Upgrade sparks yield-chasing frenzy as Ethereum-based stakes soar to $20 billion

Author: Tim Craig, compiled by dlnews: Jinse Finance, Shan Ouba

Summary

• Holding liquid collateralized tokens becomes a "smart move" after Ethereum's Shapella upgrade reduces risk.
• Pendle co-founder TN Lee noted that ethereum's liquid staking yield is becoming the benchmark in decentralized finance (DeFi), a "paradigm shift."

DeFi users flock to Ethereum

Since April’s Shapella upgrade, **DeFi users have flocked to Ethereum’s liquid collateralized tokens, bringing total deposits to the protocol to more than $20 billion, according to DefiLlama. **This trend is driven by the widespread belief that holding Ethereum for collateral has become less risky since the Shapella upgrade, and the increased integration of Ethereum’s Liquid Staking Token (LST) with existing DeFi protocols up.

The ever-increasing demand of DeFi users for liquid collateralized tokens has also prompted the scale of deposits of protocol issuers to continue to expand. Currently, Ethereum’s liquid collateralized tokens have become an important part of the DeFi ecosystem and have exerted a strong influence throughout the industry.

“Why hold regular Ethereum when you can hold Yield-bearing Ethereum?” said Dan, head of growth at DeFi protocol Pendle, in an interview with DL News. Pendle allows users to trade earnings on staked Ethereum. “The ease of exiting from Liquid Staking Tokens (LSTs) to native Ethereum makes holding LSTs self-evident,” he said.

The “easy exit” mentioned here refers to the Shapella upgrade, which allows users to withdraw their ether from the staking contract for the first time since ethereum staking began in 2020. Before the Shapella upgrade, depositors were unable to withdraw their ether from ethereum’s staking contract. Many DeFi users worry that a liquidity crisis could be triggered if investors lose confidence in liquid collateral tokens, which act as collateral against Ethereum. Such concerns have eased since Shapella enabled withdrawals, and adoption of liquid collateralized tokens has skyrocketed.

As the largest liquid staking token, Lido’s stETH represents a total of $14.6 billion in staked ETH, an increase of more than 28% since staking withdrawals were enabled in April.

“Liquid collateral tokens are more popular than ETH as collateral in Ethereum DeFi,” Max Shannon, a digital asset analyst at CoinShares, told DL News.

Shannon pointed out that on Aave, the largest DeFi lending agreement with a total deposit of more than 6 billion US dollars, Lido's stETH has surpassed Ethereum to become the largest mortgage asset.

“Those who hold liquid collateralized tokens can easily trade these tokens, use them as collateral, or take advantage of yield opportunities through lending protocols,” Shannon said.

In Ethereum’s DeFi ecosystem, protocols are increasingly replacing Ethereum with liquid collateralized tokens such as stETH.

By doing so, the protocol can incorporate the underlying Ethereum staking yield (currently around 4% to 5% annual yield) into its DeFi products, boosting potential yield.

TN Lee, Pendle’s co-founder, told DL News: “Ethereum staking returns have undergone a paradigm shift and become the reference for DeFi’s annualized rate of return. As the number of liquid staking assets continues to grow, so will the demand for them. "

However, Ethereum analyst Alice Kohn said that the pursuit of higher yields on LST is changing the way DeFi users deposit funds. DeFi users are increasingly inclined to deposit their LST into lending protocols instead of using it to provide liquidity on decentralized exchanges, which is to ensure that DeFi users can easily trade between Ethereum and its pledged version required.

The stETH-ETH Curve Pool has lost 39% in value since April, while the wstETH-ETH Pool on Balancer has dropped 71%. Meanwhile, the total value locked in stETH on lending protocol Compound has increased more than ninefold. According to Kohn, this is mainly in pursuit of higher yields. LST can be used as collateral to hedge Ethereum’s leverage risk, which allows LST holders to increase their exposure to LST by borrowing leverage and multiply their LST returns.

Circular Pledge of Ethereum

What Kohn is describing is “circulation” — a common way to boost yields on assets like stablecoins, collateralized and non-collateralized ethereum. DeFi users deposit LST (like stETH) into lending protocols like Aave or Compound, and use their deposits as collateral to borrow Ethereum. They then stake the borrowed Ethereum via Lido, deposit the earned stETH, and repeat the process. The result is that Ethereum’s staking rewards are compounded multiple times, driving up yields. However, there are risks associated with cyclically staking Ethereum.

If the price of ETH and stETH diverge too far, those who have leveraged in the lending protocol risk being liquidated. Also, since Lido's stETH is currently the most popular circulating LST, this approach runs the risk of concentrating the majority of staked ETH in one place. Many DeFi people worry that this situation threatens the decentralization of Ethereum and may reduce the security of the network.

While other LST providers such as Rocket Pool and Frax Ether have eroded Lido’s dominance in recent months, it remains by far the most dominant liquidity staking protocol with a 74% market share.

According to Shannon, this is unlikely to change anytime soon: “Lido’s stETH will continue to dominate the LST market due to its network effects and integration of stETH in DeFi.”