Chain Reactions: Analysis on the growth of LSTs and LRTs

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The latest in EVM technology fashions yet more ways to rehypothecate idle assets and generate more yield. Since the transition from proof-of-work to proof-of-stake, a huge amount of value has moved from idle native ETH to some form of staked derivative token, a yield-bearing instrument that enables liquid exchange of tokens committed to validating Ethereum itself. Where previously validators of the network’s integrity would spend energy (i.e. mining) to achieve consensus, they now lock up tokens: commit a specified amount of value (32 ETH to be exact) and you, too, can be an independent validator, helping to decentralize the network and yield staking rewards.

Briefly, the only options for staking ETH were to either commit the full 32 ETH via staking protocol Lido, or contribute to a pool with others via RocketPool. Over time, liquid derivative tokens became available that enabled simpler onboarding for users that lacked the funds or technical know-how to stake their tokens themselves. Lido’s stETH and Coinbase’s cbETH, to name a few, were the first derivatives of staked ETH, wherein just holding stETH or cbETH unlocked automatic compounding of staking yields on the underlying assets.

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These liquid staking tokens (LSTs) are reshaping the foundations of network security and capital efficiency across major blockchain platforms. Automatic rehypothecation of staking yield aligns the incentives: users are inclined to contribute to network decentralization and security in exchange for interest payments. The result of Ethereum’s transition to proof-of-stake, which is still in-progress, is nothing short of remarkable.

The chart below illustrates the ascent: it took 3 years to get $100 billion committed to staking. Today, about half of Ethereum’s market cap is staked, earning yields from the fees that the network generates in exchange for committing their capital.

What is most remarkable about this innovation is that the capital committed to validating the network does not sit idle while locked. LSTs allow people to use their staked tokens freely, perhaps to use as collateral for a loan generating more yield by providing their liquidity to a pool.

LSTs account for $31.55 billion, or about 25% of the total amount staked; it's logical to assume another $100 billion stands to be rehypothecated at a future date, since that staked ETH is leaving money on the table. The delay in adoption is likely borne from security concerns: the general consensus is that staking ETH with major providers is safe and reliable, however liquid derivatives are not quite as battle tested.

The appeal of LSTs is clear: they offer liquidity while allowing participation in network security and staking rewards. This innovation helps democratize staking as well, enabling a wider range of participants to contribute to network security without fully locking up their assets.

On the Solana network, which launched as proof-of-stake, the dynamic is slightly different. The second chart shows the total USD staked on Solana versus LSTs since early 2023. The total USD staked stands at $50.75 billion, with LSTs accounting for $3.40 billion – a ratio of 6.69%.

The delay in adoption here is more likely borne from technical limitations. Put simply, coding smart contracts on Solana is complex, leaving the job of creating safe LST tokens to more established companies building on Solana. Jito Labs has a first mover advantage, and the small LST footprint on Solana signifies a market that is wide open for the taking.

Stake again, again, again, again

As LSTs become more trusted and expand market share of total staked value on-chain, plenty of services have already sprung up to help users find yield for their newly liquid derivative tokens. By far the most popular have been Actively Validated Services (AVS), allowing users to restake their assets across multiple protocols simultaneously.

Pioneered by EigenLayer, restaking enables staked ETH to be used for securing multiple protocols simultaneously. The approach is intended not only to maximize capital efficiency but also to align validator interests with network health and security. And the results, once again, are astounding:

Eigenlayer’s mechanics are highly sophisticated, and some of crypto’s finest are working on the project. Couple that with the industry's insatiable appetite for yield, and Eigenlayer jumped to $14 billion total ETH locked in less than 6 months. Demand was so overwhelming that Eigenlayer stopped taking deposits. Many copycats (eh hem, we mean, aligned validators) have sprung up to help users gain access to liquid restaking tokens, or LRTs. LRTs are, indeed, a derivative of LSTs. And they are, indeed, marketed with yields superior to just plain old LSTs.

You can imagine why much of the ETH staked on Ethereum remains locked. The yield might be too good to be true; staking and restaking tokens introduce security risks; many users are content with their yield already. But suspend judgment for a moment, and consider the implications if it works. For Ethereum, it means that staked ETH can potentially secure not just the Ethereum network, but also layer-2 solutions, cross-chain bridges, and other decentralized applications. This multiplier effect significantly enhances the overall security of the Ethereum ecosystem without requiring additional capital lockup. Users end up with even higher yields on their ETH.

Nonetheless, it’s crucial to acknowledge the potential risks. The increased complexity of AVS systems could introduce new vulnerabilities. The concentration of restaked assets might lead to centralization concerns (what if aligning validators incentivizes behavior we aren’t expecting?). Moreover, the interdependencies created by cross-protocol staking could amplify systemic risks. As AVS continue to evolve, they may address longstanding issues in scalability and interoperability, but success will depend on careful implementation and ongoing scrutiny.

Disclaimer: Unit Zero Labs may own assets mentioned in our articles and research. This is not financial advice.