Ether (ETH) DeFi activity has declined in the bear market and the sector is facing increased competition from Ethereum’s 4% annual staking reward, according to Glassnode analysts. However, a DeFi narrative is building around liquid staking derivative (LSD) tokens that could revive activity on the Ethereum network.
The percentage of gas consumed by DeFi protocols dropped from 34% in 2020 to 8-16% today, with NFTs dominating the top share from 25-30%, according to a recent study. report from Glassnode.
Glassnode’s supply-weighted price index for DeFi, quoted in USD and ETH, has recorded a 90% loss since the beginning of 2021.
So-called DeFi “Blue-Chips”, which represent a basket of DeFi protocol governance tokens known as Uniswap (UNI), MakerDAO (MKR), Aave (AAVE), Compound (COMP), Balancer (BAL), and SushiSwap ( SUSHI), have lost 88% of their market capitalization since all-time highs of $45 billion in May 2021.
DeFi blue chip tokens have underperformed ETH during bull market rallies and saw a more severe drop than ETH “to the downside during the downtrend.” Analysts predict that since staking on ETH now yields 4%, it will act as a “new cap rate that token returns must jump over.” This yield represents the benchmark rate for ether investors.
Currently, major lending protocols like Aave and Compound offer returns of 2-3% on stablecoin and ether lending. Additionally, DeFi protocols like Aave and Compound also carry smart contract risk that is eliminated with Proof-of-Stake (PoS) validators.
Staking has become popular among Ethereum investors, especially after the Shapella update in April 2023, which allowed the staking contract to be redeemed.
At the end of May, Ethereum users staked 21.63 million ETH worth $40.021 million, representing 18% of the total Ethereum supply.
LSD rigs like Lido and Rocket Pool account for a third of this massive market. These apps offer tokenized representation of ETH staked, allowing investors to access staking returns without compromising liquidity.
A growing trend among Ethereum investors is to engage with LSD-fi, or LSD financialization, which aims to use the liquidity offered by LSD tokens in DeFi applications.
Related: LSD for DeFi: Tenet partners with LayerZero to drive adoption of liquid cross-chain betting
Is LSDfi the solution?
Essentially, LSDfi leverages the liquidity of LSD tokens in DeFi as lending protocols and liquidity on exchanges to earn higher returns. Since a considerable amount of ETH is staked with LSD platforms, LSDfi has the potential to revive DeFi activity.
A Dune analytics panel by data analyst Defimochi shows that the total value locked (TVL) in the LSDfi protocols has reached $411 million, rising exponentially since mid-May. Some of the popular names in the industry are Pendle Finance, Lybra Finance, Curve Finance, and Alchemix Protocol.
The liquidity of LSD tokens on Curve Finance, the largest stablecoin exchange in the market, has exceeded $1.5 billion. Curve also enabled the minting of its over-collateralized crvUSD stablecoin using the Frax Protocol ETH token sfrxETH as collateral.
Relatively new protocols such as Lybra Finance and Pendle Finance have also become popular, seeking to take advantage of the liquidity provided by LSD tokens.
As was the case with DeFi before, newer applications are likely to take advantage of the liquidity of LSD tokens by making it easier for early depositors to extract liquidity from their governance tokens.
While these can generate decent profits for some users, these protocols could carry smart contract risks and the possibility of being pulled out of the rug, which presents the risks that come with the higher profits that LSDfi provides.
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