The DeFi industry is about to start a new war. Unlike the curve wars for stablecoin liquidity dominance, this war will be fought for the future of liquid collateralized tokens.
The catalyst for this coming fight?
Ethereum’s much-anticipated Shanghai hard fork, which will take place at dawn on April 13 and unlock more than 18 million staked Ether (approximately $34.2 billion), will be an interesting battle.
There is no doubt that the Shanghai upgrade will trigger a period of intense competition among liquidity staking protocols – what will be dubbed the “liquidity staking wars” – although these battles will ultimately benefit the industry as a whole. .
During DeFi summer, the Curve Wars are a brutal competition between emerging stablecoin protocols for the deepest liquidity and most diverse liquidity pairs on the Curve DEX.
Let’s review the factors that lead to curve wars:
1) An Automated Market Maker (AMM) DEX designed for trading stablecoins (Curve);
2) An agreement mechanism that incentivizes liquidity providers (LPs) to transfer from LPing one stablecoin to another stablecoin (Curve incentive contract);
3) Many new stablecoin protocols are vying for market share (USDC, USDT, DAI, FRAX, LUSD, etc.).
There are striking parallels to curve wars in the emerging competition among protocols offering Liquid Staking Tokens (LST), a yield token that allows holders to remain liquid while enjoying profits from staked ETH sex.
Combinations of ingredients like this occur:
1) A new DEX AMM protocol specifically designed to support LPing Liquidity Staking (LST) token pairs;
2) The LST protocol can be used to reward the incentive contract of LST LP;
3) Various emerging LST protocols compete for market share.
There is another final component to Liquid Staking Wars – an upcoming upgrade – Shanghai – which will allow LPs to withdraw ETH from one LST and transfer it to another easily and cost-effectively.
Whichever protocol can achieve the most TVL and transaction volume for its LST will win the Liquid Staking Wars. The battle for LST supremacy will see its first skirmish in early May and will have a lasting impact on the DeFi ecosystem.
Once all staked ETH is unlocked by mid-April, unstaked ETH holders will be encouraged to move their ETH from one liquid staking token solution to another, always looking for high potential returns in liquidity pools . The LST protocol will also be incentivized to capture market share by making its token the most liquid.
This war — or the competition between LST protocols to offer the dominant asset in cryptocurrencies — will reshape all crypto pairs across all DEXs.
Liquidity Provider (LP) strategies will also evolve based on the profitable nature of LST; DEXs will evolve their services to fit this new landscape; the DeFi industry will benefit from a wave of innovation (as we have seen in most periods of heightened competition) as of the
Liquid Staking Wars strategy will mirror Curve Wars strategy
We will see the LST protocol try to differentiate itself through innovation, usability, and productivity. The most obvious mechanism will be profitable: the LST protocol will seek to maximize incentives for LPs to use their LST rather than any other LST to fund liquidity pools.
After Shanghai, there will be a significant opportunity cost for LPs to add liquidity to ETH-denominated pools rather than LST-denominated pools. ETH LPs will refund ~4% without good reason.
Even before Shanghai, we saw huge demand for LST returns: since April 3, 2018, the total value locked (TVL) of liquid collateral tokens has soared to over $14 billion, according to DeFiLlama. 2023. The LST industry is second only to the sum of all decentralized exchange protocols at its current scale.
Some might argue that Lido – with almost 75% of the LST TVL market share – won the war before it even started. But while Lido has established itself as a leader, new entrants like Frax, Coinbase, Rocket Pool, and new yet-to-be-released protocols are vying for the position to make their LST a superior ETH alternative to the protocol.
As with any war, winners and losers will be determined by strategically deploying the correct tactics on the battlefield.
This competition—especially the competitive incentives of the liquidity pools it will inherit—will also benefit other participants in the DeFi ecosystem. There is a place for LST to be paired not only with each other or with ETH in a pool, but with other utility tokens as well. For example, one could see WBTC-WSTETH, WBTC-cbETH or WBTC-rETH instead of the popular WBTC-ETH on DEX.
The underlying wave of the copper liquidity pool structure will incentivize the pairing of utility tokens and profits. These partnerships will benefit long-tail tokens by providing the liquidity needed to build businesses, as well as some of the most recognizable utility tokens looking to expand their reach.
In addition to maximizing liquidity pool incentives, automated market maker (AMM) nuances could provide significant advantages to the LST protocol — especially considering how LST gains value over time from profits from the underlying staked ETH . This growth in intrinsic value suggests that limited partners will need to monitor their positions more closely to maintain liquidity during price volatility. For example, pairing with an AMM can maximize the LP capital efficiency of a pair of LSTs, yielding significant gains.
There will definitely be more and more innovations in DEX, especially around the function of AMM. To win the Liquid Staking wars, protocols will need a set of tools to incentivize the liquidity of their liquidity staking tokens using minimal incentives and maximum efficiency. A protocol that could leverage LP incentives through this “surgical incentive” and provide greater capital efficiency would reduce the capital requirement burden on LSTs. In turn, this will allow LST to maximize profits from incentives and capture a larger market share.
For stakers and LPs, it is critical to understand the financial implications (fees, etc.) before they stake or provide liquidity on a particular platform. As mentioned earlier, due to LST’s unique profit structure, some AMMs are currently capital inefficient in terms of LST liquidity. This is because the LSTs and the unique liquidity challenges they represent did not exist when these AMMs were developed.
For example, unlimited-range automated market makers such as Sushi, Balancer, and Uniswap v2 have been known to underperform on nearly all trading pairs. But even range AMMs like Uniswap v3 and related forks have little impact on the ETH-LST pair, because unless LPs actively manage their positions, the price in the AMM will constantly exceed the range of the LP. The price range is wide. In addition to the incentives offered, LPs must understand these important structural details of the agreement before deploying capital.
Although the next stage of DeFi after the upgrade of Ethereum Shanghai is called “battle”, the end result is more liquidity entering the ecosystem. As working capital capital efficiency improves, it will usher in an era of more “working capital” that will be spent more consistently to benefit the industry as a whole.
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