What is Liquid Staking? Liquid Staking Explained for Beginners

In blockchain technology, ensuring the validity of transactions and the creation of new blocks is vital. Proof-of-Stake (PoS) blockchains revolutionized this process by requiring participants to lock up a portion of their cryptocurrency holdings as collateral. This practice, known as crypto staking, was implemented to fortify the network’s security.

However, when individuals staked their cryptocurrency, it became temporarily inaccessible for other purposes within the blockchain ecosystem. This safeguard was necessary to incentivize validators tasked with verifying transactions to uphold the network’s integrity.

In the event of misbehavior or misconduct, validators risked losing their staked funds, thus ensuring their adherence to protocol guidelines.

As blockchain technology evolved, a problem emerged. While staking strengthened network security, it also immobilized a significant portion of crypto assets, limiting their utility in other blockchain applications.

So, that’s how liquid staking appeared, and a solution was devised to address this challenge.

Liquid staking provided a means to maintain blockchain security while unlocking the potential of staked assets for utilization in decentralized liquid staking protocols and other blockchain applications.

But how did this innovative concept come to completion, and what mechanisms underpin its functionality? Let’s delve into the narrative of liquid staking and explore its transformative impact on blockchain technology.

What is Liquid Staking?

Liquid staking is the process of staking crypto assets in a way that allows HODLers to retain the liquidity of their tokens while still earning rewards for participating in the network’s consensus mechanism.

Basically, liquid staking is like traditional staking, but you can access your staked crypto tokens anytime.

Liquid staking came about because people didn’t like locking up their crypto for a long time. They wanted to be able to use it whenever they needed it. 

So, the liquid staking solutions aim to address this issue by allowing staked tokens to be used as collateral or traded on secondary markets while still earning staking rewards. This is achieved through various mechanisms, such as tokenization or the use of derivatives, which represent staked assets and can be freely transferred or traded.

How Does Liquid Staking Work?

In traditional staking, users lock up their crypto assets to help secure a proof-of-stake (PoS) blockchain network and earn rewards in return. However, the locked assets are inaccessible during the staking period.

Liquid staking offers a more flexible alternative. Through liquid staking, users just deposit their crypto tokens with a liquid staking service provider. 

Further, the provider takes the tokens and pools them with other users’ deposits. This creates a larger stake, improving the proof-of-stake blockchain’s efficiency and security. They then delegate this stake to validators.

In return for the deposit, the provider mints new LSTs (liquid staking tokens). The tokens represent your original stake plus any rewards it accumulates over time. Essentially, it’s a receipt for the staked tokens.

As the validators process transactions, they earn rewards for securing the network. The liquid staking provider distributes a portion of these rewards proportionally according to the LST holding.

What are Liquid Staking Tokens (LSTs)?

Since we briefly touched on the topic earlier, let’s dive deeper into liquid staking tokens (LSTs) to understand these receipt tokens better.

As mentioned, LSTs, also known as liquid tokens or liquid staking derivatives (LSDs), are essentially digital receipts that confirm your ownership of a staked digital asset. Their value is directly tied to that of the original asset. 

Like other blockchain assets, LSTs have a wide range of applications within the decentralized finance (DeFi) ecosystem. For instance, you can trade them or exchange them for other cryptocurrencies.

Furthermore, LSTs can be used for lending purposes and even as collateral for borrowing other tokens. Essentially, they are tokenized assets with numerous potential uses. There are countless possibilities for their utilization, making it impractical to cover all of them in this article.

A notable example is Ethereum: Following ‘The Merge,’ the blockchain introduced a Proof of Stake (PoS) consensus mechanism, allowing token holders to stake their ETH and earn rewards while retaining the flexibility to use their assets. This is how stETH came into existence.

Advantages and Disadvantages of Liquid Staking

Advantages of Liquid Staking

If you’ve read all of the above, you might probably say that the biggest advantage of liquid staking is related to the accessibility it offers, and you’re right; unlike traditional staking, liquid staking offers increased flexibility.

But there are also a lot of other advantages, so let’s explore some of the unique advantages it brings:

1. Unlocked Liquidity – Traditional staking involves locking up your tokens, restricting their immediate use. Liquid staking solves this by issuing tradable liquid staking tokens (LSTs). These tokens represent your staked assets and can be readily bought, sold, or used in DeFi applications. This injects liquidity into your holdings, allowing for more strategic capital allocation.

2. Composability in DeFi – LSTs open doors to the exciting world of DeFi. They function as Lego blocks for your crypto portfolio. You can leverage them in various DeFi protocols:

• Lending Platforms – Deposit your LSTs as collateral and borrow other cryptocurrencies, amplifying your returns.
• Prediction Markets – Stake your LSTs to predict future events and potentially earn high yields.

3. Reward Stacking – Liquid staking lets you enjoy the best of both worlds:

• Staking Rewards – You continue to earn rewards for securing the blockchain network through your staked assets.
• DeFi Yield – LSTs can be used in DeFi protocols, potentially generating additional yield on top of your staking rewards. This creates a compounding effect, boosting your overall returns.

4. Lower Barrier to Entry – Traditional staking often requires significant technical knowledge and resources. For example, running a validator node on Ethereum necessitates a minimum stake of 32 ETH. Liquid staking eliminates these hurdles. You can participate in staking with any amount through a liquid staking provider, making it highly accessible for everyone.

Disadvantages of Liquid Staking

1. Slashing Risk – In Proof-of-Stake (PoS) networks, validators verify transactions and maintain network security. However, for malicious behavior or negligence (going offline for extended periods), validators can face penalties called “slashing.” This slashing results in a portion of their staked tokens being destroyed. Since liquid staking enables users to delegate their stake to validators chosen by the provider, their tokens are also susceptible to slashing if the provider selects unreliable validators.

2. Centralization Concerns – Liquid staking providers often pool user tokens together to create a larger staking pool. While this improves efficiency, it can also lead to centralization if a single provider accumulates a dominant share of the staked assets in a particular network. To mitigate this risk, it’s advisable to choose platforms that promote a distributed network of validators.

3. Regulatory Uncertainty – The cryptocurrency industry is a relatively new and rapidly evolving space. Regulations surrounding crypto staking are still under development in many jurisdictions. It’s crucial to stay informed about any legal or regulatory changes that might impact your participation in liquid staking, especially in your specific location.

4. Reduced Governance Rights – When you stake your tokens through a liquid staking platform, you might relinquish some control over your assets. This could include sacrificing your voting rights in on-chain governance proposals related to the underlying token. While convenience comes with liquid staking, it’s important to weigh the potential trade-off in terms of your participation in the governance of your chosen cryptocurrency.

Examples of Liquid Staking Platforms or Liquid Staking Services

1. Lido Finance

As of April 25, 2023, Lido is the largest liquid staking protocol, boasting a Total Value Locked (TVL) surpassing $29.592 billion. Participants have the opportunity to stake their tokens and receive daily rewards without the need to lock them or manage their infrastructure. 

Lido extends its offerings across multiple blockchain ecosystems, including Ethereum, Polygon, and Solana, by providing stETH (staked ETH) LSTs, stMATIC, and stSOL, respectively.

2. Rocket Pool

Rocket Pool is another famous liquid staking protocol within the Ethereum ecosystem, boasting a Total Value Locked (TVL) exceeding $3.818 billion.

Notably, Rocket Pool offers accessibility without imposing a minimum deposit requirement for users seeking access to its rETH LSTs. However, individuals interested in operating a minipool validator must adhere to specific criteria, including a minimum deposit of 8 ETH alongside 2.4 ETH worth of RPL tokens.

3. Coinbase Prime

In addition to decentralized liquid staking protocols like Lido and Rocket Pool, centralized entities such as exchanges can also provide liquid staking services to their users. The fundamental contrast lies in the custody arrangement: decentralized services are non-custodial, whereas centralized services retain full control over users’ staked assets. While decentralized services face vulnerability to smart contract exploits, centralized services carry their own set of risks.

Coinbase Prime has partnered with Liquid Collective to introduce liquid staking for Ethereum (ETH). Users deposit ETH into Liquid Collective’s smart contract, where it’s staked. In return, they receive LsETH tokens, representing their staked ETH. These tokens can be traded and used in DeFi. The value of LsETH is determined by factors like staked ETH, rewards, and penalties, which are updated daily.

FAQ

What is a Liquid Staking Token (LST)?

A Liquid Staking Token is a tradable cryptocurrency that represents your stake in a Proof-of-Stake (PoS) blockchain. When you stake your coins on a PoS network to earn rewards, you traditionally wouldn’t be able to access them until the staking period ends. LSTs solve this by acting like a receipt for your stake. You receive these tokens in exchange for your original cryptocurrency, allowing you to trade, sell, or even use them in DeFi applications while your original stake continues to earn rewards in the background. Essentially, LSTs unlock the liquidity of your staked assets.

How Do I Start with Liquid Staking?

Here’s a simplified process on how to start liquid staking:

• Choose a Reputable Platform (e.g., Lido, Rocket Pool) that supports liquid staking and your crypto and has strong security.
• Fund Your Platform Wallet by transferring your desired crypto.
• Pick Your Stake Amount, considering any minimums.
• Start Staking following the platform’s instructions. You’ll receive LSTs representing your staked assets, allowing you to earn rewards with some flexibility.

What are Traditional Staking Methods?

These staking methods typically enable users to lock up their cryptocurrency holdings to participate in the consensus mechanism of a blockchain network. This can be done by either running a node or delegating their tokens to a validator.

Does Lido and Rocket Pool Support Liquid Staking?

Yes, both Lido and Rocket Pool support liquid staking using their platforms.

Conclusion

So, liquid staking combines the perks of staking with the flexibility of accessing your crypto when needed. This means stakers can get more out of their assets while still being able to use them when required, which could save them from missing out on other opportunities.

As more projects adopt liquid staking and platforms like Lido, Rocket Pool, Coinbase Prime, and Binance make it easier to use, the future looks bright for this method. 

However, users need to do their homework, understand the risks involved, and monitor any changes in the rules. With these steps in mind, liquid staking can be a valuable tool for anyone wanting to explore the many possibilities in the world of cryptocurrencies.

* The information in this article and the links provided are for general information purposes only
and should not constitute any financial or investment advice. We advise you to do your own research
or consult a professional before making financial decisions. Please acknowledge that we are not
responsible for any loss caused by any information present on this website.

Fuente