Why Is Liquid Staking and Yield Vault Difficult to Sustain in Hyperliquid?

This article analyzes how Hyperliquid's combination margin drains the liquidity of circular lending and impacts traditional DeFi primitives such as LST, and proposes a path to rebuild a complementary market around the utility of HYPE.

Written by: @DevenMat

Compiled by: AididiaoJP, Foresight News

DeFi primitives on HyperEVM are forming a structural conflict with the market structure of HyperCore. Primitives such as lending markets, tokenized vaults, and LST are difficult to replicate on Hyperliquid in the existing manner.

The core judgment is that the combination margin is making circular lending against Hyperliquid's native assets unfeasible, while the vast majority of current DeFi primitives rely on circular lending. Therefore, DeFi on Hyperliquid is placed in a position competing with the growth of HyperCore.

There are two corresponding solutions: first, to build a DeFi market rooted in token utility rather than relying on the old paradigm of circular yields; second, the DeFi layer must complement the growth of HyperCore, or it will be swallowed or eliminated by it.

I. Economy Built on Yield Leverage

The backbone of traditional DeFi is realized through circular on-chain native yield sources: native yield, similar lending against that yield certificate, and the downstream DeFi flywheel. This structure supports most DeFi activities.

The DeFi market structure on Hyperliquid has undergone two fundamental changes.

Combination Margin

The combination margin is Hyperliquid's native margin engine. All liquidity serving leveraged yields is drained to serve leveraged trading.

This mechanism is not designed for similar lending, thus changing the conditions under which the traditional DeFi flywheel operates, and lacking direct alternatives:

• There is a lack of re-mortgaged liquidity available for circular use. When borrowing USDC with HYPE collateral on AAVE, the HYPE collateral can be reused by stHYPE and kHYPE circular users, thereby reducing the cost of circular lending. When borrowing USDC with HYPE collateral on HyperCore, this portion of HYPE liquidity will not be available for circular use.
• It does not support lower capital-occupying liquidation paths like those in EVM lending markets. Its design is aimed at order book liquidation. Using yield-bearing derivatives as collateral requires establishing a separate deep order book on HyperCore; whereas on AAVE and Morpho, yield-bearing derivatives can be supported through withdrawal queues and other means.

Differences Between AAVE's Growth Strategy and Combination Margin

AAVE subsidizes ETH lending by introducing a large amount of whale ETH-USDC lending activity and provides special liquidation paths for yield-bearing derivatives through E-Mode, making stETH more usable as collateral. Of the supplied WETH, 80.6% belongs to accounts that use it as collateral to borrow stablecoins. AAVE's liquidity pool engine forms a flywheel between USDC margin and ETH yield leverage, subsidizing both sides in a symbiotic relationship.

The combination margin withdraws USDC margin from the liquidity pool system, does not re-lend collateral, and does not allow similar lending. Circular trading is thus killed off, and there is no replacement. If USDC lending migrates from the liquidity pool model to the combination margin, circular Hyperliquid native yields—including vault tokens, LP positions, and LST—will be removed from the DeFi economy. Currently, the entire DeFi economy relies on this transaction and the symbiotic relationship between margin and circularity.

II. Limited Structural Impact of Staking Emissions on Hyperliquid

The uniqueness of Hyperliquid lies in the fact that this chain is already useful enough that it no longer needs inflation at the network level to drive consensus participation. The marginal effect of staking emissions on Hyperliquid is limited; whereas on most chains, they are the native yield source that sustains most DeFi activities.

• Staking emissions have little effect on aligning token holders. The net new demand for HYPE comes from HIP-3, HIP-4, AQA, and staking tier discounts, rather than the 2.2% yield.
• The validator set is actually composed of custodians, DAT, data providers, and organizations running validators for operational purposes and latency, rather than for yield. The number of 0% commission validators shows that entering the active set is a privilege that many are willing to pay for.

If staking emissions do not provide significant benefits to Hyperliquid, they should be reassessed. DeFi on Hyperliquid also needs to quickly reposition its purpose.

III. Current Status of Hyperliquid DeFi: Liquidity is Being Drained

HyperEVM DeFi is fundamentally driven by LST leverage, and the current situation is not optimistic.

Combination Margin is Draining Liquidity

On September 18, Hyperliquid announced a manual lending feature: collateralizing HYPE or BTC on HyperCore to borrow USDC.

Two days later, an account on HyperLend withdrew 743,058 HYPE, bridged it to HyperCore, used it to borrow $25.65 million USDC, and repaid $25.6 million of HyperLend loans. The entire HyperEVM borrowing migrated to HyperCore within 33 minutes.

A second account followed suit. The utilization rate of the HYPE liquidity pool on HyperLend rose from 78% to 98%, and the HYPE borrowing rate increased from 1% to 90%. Circular trading became unprofitable.

Structurally, the combination margin moves HYPE liquidity from HyperEVM to HyperCore. Without intervention, this process may continue until liquidity is exhausted.

As a result, LST on Hyperliquid is structurally unable to support its own economy and continues to experience prolonged decoupling. The structural fragility can be observed from the more frequent and severe decoupling of kHYPE compared to similar LSTs in the Ethereum and Solana ecosystems.

Liquid staking is inherently a capital-intensive tool: it requires HYPE lenders to service low-rate, stable circularity; it needs DEX liquidity and arbitrageurs to maintain peg and reduce exit costs. When the native margin engine drains the core part of the system, the flywheel becomes difficult to sustain.

Survival Path

Valantis's strategy has always been to optimize the DeFi economy under capital constraints: the dynamic instant redemption buffer of stHYPE reduces the demand for deep DEX liquidity, helping users exit within 7 days; STEX reuses liquidity among HYPE lenders, serving both circularity and providing exchange liquidity when needed. The scale of stHYPE is only one-fifth of kHYPE, yet it is more stable in anchoring. Nevertheless, market pressure remains evident. The transaction of staking yields has become too fragile to assume that the flywheel can withstand the combination margin. HyperCore tends to absorb all liquidity, which is a natural trend under the current structure.

Kinetiq claims to have created the fastest-growing LST in history, arguing to become the Lido and Jito on Hyperliquid. However, neither Ethereum nor Solana has a native margin engine competing with lending markets. Structurally, Hyperliquid is one of the least suitable environments in the crypto world for ordinary LST to operate.

If this transaction does not exist, ordinary LST lacks work to do. The disappearance of available liquidity for yield-bearing derivatives should be understood in the following context: most of today's DeFi consists of yield-bearing derivatives—tokenized yield vaults, LP positions, and LST. The loss of circular liquidity means that most of the previously validated DeFi primitives face obsolescence. Therefore, new primitives need to be constructed.

IV. The Goal of HYPE Staking is Not Yield

Most DeFi on Ethereum lives downstream of LST leverage cycles, thus circularity is treated as a first-class citizen. However, Hyperliquid locks HYPE in a different way: it does not pay holders to stake, but rather requires every enterprise wanting to use exchange resources to buy coins and stake.

• Deploy perpetual markets under HIP-3, or deploy outcome markets under HIP-4: stake 500,000 HYPE, lock for six months, subject to forfeiture.
• Make stablecoins the aligned pricing asset: stake 1 million HYPE.
• Trade with lower fees: stake 10 HYPE for a 5% discount, with a maximum stake of 500,000 HYPE for a 40% discount. There are also tiers of 100, 1,000, 10,000, and 100,000 HYPE in between. Top traders and market makers lock HYPE to exchange for lower fee tiers, potentially saving over $40 million a year.
• Directly engage with foundation nodes for low-latency data: stake 10,000 HYPE.

Each of the above items consumes network resources by partners or traders, paying with locked HYPE. If one wants to consume network resources, staking HYPE is the key to entry. Liquid staking should create a market around this key to entry.

Valantis's classification of the evolution of liquid staking is:

• Act I, yield from high economic security costs—stETH;
• Act II, yield from privileges in liquidity flow—JitoSOL;
• Act III, yield from direct access to liquidity—staking HYPE.

This is not about tokenizing the native yield of HYPE, but constructing an economy around its gatekeeping access to network resources and liquidity.

V. DeFi Primitives Serving Core Market Structure

Primitives that can survive here are those that can bring the utility of HYPE to areas that Core itself cannot cover.

Native staking cannot serve as collateral for combination margin

Traders looking to use their HYPE for margin trading are sacrificing yields and lower Hyperliquid fees. The composite margin does not accept staked HYPE as collateral. The margin engine requires liquidators—either an order book or a lending market with risk curators willing to take on redemption risks; neither of which has native staked HYPE. The composite margin is designed not to support native staking. LST is needed to bring the benefits of staking into margin trading.

An LST that can carry trading fee discounts can solve this problem. The logic is that stHYPE tokenizes the discount; without liquidity certificates, it cannot be replicated, thus creating downstream DeFi activities. This is a Hyperliquid native DeFi flywheel.

HyperCore is responsible for USDC margin, HyperEVM handles derivative risks

HyperCore's composite margin does not support derivative assets to operate in a capital-efficient manner. It requires a separate cold start order book for stETH-USDC and stHYPE-USDC, which is capital intensive and will compete with HyperCore's ETH-USDC and HYPE-USDC order books.

One path is: HyperEVM margin takes on derivative risks, while HyperCore assumes price risks.

• AAVE: stHYPE → HYPE
• HyperCore: HYPE → USDC

This model minimizes competition with HyperCore as it only fills gaps while still utilizing HyperCore's USDC liquidity. HyperCore does not bear derivative risks; the EVM takes on that segment. The core issue is: how to maintain low borrowing rates for HYPE against the backdrop of most HYPE-USDC lending having migrated to HyperCore. If this issue is resolved, the cycle could be revitalized across a series of new DeFi assets empowered by Hyperliquid's uniqueness.

VI. The Market and Exclusive Yields of HYPE Utility

The core of tokenization is creating new markets through asset fragmentation. The integration of Valantis and Pendle achieves this: tokenizing Hyperliquid fee discounts.

Traders pay a premium to purchase fee discounts from HYPE holders. stHYPE holders monetize by selling staking position discounts to YT holders and collecting premiums, reflected in PT yield rates.

This creates new sources of yield and their markets through DeFi, centered around the utility of HYPE assets. Similar structures may also appear in HIP-3, HIP-4, and future HYPE utility use cases.

DeFi-driven Exclusive Yields

Staking is not homogeneous. The same 500,000 staked HYPE has different values for different participants: 2.2% for passive holders; a 40% discount on each market-making fee for market makers; operational licenses for perpetual exchanges for deployers; rights to launch outcome markets for another participant; and distribution channels for stablecoin issuers to enter the fastest-growing exchanges in crypto.

The same stake underpins different businesses, and almost every one is obtained through private trades, each with its own yield rates, lock-up periods, and forfeiture clauses. This is the exclusive yield on Hyperliquid. It does not come from on-chain emissions but from what staking unlocks for specific counterparties.

As staking becomes heterogeneous, re-staking, layering, and other primitives may become tools to deliver value that HyperCore itself cannot replicate. The dynamic of staking utility on Hyperliquid opens new spaces for DeFi design principles.

From December to August, stHYPE delegated HYPE to the Ethena HyENA exchange, bringing over $1 million in HYPE rewards to stHYPE holders. This transformed a private, illiquid source of yield into something publicly accessible, with over $100 million in HYPE flowing in and out without delay. This new yield creates a new economics for the stHYPE economy and permeates lending markets, AMMs, and ordinary user wallets.

The next phase of stHYPE will rebuild this state with scale and network effects. This DeFi structure is expected to support HyperCore's growth rather than compete with it. DeFi liquidity may bring more market opportunities for HyperCore than private market counterparties.

VII. Why Build?

Any Hyperliquid project built on the assumption of a "universal DeFi layer" is exposed to a greater extent than it realizes.

Speed or composability is not the reason holding back HyperEVM; the fundamental issue lies in market structure. New sidecars or L2s will not automatically fix this.

HyperEVM faces a dilemma because the mental model is no longer applicable. The DeFi script inherited by Hyperliquid has ended, and the next version of its DeFi layer is forming.