StakeWise: A massive opportunity following the Shanghai Upgrade & Lessons learned from two years competing with Lido

The Spotlight is a Coin98 Insights exclusive interview series with industry builders on hot market topics. In this episode, Coin98 Insights talked to Kirill Kutakov, co-founder of StakeWise, which deals with Liquid Staking Tokens (LSTs), also known as LSDs.

The Duo that took the “leap of faith” into Crypto world

Towards the end of 2019, Kirill Kutakov, who had not yet co-founded StakeWise, found his job at an investment fund boring, while his colleagues in the crypto industry were building a new financial system. Initially, Kirill only viewed crypto as a way to approach new risky assets, but he recognized the technology's potential when the first DeFi applications like Uniswap emerged.

Simultaneously, Kirill's longtime friend Dmitri Tsumak - later the founder of StakeWise - was working on a liquid staking platform as a hobby. Dmitri realized he had created a complete platform after about a year of tinkering and wanted Kirill to help commercialize it. As a result, StakeWise was born.

This industry is really cool. Everything is heating up...

Kirill Kutakov, co-founder of StakeWise

The Covid pandemic struck in early 2020, but Kirill continued to work tirelessly on both jobs from his apartment in northern Estonia. "At some point, I realized I was doing more for StakeWise than I was for my main job, so I knew I had to make the leap," Kirill explained.

Two young men quit their jobs to develop StakeWise on a shoestring budget. They couldn't raise any capital in the beginning, so they put their own savings into the project.

"When we were running a testnet, we built a massive infrastructure. We pondered: How can we justify this excessive spending? We'll run out of cash quickly if we don't optimize our bills," Kirill stated.

Kirill and Dmitri's decision to quit their jobs and develop StakeWise has proven to be successful, as the team has grown from two members to 12 and is now one of the top four Liquid Staking Token platforms on Ethereum according to Messari, after three years of hard work. Kirill and Dmitri's leap of faith has finally paid off.

Realizing the passion for running a node at home

Liquid Staking Tokens (LSTs) recently surpassed DeFi Lending to become the crypto industry's second largest field. This sector is attracting market attention thanks to the upcoming Shanghai Upgrade event.

LSTs provide liquidity for a large amount of capital that would otherwise be locked in staking platforms, allowing DeFi users to profit more. This service makes operating a node more appealing. However, with StakeWise v2, no node is required to participate. The same can be said for the massive Lido, whose node groups are tightly controlled.

When users consider staking ETH, they tend to think of Lido and other market leaders in the LSTs industry first. Consequently, an increasing amount of staking funds are being concentrated in a single provider with strict rules regarding node operation, resulting in high levels of centralization. This is a concerning issue for a network like Ethereum that relies on a decentralized consensus mechanism.

The problem lies in the dominance of centralized exchanges and the significant liquid stake held by protocols such as Lido, creating an oligopoly (not really a monopoly) in the staking market with a few providers holding the majority of the stake. This centralization poses risks such as censorship and chain interruptions, which contradict the values that crypto stands for

Kirill Kutakov, co-founder of StakeWise

StakeWise, which operates on a model similar to Lido, believes it is time for a change. Staking is decentralized, which means that anyone can run a node (of course with some minimum capital or skills). As a result, StakeWise v3 is born.

The new version is aimed at two groups that have yet to enter the thriving LSTs market: those who have the ability to run nodes but cannot provide the massive collateral; and those who have nothing but money, are interested in staking but do not want to take too much risk, such as organizations and institutions.

People who dislike LST platforms are the third group that StakeWise v3 is aimed at. They believe that they should have control over their money and want to help the Ethereum network by running nodes from their homes. This is in line with their passion, but it prevents them from participating in other innovative industry activities and does not help them maximize profits.

With these three groups in mind, Kirill "advertises" succinctly: "With StakeWise v3, you can deploy a home node service for yourself or others in just two minutes."

Read more: Shanghai Upgrade brings great prospects for LSTs', said Stader’s Antonio.

Take a different path than Lido

The core concept of the new version of StakeWise is that you can delegate running a node for others even if you are not a professional, and there is no massive company behind it with business operations or fundraising.

Kirill describes this model as a two-layered platform. Layer-1 is a marketplace where you can set up nodes and stake them with your own, other people's, or both capital. Layer-2 is when this capital has entered the validator and you can mint shadow tokens (used for other profit-making activities in DeFi).

However, as the barrier to becoming a validator is lowered to an extremely low level, a problem arises: What if you believe you are capable of running a node but others disagree? What if you slash a customer in order to protect other customers or organizations?

StakeWise's founders anticipated this situation.

They introduced the concept of overcollateralization - whenever you want to mint shadow tokens, you need to lock up slightly more money than the amount you receive in shadow tokens. This does not mean that your APR decreases.

For example, if you stake 100 ETH in a node, you will mint 90 sETH2, but you still receive yield based on 100 staking-ETH, only 90 sETH2 (instead of 100) are used in DeFi operations.

StakeWise believes they have "transformed" themselves with this model, separating themselves from the traditional definition of an LSTs protocol.

We act as an intermediary platform, giving users tools to easily set up staking or validator operations, after which they can receive liquidity for the amount staked in the system. This is similar to the process of transforming from a pure product to something like DAI. We are more like a maker than Lido," Kirill said.

But how can anyone run a node at home without risking slash? Part of the solution is Distributed Validator Technology (DVT). Users can use DVT to run a node in a group with StakeWise v3. According to Kirill, the risk of slash will not occur as long as 3/5 or 4/6 validators are online and functioning properly.

Liquidity, musical chairs, and Band-Aid.

StakeWise, like many other LSTs platforms in the industry, is facing the million-dollar question: How to solve the problem of token inflation?

Kirill believes that the project cannot do much due to the inflation caused by unlocking tokens from various holder groups because everything has been decided from the beginning and cannot be changed. However, he believes that the industry should have a common standard on this issue.

"Tokens will be unlocked over the course of two years by investors, and four years by the Treasury and team. This is a fairly long period of time by crypto standards "He stated.

And what about inflation caused by emissions from the treasury? The ideal solution is to shift from using tokens as farming incentives to a model where everyone uses the token to hold some rights related to liquidity, controlled or owned by the protocol.

And this is, I believe, something that's been on the minds of crypto users for a long time because of the fact that token emissions typically are unsustainable

Kirill Kutakov, co-founder of StakeWise

What would happen if you run out of incentives? Kirill posed the question. At that point, many people are likely to switch to other protocols where incentives are still available. And this loop could repeat indefinitely, like in the musical chairs game where after each round, a player and a chair are eliminated.

This problem leads to the urgent need for protocols to own or control their own liquidity. They do this by diversifying tokens into assets that can provide liquidity, such as assets that allow them to control liquidity elsewhere. This is the difference between protocol-owned liquidity and protocol-controlled liquidity.

"For protocol-owned liquidity, with the amount of liquidity we need for the current and future product, we may not be able to own that much liquidity," Kirill said. This leaves StakeWise with the remaining option: protocol-controlled liquidity - which means holding more AURA or CONVEX tokens to vote on emissions on Balancer or Curve.

"But if you don't issue tokens and rely on other people's tokens, the problem of unsustainable emissions will not go away. The old question still remains: What happens if they also run out of incentives at some point? You'll need to look elsewhere for those incentives," Kirill said.

Given the current market landscape, Kirill believes that protocol-controlled liquidity is probably the best way to reduce the scale of inflation in StakeWise's treasury.

At the same time, it isn't a perfect solution. It's similar to a Band-Aid. And, more fundamentally, we need to grow larger and consider protocol-owned liquidity, as well as, say, engage market makers in situations where it is appropriate

Kirill Kutakov, co-founder of StakeWise

Lessons learned from two years of competing against Lido

The activation of the withdrawal feature in the Shanghai Upgrade could be a defining moment for LST protocols. Ahead of an unprecedented event in the crypto industry, the market was filled with speculation. Some believe the Shanghai Upgrade event will result in massive unstaking and selling, causing the price of ETH to fall.

StakeWise and other LST platforms, on the other hand, remain optimistic that many people will eagerly stake their tokens.

"This belief is not without foundation," Kirill asserted. "There will be a segment that wants to unstake in order to profit, but not many. Another reason to unstake is to use a different service that may yield a slightly higher profit."

"However, this issue is more about flexibility than profit, because whether you make a lot or a little profit depends on what you do. There are many people who are not stubborn, but are fully committed to the staking method they have chosen up to this point. Because large LSTs have abundant liquidity, you can generally exit at any time.

This means that you have already exited if you wanted to. "Therefore, even if the Shanghai Upgrade is implemented, there is no reason for them to change," Kirill explained.

But, in part because of these hard-headed or dedicated users, Kirill thinks that after the Shanghai Upgrade, it will be hard to knock Lido off the top spot in the Liquid Staking market. Lido will still be on top. Kirill thinks that even though there are at least seven promising LST protocols and many more about to launch, they are all just the same thing. If they all compete at the beginner level with big players like Lido, many of them will only be able to get the last spot on the leaderboard. But he hopes that the new changes to Rocket Pool will make the game different.

StakeWise, on the other hand, has a different worry: as more and more LST players appear, how can the project stand out from the rest? This is what StakeWise learned from competing with Lido for two years.

"If you look at the amount of money at stake, it's not really a race, but for us it is. The reason is that the products from StakeWise and Lido are very similar, and more people will use the front side. It's like how network effects help, "Kirill told me.

As was already said, the upcoming v3 version will be StakeWise's attempt to stand out, at least in terms of how users interact with the product and what they get from it.

But this market competition could also make people miss the bigger picture, which is reducing DeFi's reliance on big companies like Lido and making sure the industry has serious alternatives for running decentralized nodes. This is also one of the reasons why StakeWise has decided to transform itself.

The more people supporting the network from home, the better decentralization we get. This is the mission of StakeWise, Rocket Pool, and all of these upcoming protocols

Kirill Kutakov, co-founder of StakeWise

'Even if we vanished, the product would still exist'

The StakeWise team sees itself more as a group of contributors than as the core of the protocol. This is shown by the fact that the majority of governance rights and tokens are given to the community.

“But our long term goal is always to make sure that the community is sufficiently diverse and decentralized,” Kirill said.  “So that even if we vanished, the product would still exist.”

In StakeWise's plan, we see a familiar echo of what happened to Satoshi Nakamoto after he created Bitcoin and then disappeared.

StakeWise was once just a group of guys who were more interested in coding and building products than in marketing the platform's benefits. However, with the upcoming Shanghai Upgrade bringing strategic changes in the LSTs field, StakeWise does not want to miss out on the opportunity to make a market statement.

"We'll talk about the product more, and make sure that even if you don't use StakeWise, you've heard about it and remember it," Kirill said.

And Kirill frequently begins discussing StakeWise with a story from three years ago, when he hid from his family and girlfriend to build the platform with Dmitri, with endless concerns about its future.

You think this is the only chance. You're sort of afraid it's not going to work, but you do it anyway and hopefully it works out. So it did work out for us and I'm forever grateful for that

Kirill Kutakov, co-founder of StakeWise