LSTs are superior collateral because they are productive assets. Unlike idle ETH or stablecoins, LSTs like Lido's stETH and Rocket Pool's rETH generate staking yield while simultaneously being deployed in lending protocols like Aave and Compound.
liquid-staking-and-the-restaking-revolution
Blog
The Future of Money Markets: LSTs as the Dominant Collateral Asset
An analysis of how Liquid Staking Tokens (LSTs) will structurally displace stablecoins and volatile assets as the primary collateral in DeFi lending, fundamentally altering interest rates, risk parameters, and protocol design.
introduction
THE COLLATERAL SHIFT
Introduction
Liquid Staking Tokens (LSTs) are becoming the primary collateral asset in DeFi, fundamentally altering the risk and capital efficiency of money markets.
This creates recursive yield loops that traditional finance cannot replicate. Users deposit stETH as collateral, borrow stablecoins, and restake for additional yield, a process amplified by protocols like EigenLayer for restaking.
The shift is data-driven. LST collateral on Aave V3 exceeds $5B, and MakerDAO's Spark Lend uses sDAI as its primary collateral type, demonstrating protocol-level adoption.
thesis-statement
THE COLLATERAL SHIFT
The Core Thesis
Liquid Staking Tokens (LSTs) will displace volatile crypto assets as the primary collateral in DeFi money markets, creating a new risk-adjusted yield standard.
LSTs are superior collateral because they combine yield-bearing utility with low volatility. Unlike ETH or BTC, assets like Lido's stETH and Rocket Pool's rETH accrue staking rewards natively, making them capital-efficient collateral that doesn't dilute borrower returns.
This creates a reflexive flywheel where LST demand fuels DeFi lending, which in turn validates the LST's utility, driving more staking. Protocols like Aave and Compound are already optimizing their risk parameters to favor LSTs over unproductive assets.
The endgame is a unified yield layer. LSTs from EigenLayer, Swell, and ether.fi will become the base collateral for lending, perps, and options vaults, establishing a risk-free rate for crypto that is detached from traditional finance.
key-trends
FROM STABLECOINS TO LSTs
The Inevitable Shift: Three Catalysts
The collateral base of DeFi is undergoing a fundamental re-rating, driven by yield, security, and network effects.
01
The Problem: The Opportunity Cost of Idle Capital
Holding stablecoins as collateral is a negative carry trade. LSTs solve this by turning idle collateral into a productive asset.\n- Key Benefit: Unlocks native yield on collateral, transforming a cost center into a revenue stream.\n- Key Benefit: Creates a positive feedback loop where higher LST yields attract more TVL, increasing protocol revenue and security.
3-5%
Native Yield
$30B+
LST TVL
02
The Solution: LSTs as the Ultimate Risk-Weighted Asset
Compared to volatile altcoins or opaque stablecoins, LSTs offer superior capital efficiency for money markets.\n- Key Benefit: Lower risk-weighting (e.g., Aave's ~65% LTV for stETH vs. 0% for most alts) enables higher borrowing power.\n- Key Benefit: Deep, liquid secondary markets (Curve, Balancer) and oracle resilience make them the most defensible collateral type.
65% LTV
Capital Efficiency
-90%
Volatility vs. Altcoins
03
The Network Effect: EigenLayer and the Restaking Flywheel
EigenLayer doesn't just create a new asset class; it supercharges the utility and demand for LSTs as collateral.\n- Key Benefit: Restaking creates a secondary yield layer, increasing the total return profile of LST collateral.\n- Key Benefit: Money markets that natively integrate restaked LSTs (e.g., EigenLayer-native lending) will capture the next wave of institutional DeFi TVL.
2x+
Yield Stack
$15B+
Restaked TVL
THE FUTURE OF MONEY MARKETS
Collateral Efficiency: LSTs vs. The Incumbents
A quantitative comparison of collateral assets based on yield, composability, and risk-adjusted returns for DeFi lending protocols.
| Feature / Metric | Liquid Staking Tokens (e.g., stETH, rETH) | Native Tokens (e.g., ETH, AVAX) | Stablecoins (e.g., USDC, DAI) |
|---|---|---|---|
Base Yield Generation | 3-5% (Staking Rewards) | 0% | 0% |
Collateral Factor (Avg. Aave v3) | 73% | 80% | 77% |
Capital Efficiency (Yield + Borrowing Power) | High | Medium | Low |
Composability (DeFi Integrations) | |||
Yield-on-Yield (e.g., Restaking via EigenLayer) | |||
Price Volatility (30d Avg.) | Correlated to ETH | High | < 0.5% |
Oracle Attack Surface | Medium (Price + Reward Accrual) | Low (Price Only) | Low (Price Only) |
Protocol Revenue Share (e.g., Lido stETH) | ~10% of staking yield | 0% | 0% |
deep-dive
THE COLLATERAL SHIFT
The New Mechanics of LST-Backed Credit
Liquid staking tokens are becoming the primary collateral for on-chain money markets, fundamentally altering risk models and capital efficiency.
LSTs are superior collateral because they generate native yield. This yield directly offsets borrowing costs, creating a negative carry trade where users can borrow stablecoins for less than the staking yield they earn. This arbitrage is the primary driver of LST-based lending on platforms like Aave and Compound.
The risk profile diverges from traditional collateral. LSTs carry slashing and depeg risk, not just price volatility. Protocols like EigenLayer introduce restaking risk, creating complex, nested dependencies that traditional risk oracles from Chainlink cannot fully price.
Capital efficiency is multiplicative. LSTs enable recursive strategies where borrowed assets are restaked to mint new LSTs, a loop that amplifies both returns and systemic leverage. This is the core mechanism behind Ether.fi's eETH and Kelp's rsETH.
Evidence: Over 40% of staked ETH is now in LSTs, and LST collateral on Aave V3 exceeds $5B, demonstrating the market's preference for yield-bearing assets over static ones like WBTC.
counter-argument
THE SYSTEMIC RISKS
The Bear Case: Slashing, Depeg, and Concentration
The dominance of Liquid Staking Tokens introduces novel, interconnected risks that threaten the stability of the entire DeFi credit system.
Slashing risk is non-diversifiable. A major slashing event on Ethereum (e.g., correlated client failure) simultaneously devalues the collateral backing billions in loans across Aave, Compound, and Morpho. This creates a systemic margin call cascade that traditional DeFi insurance like Nexus Mutual cannot fully underwrite.
LST depeg mechanics differ from stablecoins. A USDC depeg is arbitraged on-chain via Curve pools. An stETH depeg from a slashing rumor requires off-chain validator exit queues, creating a multi-day liquidity black hole that protocols like MakerDAO's PSM cannot instantly resolve.
Concentration begets centralization. The dominance of Lido's stETH creates a single point of failure. Governance attacks or a bug in its oracle network (e.g., Obol) could destabilize the collateral base for the majority of DeFi money markets, replicating the 'too big to fail' problem from TradFi.
Evidence: During the Terra collapse, stETH briefly traded at a 7% discount, causing significant stress for leveraged positions. Today, over 70% of DeFi's ETH-denominated collateral is in LSTs, creating unprecedented correlation risk.
protocol-spotlight
THE FUTURE OF MONEY MARKETS
First Movers: Protocols Building the LSTfi Stack
Liquid staking tokens are becoming the foundational collateral asset, forcing money markets to evolve beyond simple lending into complex yield and liquidity primitives.
01
Aave: The Dominant LSTfi Gateway
Aave's GHO stablecoin and V3's isolation mode have made it the primary venue for leveraged staking loops. It's where yield is extracted from LST collateral.
- GHO minting directly against stETH/aETH collateral creates reflexive demand.
- Isolation Mode limits contagion risk, allowing for aggressive LST integrations.
- ~$8B+ in LST collateral demonstrates its role as the core liquidity hub.
$8B+
LST TVL
GHO
Native Stable
02
Morpho Blue: The Capital-Efficient LST Engine
Solves the problem of inefficient, one-size-fits-all lending pools. Its isolated, permissionless markets allow for hyper-optimized LST lending vaults.
- Custom Risk Parameters per market let protocols like MetaMorpho build optimized LST vaults.
- ~100% capital efficiency via peer-to-peer matching, maximizing lender yield and borrower rates.
- Rapid integration for any new LST, bypassing slow governance of monolithic protocols.
~100%
Capital Eff.
MetaMorpho
Vault Standard
03
EigenLayer: The Restaking Collateral Primitive
The problem is securing new services (AVSs) without issuing new, illiquid tokens. EigenLayer turns staked ETH into programmable, yield-bearing security.
- Native Restaking of LSTs (e.g., stETH) creates a unified collateral layer for cryptoeconomic security.
- Dual Yield: Base staking rewards + AVS operator fees, boosting LST utility.
- $15B+ TVL proves the demand for repurposing staked capital, forcing money markets to adapt.
$15B+
TVL
Dual Yield
AVS + Staking
04
The Problem of Fragmented LST Liquidity
Dozens of LSTs (stETH, rETH, wstETH) fragment liquidity across chains. This creates inefficiency for borrowers and lenders seeking the best rates.
- Solution: Omnichain money markets like Radiant Capital and Compound III on Base aggregate cross-chain LST demand.
- Unified Markets allow borrowing against stETH on Ethereum to mint USDC on Arbitrum.
- LayerZero & Axelar enable the secure cross-chain messaging required for this architecture.
Omnichain
Architecture
Radiant
Key Protocol
05
Lybra & Prisma: LST-Backed Stablecoin Specialists
Generic stablecoins (DAI, USDC) don't capture LST yield. These protocols issue stablecoins that automatically accrue value from the underlying staking rewards.
- Yield-Bearing Collateral: eUSD and mkUSD are backed by stETH and other LSTs.
- Auto-Compounding: The stablecoin's peg is maintained via yield, not just liquidation.
- ~$1B+ TVL niche shows demand for a native, yield-generating stable asset.
Yield-Bearing
Stable Asset
$1B+
Combined TVL
06
The Endgame: LSTs as Universal Margin
The final evolution is LSTs as the default margin asset across all of DeFi, not just lending. This requires solving liquidation efficiency and oracle reliability.
- Solution: Perpetual DEXs like Hyperliquid and Aevo already accept LSTs as margin.
- High-Frequency Oracles from Pyth Network and Chainlink enable safe, sub-second liquidations.
- Result: A single stETH position can collateralize loans, trade perps, and earn restaking yield simultaneously.
Universal
Margin Asset
Pyth/Chainlink
Oracle Stack
risk-analysis
LST COLLATERAL RISKS
The New Risk Matrix: What Could Go Wrong?
The rise of Liquid Staking Tokens as the backbone of DeFi money markets introduces novel, systemic vulnerabilities beyond traditional credit risk.
01
The Slashing Contagion Problem
A major slashing event on a foundational network like Ethereum could trigger a cascade of bad debt across protocols using that LST as collateral. This is a correlated failure mode that traditional risk models fail to price.
- Unmodeled Correlation: LST value is tied to validator health, not just market price.
- Protocol Dominoes: Aave, Compound, and Morpho would face simultaneous collateral shortfalls.
- Liquidation Inefficacy: Mass liquidations during a network crisis are impossible, creating a death spiral.
>32 ETH
Slashing Event
Systemic
Risk Tier
02
The Rehypothecation Liquidity Mirage
The same LST collateral is often deposited across multiple layers (e.g., stETH in Aave, used as collateral to mint USDs, which is then deposited in Euler). This creates a liquidity illusion and extreme fragility.
- Hidden Leverage: True leverage ratios are obscured across protocols.
- Instant Dry-Up: A withdrawal cascade from one layer drains liquidity from all others.
- Oracle Dependency: All layers rely on the same price feed (e.g., Chainlink's stETH/ETH), a single point of failure.
5-10x
Effective Leverage
Seconds
Cascade Speed
03
The Centralization of Trust in LST Issuers
Dominance by a few LST providers like Lido, Rocket Pool, and Binance shifts critical trust from decentralized validators to their governing DAOs and multisigs. This creates political and custodial risk.
- Governance Attack Surface: A malicious proposal or takeover could compromise the underlying stake.
- Withdrawal Queue Control: Centralized operators could censor or reorder withdrawals.
- Regulatory Single Point: Targeting a major issuer (e.g., Lido's $30B+ TVL) becomes a regulatory priority, threatening the entire stack.
>70%
Lido Dominance
DAO/Multisig
Control Point
04
The Oracle-Staking Yield Feedback Loop
Money markets use LST yield as a key input for risk assessment and interest rate models. A drop in staking yield (e.g., from lower network fees) can be misinterpreted as increased risk, triggering unnecessary deleveraging.
- Pro-Cyclical Pressure: Lower yield -> higher borrowing costs -> forced selling -> lower collateral prices.
- Model Misalignment: Protocols like Aave v3 risk mispricing collateral based on transient yield data.
- Validator Economics: Network security and DeFi stability become unintentionally coupled.
3-5%
Yield Volatility
Auto-trigger
Risk Model
future-outlook
THE COLLATERAL SHIFT
The 2025 Landscape: Predictions and Implications
Liquid staking tokens (LSTs) will displace volatile crypto assets as the primary collateral in DeFi money markets.
LSTs become prime collateral because they offer yield-bearing stability. Protocols like Aave and Compound will re-weight their risk parameters, favoring stETH and rETH over ETH and other volatile assets. This creates a positive feedback loop where staking demand fuels DeFi liquidity.
Native yield kills money market APY. LSTs carry inherent staking yield, which compresses the lending rate spread for borrowers. This makes borrowing against LSTs cheaper than traditional assets, forcing protocols like Euler and Morpho to innovate on risk models to maintain profitability.
Restaking creates collateral supercycles. Platforms like EigenLayer and Karak transform LSTs into productive, rehypothecated assets. This introduces new systemic risks but also unlocks capital efficiency orders of magnitude beyond today's isolated lending pools.
Evidence: LST collateral on Aave V3 exceeds $4B, growing 300% year-over-year while volatile crypto collateral stagnates. The TVL in restaking protocols surpasses $15B, proving demand for yield-generating collateral.
takeaways
THE LIQUID STAKING PRIMACY
TL;DR for Builders and Investors
The next generation of DeFi money markets will be built on and for Liquid Staking Tokens, fundamentally reshaping capital efficiency and risk models.
01
The Problem: Idle Yield & Capital Inefficiency
Traditional money markets treat staked assets as dead capital. A user's $100k in stETH earns staking yield but cannot be used as collateral, creating a massive opportunity cost and fragmenting liquidity.
- $30B+ TVL in LSTs is largely sidelined from DeFi leverage loops.
- Forces users to choose between security (staking) and utility (collateral).
$30B+
Idle LST Capital
0%
Collateral Utility
02
The Solution: Native Yield-Bearing Collateral
Protocols like Aave and Euler are enabling LSTs as primary collateral, allowing users to borrow against an asset that appreciates in real-time. This creates self-repaying loans and superior risk-adjusted returns.
- Double-dip yield: Earn staking APR while accessing liquidity.
- Automatic deleveraging: The underlying collateral value grows, reducing loan-to-value ratios passively.
2x
Yield Source
Dynamic LTV
Risk Model
03
The Risk: Systemic LST Depeg Contagion
Concentrated LST collateral creates a new systemic risk vector. A depeg event (e.g., stETH during the Merge) could trigger cascading liquidations across integrated money markets like Compound and Morpho.
- Requires over-collateralization ratios and oracle robustness.
- Demands LST diversity (e.g., rETH, cbETH, sfrxETH) to mitigate single-provider risk.
High
Contagion Risk
Multi-Oracle
Mandatory
04
The Frontier: LST-Centric Money Market Stacks
Native stacks like MarginFi on Solana and Ethena's USDe synthetics are being built from first principles for LSTs. They optimize for high leverage, cross-margining, and integrated yield strategies that generic platforms can't match.
- Purpose-built risk engines for staking derivative volatility.
- Capital efficiency is the primary product metric, not an afterthought.
10x+
Target Efficiency
Native
Architecture
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