From Shanghai to LSDfi: A Twitter Space with Pendle Finance
With the big upgrade less than a week away, we were joined by Anton from Pendle Finance to discuss Shapella and LSDfi.
Apr 6, 2023
As Ethereum gears up for Shapella, the hashtag #LSDfi is rapidly spreading across Twitter.
But what does this term mean? Why is it a big deal? And how could it impact DeFi?
With the big upgrade less than a week away, we were joined by Anton from Pendle Finance to discuss the answers to these questions:
What is the difference between LSDs and LSTs? And which term should we use?
LSD = Liquid staking derivative
LST = Liquid staking token
These two terms are used to refer to the same thing, but there is a distinction between them.
Derivatives can be defined as assets which derive value from an underlying asset, such as a commodity, currency, or security. For example: futures that give holders the right to purchase an asset at a set date in the future.
Liquid staking tokens, however, are a type of token that demonstrate ownership of staked ETH. This makes LST the more accurate term, although with lots of people coming to DeFi from traditional finance it is understandable why we are seeing familiar terms like derivatives used.
The distinction between LST and LSD might also be significant from a legal perspective. Using derivatives as a term could invite undue regulatory oversight, which is one of the reasons why the Proof of Stake Alliance recommend using the term LST.
With that said, let's move on to LSDfi.
What are your thoughts on LSDfi?
Liquid staking tokens have become the second-largest sector of DeFi according to Defillama — beating the thriving sectors of money markets and DEXes.
At the same time, in addition to the original DeFi primitives of money markets, collateralized debt protocols, and borrowing and lending protocols, we have started to see the emergence of new primitives built on LSTs.
For example, Pendle is a primitive for enabling the trading of yield. Another example could be the protocol Y2K, which enables users to hedge or speculate on deviations in pegged assets, including stablecoins, and increasingly, LSTs.
Looking ahead, whatever you see in DeFi today is likely to be reimagined around LSTs.
Would you expect liquid staked tokens to replace ETH as the primary form of collateral in DeFi?
This comes back to an earlier discussion about whether DeFi cannibalizes the security of Ethereum.
The argument previously was that if DeFi protocols like money markets were more profitable than staking, why would you bother locking up your ETH to earn staking rewards?
But now that we have LSTs, stakers can still use their ETH to secure the network, while simultaneously deploying it for additional yield in DeFi.
Essentially, what has happened is that we have removed the opportunity cost of deciding between ETH staking and DeFi — instead we allow people to do both.
In the long-term, if we expect the terminal ETH staking rate to hit rates above 70%, as with other proof-of-stake protocols, then we might expect LSTs to begin to be treated not only as prime collateral, but as a base asset in DeFi.
After all, why would you pair with a non-yield bearing asset like WETH when you can pair with an LST like swETH and get a portion of the yields on that token?
What will be the short-term impact of Shapella?
You have to stake 32 ETH to be able to validate and produce blocks on Ethereum, and most of this staked ETH has been locked for quite a while.
Shapella will enable validators to exit this 32 ETH position, and withdraw ETH from being staked on the beacon chain to use it as real ETH on the execution layer. This could be either a partial or full exit.
But, the withdrawals won't be processed immediately, as the flow is controlled through two queues: the slower exit queue, and the faster withdrawal queue.
The slower exit queue only allows 7-8 full withdrawals to happen every 32 blocks, and is applied to validators trying to withdraw all of their staked ETH in what is called a full withdrawal.
The faster withdrawal queue applies to both full or partial withdrawals, and processes a maximum of 16 withdrawals every block (or every 12 seconds).
As you can imagine, these mechanisms mean that if everyone withdrew their ETH at the same time, it would simply create a long queue — and not a sudden supply shock.
In the bigger picture, the success of the Shapella upgrade could be a massive derisking event for not just Ethereum but the industry at large, and could even pique the attention of larger capital allocators.
Another thing worth noting is that a significant chunk of staked ETH (44%) is staked through LSTs, which already give the stakers liquidity. These stakers can already exit at just under the peg, so it is unlikely that simply making a pure 1:1 redemption available would change their thinking.
Pendle has recently launched an ankrETH pool. How does it work?
To set the context, Pendle enables the permissionless tokenization and trading of yield.
This is achieved by taking yield-bearing assets — such as liquidity provider tokens or Ethereum LSTs — and splitting them into two component tokens (the yield and the principal) that can be traded against each other on Pendle's automated market maker (AMM).
Regarding ankrETH, Pendle hasn't integrated vanilla ankrETH, but ankrETH held in Aura — enabling traders to speculate on the yield generated by the Aura pool.
Aura generates yield in multiple ways: through trading fees generated for trading between ankrETH and wETH, through the Aura and Balancer rewards, and also through the accrual of value to ankrETH itself through liquid staking. All of these rewards are reflected in the APY, which can then be speculated on in Pendle.
This enables various different strategies to be deployed, including providing liquidity on Pendle to earn Pendle AMM trading fees and channel incentives, or speculating on the interest rate itself to collect future yield in advance.