Recently, we discussed the coming V2 launch enabling Liquid Staking Derivatives (LSDs) for investment and the role of Deposit NFTs (dNFTs) and Smart Vault Tokens (SVTs).
Now, it’s time to break that down a little more by looking at the benefits of both LSDs and SVTs for investors, as well as some of the potential end products they can be used to create.
A brief recap
Liquid Staking Derivatives (LSDs) are tokens issued by a Staking Provider in exchange for staking your cryptocurrency, such as Ethereum, through them. In the Ethereum model, in order to stake and act as a Validator, you are required to stake a minimum of 32 ETH. For many holders this is outside their financial means, so Staking Providers give them indirect access to that validator process. LSDs usually also provide a way to instantly withdraw your staked ETH as when you are acting as a Validator an instant withdrawal is impossible.
Deposit NFTs (dNFTs) are an NFT receipt of your specific deposit into a Smart Vault. These can be used later to withdraw your original deposit, or they can be burned for Smart Vault Tokens.
Smart Vault Tokens (SVTs) are created by burning the Deposit NFT (dNFT) an investor receives for depositing into Spool Smart Vaults. While the dNFT represents the entirety of a specific investment into a Smart Vault, the SVTs represent a smaller share of that Vault, creating more flexibility in how they can be traded and used.
Guards are processes that restrict which users are able to deposit into or withdraw from a Vault. These include services such as NFT Gating (where you need to hold a specific NFT to deposit), Time Locks (you can only withdraw after a fixed time from your deposit), and Token Gating (you need to hold a minimum number of certain tokens). For more information on Guards, please see our article: Spool V2 Smart Vault Guards: Adding control for Institutional DeFi product creators.
What are the benefits of Liquid Staking Derivatives (LSDs) and Smart Vault Tokens?
Before we discuss use cases, we need to understand exactly why LSDs and SVTs exist, and the core benefits they provide to investors within the DeFi ecosystem.
Enhanced Liquidity
When staking a digital asset, particularly when staking Ethereum as a Validator, those assets are locked for a certain period and cannot be used for other purposes. LSDs, being a tokenised representation of staked assets, can be traded or used in the broader DeFi ecosystem, thereby providing flexibility and accessibility to the staked capital.
Within Spool assets are not staked in the same way but, in the V2 model, Smart Vault creators have the option to include Entry and Exit Guards including Time Locks. In Smart Vaults using this function, SVTs can give investors the flexibility and liquidity they would otherwise not have. It’s important to note that, even using this model, Spool is still a fully non-custodial solution, with investors only routing their assets through Smart Vaults to the underlying strategies.
Even without a vault being time-locked, SVTs provide investors with a means to access their liquidity without losing out on rewards they are earning through the Smart Vault.
For the wider DeFi ecosystem, LSDs and SVTs create an additional layer of liquidity to help prevent large price and availability swings should an asset have a change in staking popularity. This is particularly noticeable in “thinner” markets where tokens may have a high percentage of staked tokens and a single “whale” or change in sentiment towards staking across a market could otherwise create a rapid price movement.
Risk Mitigation
Risk management and mitigation have always been key factors in Spool’s design, and this continues throughout V2, with a key advantage of LSDs being their potential for risk mitigation.
By staking assets across multiple Staking Providers and obtaining their respective staking derivatives, investors can diversify their portfolios. This reduces the risk of exposure to any single Provider, giving a level of security that’s highly valued in institutional financial investing.
SVTs continue this diversification model and creates a solution simiar to other Yield Generator tokens found in the DeFi ecosystem. Not only can you invest into a specific Smart Vault, or into multiple Vaults manually, it is now much easier to actively trade SVTs representing a share in those Vaults.
As Vaults can now Guards, it also adds the potential for investors to diversify into Smart Vaults they were not able to directly invest into.
Yield Farming
In the ever-evolving DeFi landscape, yield farming has emerged as a popular strategy for earning returns and is now a core function of the wider industry. LSDs, in addition to being yield-bearing assets themselves, can be used in yield farming strategies, where they can be deposited in different DeFi protocols to earn rewards.
This allows holders to earn additional returns on their staked assets while they’re being used to secure a network such as Ethereum, optimising their investment strategy.
Spool V2 allows for these LSD-powered strategies to form part of a Smart Vault and, in turn, be used to generate SVTs. As the SVTs are also yield-bearing assets, they in turn can be used to create further strategies. This creates additional yield farming potential with increased diversification and flexibility around how individuals choose to invest and manage their risk.
Collateral in DeFi
In addition to their role in yield farming, LSDs can also be used as collateral in DeFi lending and borrowing platforms. This can allow stakers to borrow funds against their staked assets, effectively leveraging their holdings for additional financial activities.
Alternatively, users may wish to loan their assets to others in exchange for fees, generating a new source of revenue from assets that would otherwise be unavailable due to staking.
The same will likely be true of SVTs due to their representation of a basket of yield-bearing assets, with the potential for them to be loaned to others and borrowed against in DeFi protocols.
Governance Participation
Governance is a key aspect of many DeFi protocols, including Spool, and some LSDs allow holders to participate in this process. LSD holders can have the opportunity to vote on key decisions related to the network, making them active participants in the protocol’s future.
This enhances the sense of community and ownership in the network, which can be a significant attraction for many investors.
This can also be a service offered by Vault providers for investors within their specific Smart Vault, particularly those which are gated to specifically qualified investors. This governance could represent actions such as rewards issued to investors in the Vault or could form part of a wider governance protocol for a project.
For projects looking at these options, the highly structured and planned approach taken by the Spool DAO, both in its creation and its long-term governance, could be a suitable model to act as a guide.
What products can be built with the new Spool V2?
The key to Spool V2 is that it is a full infrastructure solution, built to the requirements of institutional providers, that allows anyone to build exactly the product they want, be it for themselves or for their clients. Built to act as a middleware between investors and multiple DeFi Yield generators, it also makes an ideal white label solution for institutions looking to create DeFi investment products for their own clients
The products will always be based around the Spool framework of risk-managed, automated, and non-custodial investment, but with the flexibility to tailor the Smart Vault to multiple different use cases and regulatory requirements.
In short, institutions can build the products they want, in the way they want. The following are two sample use cases that can be built, enabled by Spool V2’s support of LSDs, SVTs, and Guards.
Ethereum LSD Aggregator
An institution could create a Smart Vault specifically for strategies using Ethereum LSDs. The automation within the Smart Vault would source the best returns from various staking strategies available, based on the risk models and preferences selected during Vault creation.
For an institution with clients who are not crypto-native, this provides an easy way for them to invest in multiple LSD-based strategies. They would be able to do so in a highly risk-managed way without needing much, if any, technical understanding of Ethereum staking, staking providers, or directly handling those assets.
Using the Entry and Exit Guards, an institution can restrict who can invest in the product, for example, by whitelisting a set of addresses who have completed KYC, or even only allowing themselves to invest on behalf of clients they act as financial custodians for. This creates the flexibility to create a DeFi aggregator product that is regulatory compliant across a range of jurisdictions.
In this model, investors using these institutions, as well as any third-party auditors or regulators, can view the Smart Vault, see the returns that are being earned, and how funds are being handled. This increases the transparency of custodial providers, without investors ever having to directly touch cryptocurrency or DeFi themselves.
Even for those who do want to directly control their funds and who are allowed to directly invest into the Vault, the automatic exchange of assets solution that is coming in V2 (which we’ll be discussing in detail closer to the launch) will streamline the process and make their investing easier.
This creates a highly complex financial product, built around investing in multiple variations of staked asset derivatives, but abstracts all that complexity away from the investor. Building the product is quick and simple for the institution yet, the risk management and diversification Spool V2 offers helps to keep everyone protected.
Spool Smart Vault Yield Aggregator
The addition of dNFTs and the ability to burn them to create SVTs adds another layer of diversified yield farming, similar to the LSD Aggregator model above, but with additional functionality.
As with the LSDs, SVTs allow for the creation of new strategies which use them as a yield-bearing asset. The same principles as the LSD Aggregator would apply, with it creating a way to easily access and diversify across multiple Smart Vaults from a single location.
At this layer, once again, the Guard solutions in V2 become key to how the end investment product can be built.
For example, NFT gating might be added to a Smart Vault where only holders of a specific dNFT (which has not yet been burned to create SVTs) representing an investment in an earlier Smart Vault, can invest. Alternatively, only holders of a minimum number of specific SVTs might be able to invest. Both these models enable institutions to create multiple Smart Vault products which reward investors who follow certain behaviours and patterns of investment.
In turn, those investors who are eligible could use their new dNFTs or SVTs in governance. That might be part of the wider governance of the institution that has created the Smart Vault, for example, to leverage its treasury but has also opened access to others. Alternatively, it could allow for smaller governance voting around how the Smart Vault is handled, what the requirements are for new Vaults created by the project, or how incentivised rewards are issued within the Vault.
The key for all the above is that any institution using Spool V2 to create a DeFi investment product has the ability to control exactly who can invest in the product, and what the conditions of their investment are. They can also make the investment process as simple, or as complex, as they wish.
The end product will remain non-custodial, with the Smart Vault routing the assets to the underlying strategies, and the automated risk management will handle trading within the Vault based on yields at any given time.
The addition of LSD compatibility, and the new function of dNFTs and SVTs, create advanced levels of flexibility in how and why Smart Vaults are created but still allow for full abstraction of that complexity from the investor.
In short, Spool V2 allows for the easier investing models people are familiar with from traditional finance, but powered by the new potential of DeFi.
To discuss the potential of Spool V2, and how it can be used to build the products you need, visit enterprise.spool.fi.
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Spool is a permissionless DeFi platform that connects Capital Aggregators with DeFi Yield Generators. Funds are dynamically and efficiently allocated to ensure optimized yields, for custom strategies, managed by DAO-curated Risk Models.
Spool was established as a DAO, with a selection of founding contributors representing a diverse cross-section of the blockchain community.
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