A new chapter is emerging as we step into 2025 and the BTCFi track nears its final competition phase. New opportunities to improve the DeFi landscape arise, and we seek to analyze these future opportunities, beginning with Liquid Staking Derivatives (LSDs).

Since their inception with Lido, LSDs have gradually ignited a new wave of DeFi demand, but this opportunity for the market has its faults. Building on the success of LSDs, and avoiding their faults, Liquid Yield Derivatives (LYDs) present an opportunity to refine and elevate the crypto market by balancing liquidity with sustainable yield.

Explore the origins of these groundbreaking financial tools, their role in shaping the present landscape, and how they can unlock the next phase of growth and stability in DeFi.

tl;dr

1. LSDs revolutionized DeFi by unlocking liquidity and driving rapid growth, establishing a foundational model for liquid yield-generating assets while LYDs build on their success.
2. LSDs originated with Lido, introducing a liquidity balancing mechanism for token issuers and holders and evolving into a central pillar of DeFi and CeDeFi ecosystems.
3. LSDs expanded into the BTC ecosystem through BTCFi, fostering growth and innovation in 2024’s TVL race while enabling projects to scale rapidly.
4. LSDs function as a deposit-gathering model, akin to TradFi banking, fueling liquidity while introducing challenges like over-staking and sustainability concerns.
5. LYDs emphasizes real yield, positioning projects as asset managers and originators while mitigating risks and over-staking.
6. LYDs focus on yield and introduces sustainable value to the market through the trade-off mechanism between liquidity and yield.
7. LYDs address the sustainable real yield problem, positioning projects as roles like Crypto funds, asset management, and asset originators.
8. LYDs drive Protocol Asset Management, forming the foundation for AIFi, where AI agents participate in financial management.
9. LYDs initiate a shift for crypto from speculative to real-world applications, becoming the foundation for payments, asset yield, and other financial scenarios.

1. What Are LSDs and LYDs?

The purpose of LSDs (Liquid Staking Derivatives) is to keep liquidity in a crypto holder’s wallet while also generating returns by creating a derivative token. LSDs defined the model for liquid yield-generating assets. Using a highly native approach, LSDs directly address the essence of crypto and DeFi strategies, successfully igniting the market through promoting liquidity and leading to rapid development in the DeFi and CeDeFi ecosystems. However, while LSDs successfully stimulate growth, it also introduces challenges such as over-staking, liquidity constraints, and yield concerns, which hinder long-term sustainability.

LYDs (Liquid Yield Derivatives), on the other hand, aim to strike a balance between crypto liquidity and yield, creating various derivative scenarios. LYDs inherit the native concept of LSDs (staying fully on-chain and operating within the ecosystem) while mitigating the negative impacts and bubbles caused by staking on liquidity. By emphasizing real yield, LYDs foster sustainability in the crypto market, paving the way for a secure, scalable, and sustainable market environment.

2. The Origin and Intent of LSDs

LSDs originated in December 2020 with Lido’s launch of stETH and surged in popularity between 2023 and 2024. This model closely resembles the role of U.S. Treasury bonds for the dollar, essentially using yield expectations to make trade-offs on liquidity, achieving a balance for token issuers and holders.

The original intent of LSDs differed from their later development. The rebase model represented by stETH is anchored to the staking rewards of the Ethereum PoS network. While not a fixed-rate guarantee promised by the foundation, they have relatively solid underlying value. This model attracted liquidity for staking through yield expectations, driving significant TVL as an industry KPI and spawning various innovative derivative strategies. Consequently, LSDs quickly evolved and formed a diverse DeFi and CeDeFi industry landscape.

3. The Explosion of LSDs in BTCFi and Competitive Landscape

Shortly after emerging, LSDs began to capture and awaken a real need among BTC holders during the bear market’s end in 2022: BTC holders sought to increase the value of their BTC but lacked suitable ecosystems and financial assets.

The appearance of Merlin initiated the BTC ecosystem, BVM, BTC Layer 2, and BTCFi, rapidly becoming a critical track in 2024’s crypto market. From a chaotic multitude of projects to a few core players, the BTCFi competitive landscape built on LSD approaches became clear by Q3 2024. Project teams leveraged yield expectations to stake users’ BTC liquidity, achieving TVL scales of billions of dollars.

This cycle featured projects like Pendle, which created a marketplace through model innovation, and Ethena, which adopted stablecoins as yield strategies. By the end of 2024, after intense competition in TVL and listings, Solv and Babylon emerged as likely winners.

4. LSDs: Industry Significance and Value

LSDs successfully captured the genuine needs of BTC holders. Essentially, it facilitated a deposit-gathering process for crypto tokens through the Liquid → Staking mechanism. This means that LSD projects inherently operated with a banking mindset, with BTCFi competition revolving around deposit-gathering for BTC.

The value LSDs brought to the market includes:

i. Providing a liquidity balancing mechanism for token issuers and holders.

ii. Addressing the universal need for yield among token holders and offering yield products and marketplaces.

iii. Aggregating token holder funds, forming a deposit-gathering process and a Crypto equivalent of a bank.

5. Challenges and Issues with LSDs

As with any deposit-gathering process, competition is fierce. To achieve TVL growth quickly, projects, players, and markets sought to differentiate ecosystems and strategies, leading to rapid developments like staking, restaking, and recursive staking. The widespread “one shovel for multiple mines” phenomenon revealed core issues with LSDs.

While the name “Liquid Staking Derivatives” cleverly emphasizes staking, it ultimately overemphasizes this aspect while overlooking the importance of real yield in derivatives. Fundamentally, LSD cycles relied on the traditional model of creating narratives, painting expectations, building consensus, and monetizing tokens. Without real yield and real applications as the foundation, the market struggles to sustain growth — even with the temporary confidence boost from Trump’s election.

The over-staking issue in LSDs resulted in two critical problems:

i. For users: Over-staking introduced opacity in the underlying assets and cumbersome redemption processes, leading to information asymmetry and reduced fairness in yield trade-offs. This created conflicting motivations and interests between projects and users, forming bubbles and risks.

ii. For the industry: Excessive staking reduced liquidity for many ecosystem tokens, creating damping effects. While this limited downturns during bear markets, it also hindered growth in bull markets, stifling ecosystem flexibility and rapid price fluctuations.

Interestingly, to address the situation arising from LSDs, many projects have introduced T-Bills as underlying assets. Projects like Ondo and OpenEden are classic examples, essentially products of the LSD cycle. They used T-Bills as a “safety cushion” and enlisted some big names for credit backing. A few seemingly simple (but challenging) operations created a market niche, resulting in valuations worth billions of dollars.The emergence of this segment highlights the fundamental issue: the LSD market severely lacks real yield.

6. The Necessity of LYDs

The success of LSDs lies in the seamless and native process of Liquid → Staking → Derivatives. However, the counterpart for liquid should not be staking, as staking serves as a liquidity management tool for issuers. Instead, the counterpart of liquid should be a financial fundamental: Yield.

Liquid and yield are both a binary seesaw and a contradictory unity. Issuers, holders, and the overall market must consider the balance between the two. This applies to government bonds, funds, and crypto derivatives alike.

The trade-off process between liquid and yield should not be restricted by unilateral rules imposed by one party. Instead, it should reflect a market-driven mechanism, which in web3 and crypto can be embodied by a protocol. CICADA’s R² Protocol, introduced in Q4 2024, achieves this balance effectively.

The problem with LSDs is that the staking process constrains the mechanism of market dynamics. For crypto to truly pump production value into the market and achieve sustainable growth, this restriction must be lifted, allowing free trade-offs between liquid and yield. This ecosystem mechanism and financial derivative are embodied in LYDs.

7. The Surface-Level Problems Solved by LYDs

The emergence of LYDs shifts the focus of the market, projects, and established funds toward real and sustainable yield-bearing assets. It gradually brings various RYAs (Real Yield Assets) into the marketplace, encouraging development, selection, and competition in delivering real yield. This process fosters a stable and healthy growth environment.

Projects and crypto protocols advocating LYDs will take on roles akin to asset managers, trusts, funds, and family offices in TradFi. These entities complement the crypto deposit-gathering and quasi-banking structures established during the LSD cycle, providing solutions that emphasize real yield and forming a more complete financial system.

8. The Fundamental Problems Solved by LYDs

On a micro level, LYDs allow crypto holders and investors to choose their own balance between liquid and yield by creating a market-driven mechanism that offers flexibility in managing staked assets. Institutions and individuals can make trade-offs based on their needs, information analysis, and risk preferences. This approach aligns with TradFi’s long-standing practices, returning freedom to the market and ensuring the sustainable development of the crypto market.

On a macro level, LYDs drive the rapid entry of RYAs and Real-World Assets (RWAs) into the crypto market. This trend will soon transition from quantity to quality, ushering in the Protocol and AI era for global economic and financial systems. More Protocol Asset Management and Smart Contract Asset Management solutions will emerge, laying the groundwork for AI agents to participate in economic and financial management, forming the foundation of AIFi.

9. LYD as a Turning Point for Crypto

The transition from LSDs to LYDs could very well mark a critical turning point for the crypto market — a shift not from prosperity to decline, but from speculation to real-world applications.

In the early stages of this bull market, many speculated it might be the “last chance.” However, this “last chance” does not signify the end of the crypto market. On the contrary, crypto is transforming global economic, financial, and payment systems in an unstoppable way. The so-called “last chance” refers to the end of crypto’s initial phase, where narratives build consensus.

The next phase will be characterized by substantial development in real-world applications, including payments, yield-bearing assets, and various financial scenarios. These will rapidly integrate into the crypto market, forming the next generation of the global economic and financial system. In this evolution, LYDs will serve as a crucial connecting link.