.

Coinbase recently announced its intention to join Rocket Pool’s Oracle DAO. As a member of the DAO, his responsibilities will include providing real-time ETH price data, running Rocket Pool nodes, and voting on protocol upgrades. In exchange for these services, Coinbase receives RPL tokens as compensation.

Although the leading centralized exchanges Coinbase, Binance and Kraken already offer staking services for their retail user base, the institutional market has remained largely untapped. That could change with the launch of Alluvial, which will form a consortium of some of the leading centralized staking providers, including Coinbase, Figment, Kraken, and others. First announced in September 2022, Alluvial is a liquid collective aiming to provide an enterprise-class, multi-chain liquid staking protocol initially aimed at institutional investors.

The fact that Lido accounts for such a high percentage of the entire validator set raises its own concerns about centralization risk and the potential for a single platform to censor transactions at the protocol level, given the ability for validators to order transactions or even from a block to exclude . This could pose a bigger problem as Coinbase gains more market share, as centralized platforms will face additional pressure to adhere to OFAC sanctions and local compliance regulations.

If withdrawals are enabled with the Shanghai upgrade, staked ETH tokens will be unlocked, which could potentially lead to more supply entering the market and additional selling pressure. On the other hand, opening withdrawals can actually result in a higher number of tokens being staked and reduce selling pressure as it can convince potential stakers that their tokens are freely redeemable and no longer locked indefinitely.

Among the top proof-of-stake networks, Ethereum has a relatively low stake ratio of ~14%, compared to 71% for Solana, 72% for Cardano, and 97% for BNB. This suggests that there is room for more ETH holders to get involved and secure a larger percentage of the supply through staking.

Judging by the relatively small amount of ETH staked as a percentage of the total market cap compared to its peers, there is plenty of room for growth.

Staking Rewards

decision points

ETH holders looking to generate returns through staking need to be aware of the tradeoffs between centralized and decentralized providers. Centralized providers like Coinbase require users to open accounts and undergo KYC/AML checks. Additionally, users must first send their assets to Coinbase, which holds the assets and is a third-party risk.

Alternatively, decentralized solutions like Lido and Rocket Pool never assume custody of users’ private keys, and users can deploy their assets directly from their non-custodial wallets like Metamask or Ledger. However, these platforms come with their own unique risks in the form of smart contract risks that could result in the loss of user funds if exploited.

Staking platforms also provide liquid staking solutions for crypto networks other than Ethereum. For example, Lido supports staking on Solana, Polygon, Polkadot, and Kusama with their respective stSOL, stMATIC, stDOT, and stKSM tokens. These other networks are not subject to the same withdrawal restrictions, and investors can earn returns by supporting the networks they are inherently bullish on.

More exotic yield farming and DeFi strategies can help users maximize the yield investors earn by properly managing their staking tokens. Users can earn an additional estimated ~3% APY by mining liquidity on Curve and depositing their stETH and the corresponding amount of ETH into DEX’s stETH-ETH pool. DEX’s Uniswap and Sushiswap offer similar pools that allow users to deposit their wealth for an additional return. Users can also lend their staking funds or borrow money against their staking positions using DeFi loans such as the Aave or Compound protocols.

Before deploying these strategies, users need to do their own due diligence and understand the risks inherent in these DeFi protocols such as:

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