Liquid Staking Explained: The Ultimate What, Why, How, & Who

8 min read
liquid-staking-what-why-who-how

Explore what liquid staking is. Understand its mechanics, the key players driving its adoption, and its profound impact on the DeFi landscape.

Navigating the DeFi world can feel like walking through a maze with countless paths to grow your crypto assets. Staking has always been a reliable signpost, especially with Ethereum’s shift towards Proof-of-Stake. But here’s the catch: once you’ve staked your tokens, they’re tied up, leaving you watching other DeFi opportunities pass by. It’s like having money in a fixed deposit when there’s a sale going on. Liquid staking comes to the rescue, offering a way to have your cake and eat it too. It’s like getting a receipt for your staked tokens, which you can use elsewhere.

Curious about how this works and why it might be a game-changer for your DeFi strategy? Stick around as we break down the nuts and bolts of liquid staking and highlight its edge over traditional staking.

liquid-staking-pink-brains

In this article:

  1. Proof-of-Stake: The Origin of Staking
  2. What is Liquid Staking?
  3. Why is Liquid Staking important?
  4. How does Liquid Staking work?
  5. Who are the key players in Liquid Staking?

1. Proof-of-Stake: The Origin of Staking

Proof-of-Stake-Work-Liquid-Staking-Pink-Brains
Proof-of-Work vs. Proof-of-Stake

In Proof-of-Stake (PoS) blockchains, participants need to set aside a specific sum of their funds as a security deposit to confirm transactions and establish blocks. This process is termed as ‘staking‘. Those funds are off-limits for any blockchain-related activities or services. These staked coins ensure blockchain validators operate in the network’s best interest. If they step out of line, their staked funds are at risk. However, this isn’t where our tale ends.

Given that this approach ties up a considerable chunk of one’s assets, the crypto community brainstormed a solution to this limitation. An innovative method that lets you leverage your staked coins within the blockchain universe without jeopardizing your original stake. And the cherry on top? You continue to bag those staking rewards. Sounds too good to be true, right?

In simple terms, this solution is called ‘liquid staking’. It’s one of the game-changing trends in DeFi this year, allowing you to reap the benefits of safeguarding blockchains while simultaneously deploying those funds in DeFi ecosystems and other blockchain applications. So, what’s the magic behind it, and how does it come to life?

2. What is Liquid Staking?

overview-liquid-staking-pink-brains
Overview of Liquid Staking. Source

Liquid staking or LSD is a mechanism that allows users to stake their assets while retaining liquidity. But before diving deep, it’s crucial to understand the backdrop:

Ethereum’s Transition to PoS

Ethereum, the most extensive blockchain network, has transitioned from a Proof of Work (PoW) to a Proof of Stake (PoS) consensus mechanism. This monumental shift means that validators will secure the network instead of miners. To become a validator, one needs to stake or lock up a certain amount of ETH. However, as an individual, staking your ETH on Ethereum is not capital-efficient, as the giant “ETH whales” which are entities and VCs, with large fund will receive staking rewards. From the standpoint of wholesale investors, they are searching for a way to unlock liquidity from that captivated capital, like putting their savings into the bank. This is where liquid staking shines, offering a solution to the inherent liquidity challenges of staking in Ethereum 2.0.

Liquid Staking in Action

Liquid staking allows users to pledge their tokens in order to secure the network, but it is still liquid or fluid in the sense that users can access their funds.

Unlike the classic PoS approach, LSD requires funds stored in DeFi escrow accounts. Because the money is highly liquid, users can access their tokens whenever they wish. When you stake your assets in liquid staking protocols, you will receive a representative or derivative token in return, called “Liquid Staking Tokens” (LSTs). This token can be traded, utilized in DeFi protocols, or even used as collateral, all while the original assets continue to earn staking rewards.

In this way, you can establish several revenue streams from their crypto assets with LSD because they can lock their holdings while still accessing them. You can use their liquid assets on other DeFi protocols to make more on your initial deposits.

3. Why is Liquid Staking important?

To appreciate the significance of liquid staking, it’s essential to understand the limitations of traditional staking.

  • Illiquidity: Once assets are staked, they’re often locked up for a predetermined period, making them inaccessible for other opportunities.
  • Opportunity Costs: With assets locked, users miss out on other potential DeFi opportunities, from yield farming to providing liquidity in burgeoning pools.

Liquid staking addresses these challenges by

  • Enhancing Liquidity: Users can simultaneously earn staking rewards and leverage their assets in the broader DeFi ecosystem.
  • Diversifying Earning Potential: The representative tokens can be used in various DeFi protocols, amplifying earning avenues.
  • Increasing flexibility and Market Responsiveness: Liquid staking offers the agility to respond to market dynamics, a feature traditional staking often lacks.

4. How does Liquid Staking work?

Breaking it down, liquid staking revolves around three main stages: staking your asset, receiving liquid staking tokens (LSTs), and eventually unstaking. It’s straightforward, so let’s dive into how this trio offers stakers added liquidity.

Staking

Kickstarting the process is no different from traditional staking: Users deposit their coins onto their chosen liquid staking platform. Once the platform confirms the authenticity of these tokens, they’re safely tucked away in a smart contract. But here’s the twist: instead of just sitting there, the platform grants users LSTs, mirroring their initial deposit.

Wondering where your staked assets go?

In a nutshell, these platforms channel your funds into native staking. They leverage your assets to fortify a proof-of-stake blockchain, earning rewards as fresh crypto. A slice of these rewards then finds its way back to you, the staker, in the form of additional LSTs.

For DeFi enthusiasts, this is a win-win. They retain a liquid asset to trade and enjoy a neat bonus atop their primary investment—a nifty avenue for passive earnings.

What are LSTs?

Diving deeper, these LSTs or liquid staking derivatives (LSDs) act as yield-bearing blockchain receipts of your staked digital asset ownership, whose value is aligned with your original asset. Beyond just being receipts, LSTs play versatile roles in the DeFi world. Be it trading, swapping for other cryptos, lending, or even using as collateral, their potential is vast. A typical example? stETH, the liquid staking token for Ether on Lido, has been massively used on numerous DeFi platforms.

Unstaking

If you want to retrieve your original coins, the unstaking phase steps in. You need to “burn” your LSTs on the initial liquid staking platform. Once the platform confirms the burn transaction, your unstaked coins are returned. Simple, right? Just remember, this convenience often comes with a fee, and it might not always be pocket-friendly.

5. Who are the key players in Liquid Staking?

Several platforms are pioneering the adoption of liquid staking. Let’s discover top 3 leading Liquid Staking platforms.

Lido – The Best Liquid Staking Protocol

lido-what-is-liquid-staking-pink-brains
Lido Finance – Liquidity for staked assets. Available for Ethereum, Solana, Polygon, Terra, Kusama & Polkadot.

Lido Finance, or just Lido is the number one innovative DeFi projects in Liquid Staking sector. Launched in 2020, Lido made waves by letting users stake their Ether into Ethereum PoS and earn rewards. While it started as Ethereum’s go-to for liquid staking, Lido’s now shaking hands with big players like Solana, Polygon, Polkadot, and Kusama.

Besides liquid staking, users can enjoy more earning options from lending on platforms like Aave and other LSDfi protocols. When staking your assets, stakers will receive “st-tokens”, then they can withdraw these derivatives and use them in 27+ DeFi applications and crypto wallets.

Lido’s returns range from a neat 4.8% to 15.5%, which is governed by a DAO. By its governance token, LDO, you have voting power over protocol changes and can potentially watch your assets grow.

Lido’s liquid staking comes with a 10% fee.

Rocket Pool – Ethereum Liquid Staking Platform

rocket-pool-what-is-liquid-staking-pink-brains
$RPL – Decentralized Ethereum Staking Protocol.

Rocket Pool is the second-best option if you are looking for an alternative LSD to Lido. Launched in 2016, Rocket Pool offers a simple mechanism for users to stake their ETH tokens on its platform. It is a trustless and decentralized ETH staking platform that was recently invested in by Coinbase Ventures. The platform exclusively supports ETH.

Nonetheless, it provides its consumers with two services. Users can stake their ETH directly on Rocket Pool and receive a tokenized form of their asset pegged as rETH, or they can host a node on the Rocket Pool ecosystem directly.

The Rocket Pool service pays customers who solely bet ETH in exchange for rETH a 4.16% annualized potential profit. On the other hand, those who stake ETH while running a node get a set 6.96% annualized potential return plus a variable RPL payment granted by the platform for safeguarding the Ethereum network.

Node operators do not have to stake 32 ETH to run a node, thanks to the Rocket Pool service. Instead, validators can begin with half, or 16 ETH. This makes it a more cost-effective choice for Ethereum PoS node operators.

Frax Finance – ETH-pegged Stablecoin Approach to Liquid Staking

frax-liquid-staking-pink-brains
frxETH Ecosystem. Source: Frax Finance website.

Frax Ether (frxETH) is a liquid ETH staking derivative and stablecoin system within the Frax Finance ecosystem, designed to streamline the Ethereum staking process and maximize staking yield.

It consists of three primary components: Frax Ether (frxETH), Staked Frax Ether (sfrxETH), and the Frax ETH Minter. frxETH acts as a stablecoin loosely pegged to ETH, allowing for a simplified and secure way to earn interest on ETH, while sfrxETH accrues staking yield, and the Frax ETH Minter facilitates the exchange of ETH for frxETH.

The system offers a DeFi-native approach to Ethereum staking, eliminating the need for technical knowledge to run a validator node and the requirement to stake 32 ETH at a time. Using frxETH, users can earn yield on any amount of ETH, withdraw at any time, and enjoy greater composability throughout DeFi.

Final conclusion on Liquid Staking

The horizon of liquid staking is brimming with innovations. Liquid Staking DeFi (LSDfi) is an emerging concept where liquid staking meets DeFi, creating a synergy that enhances the utility of staked assets. Another narrative that has great potentials to bloom when Liquid Staking grows faster is Restaking. To put it simply, restaking allows users to stake the same ETH on both Ethereum and on other protocols, securing all of these networks simultaneously. Hence, restaking allows for the leverage of existing trust networks.

Liquid staking stands at the confluence of innovation and opportunity in the DeFi space. As the ecosystem matures and embraces the benefits of liquidity and rewards, liquid staking is becoming the foundation of the next DeFi wave.

FAQ

How is Liquid Staking different from traditional staking?

Traditional staking often requires users to lock up their assets, making them illiquid. With liquid staking, users receive a tokenized representation of their staked assets, which they can use in other DeFi activities without unstaking.

What are the benefits of Liquid Staking?

Liquid staking offers multiple benefits, including increased liquidity, the potential for multiple revenue streams, and enhanced capital efficiency in the DeFi ecosystem.

What is the future of Liquid Staking?

The future of liquid staking looks promising with innovations like LSDfi (Liquid Staking DeFi) and Restaking. These concepts aim to further enhance the utility and efficiency of staked assets in the DeFi space.

Are there any fees associated with Liquid Staking?

Yes, platforms offering liquid staking services may charge fees. For instance, Lido Finance charges a 10% fee for its liquid staking services.

What is LSDfi?

LSDfi refers to the integration of liquid staking with DeFi, allowing for more complex financial products and services.

What is Restaking?

Restaking is an innovative type of Ethereum staking in which stakers use the same collateral staked to secure the blockchain to secure other apps at the same time. Essentially, the resources required to confirm Ethereum transactions can now be used to validate transactions on other implementations such as dApps, oracles, layer-2 sidechains, and others.

Is Liquid Staking safe?

While liquid staking offers numerous benefits, it’s essential to understand the risks associated with any DeFi protocol. Users should conduct thorough research and consider platform security, smart contract audits, and potential vulnerabilities before participating.

Dive into the Web3 Bible 🧠

hello@pinkbrains.io

Disclaimer: This article serves informational purposes only and does not constitute financial advice. Conduct your own research before making investment decisions.