Why LSTs as Collateral Are More Than Just Leveraged Staking

Staked ETH was historically locked in a non-composable silo, creating a massive $70B+ opportunity cost for DeFi. This forced users to choose between securing the network and accessing liquidity.

• Capital Inefficiency: Staked ETH couldn't be used as collateral on Aave, MakerDAO, or in perp markets.
• Fragmented Yield: Users missed out on stacking staking yield with lending/borrowing APY.

LSTs like Lido's stETH and Rocket Pool's rETH transform staked ETH into a yield-bearing, composable asset. This enables a new design space for auto-compounding leverage and risk-tranching.

• Capital Efficiency Multiplier: Use LSTs as collateral to borrow stablecoins, creating a self-repaying leveraged staking position.
• Yield Stacking: Native staking yield + lending/borrowing spreads + trading fees = potential 2-3x yield multiplication.

Specialized protocols are building the infrastructure to maximize LST utility, moving beyond simple lending markets.

• Restaking (EigenLayer): Use LSTs to secure additional Actively Validated Services (AVS), creating a new yield layer.
• Yield-Tranching (Pendle): Separate LST yield into principal and yield components, enabling fixed-rate staking and leveraged yield speculation.

Concentrated LST collateral creates new systemic risks. A major LST depeg could trigger cascading liquidations across DeFi, reminiscent of the UST collapse.

• Correlated Collateral: Heavy LST usage on Aave/Maker creates a single point of failure.
• Liquidity Fragility: During stress, secondary market liquidity for LSTs can evaporate, exacerbating depegs.

The stability of this new system depends on robust oracle design and collateral diversification. Protocols are moving beyond relying solely on Chainlink for LST prices.

• Redundant Oracles: Using Pyth Network, Chainlink, and TWAPs to mitigate manipulation.
• Basket Strategies: Encouraging use of a diversified LST basket (stETH, rETH, cbETH) instead of a single asset to reduce protocol-specific risk.

LSTs will become the default collateral type, fundamentally changing economic security. The line between staking and DeFi will disappear.

• Base Layer Security: More ETH staked via LSTs increases Ethereum's economic security.
• Unified Money Market: Future lending markets may natively accept staked ETH, rendering non-yielding collateral obsolete.

Staked ETH in LSTs earns yield but sits inert, unable to participate in DeFi's most capital-efficient activities. This is a $50B+ opportunity cost locked in passive assets.

• Capital Inefficiency: LSTs are often stashed in wallets or simple lending pools.
• Yield Fragmentation: Staking yield is siloed from trading, lending, or LP fees.
• Protocol Opportunity: DApps can't build composable products on 'sleeping' collateral.

Lybra transforms stETH into a yield-bearing stablecoin (peUSD), solving the 'idle collateral' problem by making the yield itself the product.

• Native Yield Accrual: peUSD minters earn ~5-8% APY from the underlying stETH while their stablecoin is in circulation.
• Capital Multiplier: Users gain a liquid, yield-generating stable asset without selling their staked ETH position.
• DeFi Composability: peUSD becomes a base asset for lending, trading, and payments across chains via LayerZero.

Prisma accepts multiple LSTs (wstETH, rETH, cbETH) as collateral for its mkUSD stablecoin, aggregating governance power and de-risking through diversification.

• Collateral Diversification: Mitigates single-LST slashing or depeg risk via a basket.
• Meta-Governance: Protocol votes with its aggregated LST holdings, creating a new political entity in Lido, Rocket Pool, and Coinbase governance.
• Yield Optimization: Fees from stability mechanisms and liquidations are distributed to mkUSD holders and stakers.

EigenLayer's restaking allows LSTs to secure new Actively Validated Services (AVSs), turning passive collateral into active cryptoeconomic security.

• Dual Yield: Earns native staking yield plus AVS rewards for providing slashing-backed security.
• Trust Network Expansion: LSTs become the base security layer for oracles, bridges (like Across), and new L2s.
• Capital Super-Charge: A single stETH deposit can now secure the Ethereum beacon chain and multiple external protocols simultaneously.

LST liquidity is scattered across isolated chains and pools, creating arbitrage inefficiencies and slippage that hinder their use as universal collateral.

• Siloed Markets: stETH on Ethereum, wstETH on Arbitrum, and rETH on Optimism trade at different premiums/discounts.
• Bridge Risk & Cost: Moving LSTs cross-chain introduces custodial risk and high gas fees.
• Slippage: Large trades on secondary pools incur significant price impact, making LSTs poor large-scale collateral.

Mellow automates complex DeFi strategies for LSTs, like delta-neutral liquidity provisioning, turning collateral into a yield-optimizing engine.

• Automated Vaults: Deposits LSTs into optimized Uniswap V3 LP positions or perp funding rate arbitrage.
• Risk-Managed Yield: Strategies target 10-20%+ APY by programmatically leveraging the LST's inherent yield and liquidity.
• Capital Efficiency: Maximizes returns on collateral that would otherwise sit idle in a lending market or wallet.

LSTs promise instant liquidity for staked ETH, but during a market crash, redemptions are gated by the underlying validator exit queue (~27 days). This creates a liquidity illusion where $30B+ of "liquid" collateral can face a bank run.

• Redemption Run Risk: Mass unstaking triggers a queue, crashing LST prices below NAV.
• Cascading Liquidations: DeFi protocols (Aave, Compound) liquidate positions as LST depegs, creating a death spiral.
• Contagion Vector: Failure of one major LST (e.g., stETH depeg) can spill over to all LST-collateralized DeFi.

LST prices are synthetic, relying entirely on oracles (Chainlink, Pyth). Manipulating this price feed is a single point of failure for the entire collateral stack.

• Low-Liquidity Manipulation: Attacker shorts LST on a DEX, manipulates oracle price, triggers mass liquidations, and profits.
• Protocol Dependence: Systems like EigenLayer and restaking protocols compound this risk by layering additional oracle dependencies.
• Historical Precedent: The 2022 stETH depeg and Mango Markets exploit demonstrate the fragility of oracle-reliant collateral.

Using LSTs as collateral is often a regulatory gray area, treating a security-like derivative as a money-market asset. This invites severe intervention risk.

• SEC Target: Platforms like Lido Finance and Rocket Pool are under scrutiny; their tokens used as collateral could be deemed unregistered securities.
• Protocol Blacklisting: Regulators could force centralized oracles or fiat on-ramps to blacklist LST contracts, freezing collateral liquidity.
• Killer Precedent: The collapse of Terra's UST demonstrates how regulatory action can permanently destroy a "stable" asset's viability.

LSTs bundle individual validator slashing risk. A major slashing event (e.g., client bug) directly impairs the collateral value of the entire LST pool, a risk opaque to end-users.

• Non-Transparent Impairment: User's LST collateral can be diluted overnight due to slashing penalties applied to the underlying validators.
• Correlated Failure: A catastrophic network-level event could slash hundreds of validators simultaneously, causing a step-function drop in LST NAV.
• Insurance Gaps: Native staking insurance (e.g., via EigenLayer) is nascent and adds another layer of smart contract risk.