What is Liquid Staking: Benefits, Risks, and Platforms
The cryptocurrency industry is constantly evolving. New coins, tokens, ways of profiting, and other aspects are appearing. The same thing happens with staking. Now, in addition to classic, liquid staking has emerged, which is claimed to be better than traditional staking in every way. Is it truly so? Does it really have no drawbacks? Find all the answers in this article.
What is Liquid Staking?
Traditional crypto staking is a way of investing your assets, blocking them for a certain period while receiving bonuses in return. The main disadvantage of this process is the freezing of finances and their inaccessibility for other operations, which is where liquid staking became a game-changer.
Liquid staking is an innovative approach in the crypto ecosystem that appeared in 2020 as a better version of staking. It allows users to invest their assets while maintaining liquidity, i.e., being able to use their finances.
Thanks to liquid staking protocols, you not only get rewarded for staking but also have the ability to use your assets for trading, lending, or investing in DeFi applications. This works based on the mechanism in which you invest your assets and receive a derivative asset in return.
LST or Liquid Staking Token is a derivative asset that you will receive in return for investing your assets. These liquid tokens allow you to freely trade and use them on various platforms.
A basic example is Ethereum, which is a liquid staking platform that allows users to invest their ETH in exchange for staking ETH (stETH). These received liquid tokens can be used to provide liquidity on decentralized exchanges, generate income through DeFi protocols, or even participate in secured lending.
Another example would be the Solana liquid staking. It similarly provides mSOL tokens to users, while also additionally allowing them to unlock new features on the active Solana blockchain network.
What are Liquidity Pools?
Liquidity pools are so-called shared wallets, or cryptocurrency pools, where users can deposit coins through smart contracts. These pools are the basis of the Decentralized Finance (DeFi) system, where financial services operate automatically and without intermediaries. For DeFi, pools eliminate the need for order book management by ensuring that participants provide liquidity for its purposes.
The main beneficial features of the pools allow users to:
- Exchange cryptocurrency without a bank or an exchange
- Take loans or borrow crypto
Users can provide their liquidity staking tokens, such as the aforementioned stETH, mSOL, and others, to liquidity pools. In this way, they will receive a percentage of the profit from all transactions that will be conducted in these pools. At the same time, their initial tokens will earn them interest on staking.
Why are Liquid Staking Tokens so Popular?
The reason for the popularity of LSTs is simple and understandable by their meaning, which we have already explained. The main reason for this is the combination of staking rewards and the ability to freely use your assets in DeFi protocols. Liquid staking tokens provide the flexibility to perform operations such as lending, trading, and yield farming while still earning rewards.
Various DApps can also improve the flexibility, functionality, and usability of LST in DeFi ecosystems.
Insight: The development in the Crypto industry keeps going and the same goes for LSTs. Enthusiasts are constantly coming up with something new and are currently exploring the possibilities of combining liquidity tokens and NFT staking. This combination makes LST even more popular due to its attractive features. These opportunities include:
- gamified staking
- digital collectibles
- cross-ecosystem rewards
- bonuses in different cryptos
Process of Liquid Staking
Now we will describe the liquid staking process in detail through the step-by-step scheme for operating it:
1. Depositing Assets:
The user deposits the assets, as tokens, into the liquid staking protocol.
2. Token Minting:
After the contribution, the protocol performs the process of minting the corresponding LSTs in an equal ratio to the deposited assets.
3. Staking:
In its turn, the staking protocol stakes the deposited tokens on behalf of the user, dividing them among validators in order to reduce risks.
4. Reward Accrual:
The reward for liquid staking is paid in a slightly different way than in traditional staking. It is still accumulated but reflected in the value of the LST. The exchange rate between the LST and the underlying asset gradually increases over time.
5. Unstaking:
In order to get back the initial assets, the user will need to “burn” their LST to get an amount equivalent to the value of the base token, along with the accumulated rewards.
Warning! We should also note that depending on the liquid asset staking protocol, the process may differ slightly, although the basic concept is mostly the same.
Components Behind Liquid Staking
Liquid staking is a combination of blockchain mechanisms and DeFi integration. It contains various components that we will analyze below:
- Validators
Validators are an integral part of staking in general because they are the key to the security and operation of PoS networks. In the case of liquid staking, platforms guarantee the protection of your assets by cooperating with professional node operators.
- Consensus mechanisms
The essence of Proof-of-Stake (PoS) is the validators that are selected based on the number of staked assets. The fact that liquid staking is based on PoS guarantees that the blockchain will remain decentralized and, most importantly, tamper-proof.
- Liquid staking tokens (LST)
Of course, an integral and most important component of liquid staking is LST, which you receive in exchange for your staked assets.
- Liquid staking derivatives (LSD)
Some advanced protocols increase the already high level of flexibility of liquid staking by additionally offering liquid staking derivatives. The advantage of these derivatives is that they grant partial ownership of the staking reward, which is highly attractive to seasoned investors.
What are the Benefits of Liquid Staking?
As we have repeatedly said, liquid staking was created as a better version of traditional staking. Let's now move on to the specific benefits of this type of staking. The main compelling benefits are asset flexibility and more. So let's get down to liquid crypto staking analytics of the key benefits in detail:
| Benefit | Description |
|---|---|
| Accessible liquidity | Liquid staking does not lock your assets by providing you with LST. It preserves the inherent value and liquidity, enabling you to use them in different DeFi protocols. |
| Numerous DeFi protocols | Liquid staking tokens integrate with a wide range of protocols in the DeFi ecosystem, such as lending pools and prediction markets. These opportunities provide access to many activities, including yield farming and lending. Liquidity is also provided on platforms such as Aave or Uniswap. |
| Better rewards for staking | Liquid staking users not only receive a stable staking reward. With LST, they also get additional opportunities to earn extra profitability through DeFi protocols. |
| Lower entry level | Liquid staking allows you to participate with fewer tokens. |
| Mobility | Users can easily exit and change their staking positions while being able to trade LST on secondary markets. |
| Higher security due to decentralization | Liquid staking contributes to greater user and financial security due to the decentralized structure of the network. |
| Diversification | Users get a more balanced and diversified crypto portfolio. |
What are the Risks of Liquid Staking?
Despite the appealing benefits of liquid staking, you need to examine it in its entirety to make informed decisions. Although liquid staking is a rather innovative solution, it still has some disadvantages that you should be aware of in order to manage your assets more reasonably.
Slashing
In the process of liquid staking, users outsource the support of the validator node, which involves the risk of complete loss of funds in case of a fraudulent or unreliable service provider.
Exploits
A common problem with staking in general is the risk of compromising operator private keys or exploiting vulnerabilities in the protocol's smart contracts. In this way, token deposits are also put at risk.
Volatility of LST
Liquid staking tokens usually have a lower trading volume than the main tokens, which means they are highly volatile. The price of the LSTs you receive is not tied to the underlying assets they represent. Without a link, during a liquidity crisis or market disruption, the price of LST can fall below the price of the base token.
Permanent Updates
The cryptocurrency market is in a state of constant change and development. The potential for these regulatory changes could have a significant impact on the liquid staking ecosystem.
Regional Regulations
Regulations may vary from region to region, which is why users need to be attentive and aware of the regulations in their area.
Validator Risks
When choosing reliable liquid staking protocols, you should also review the credibility of the validator selection process. Some validators in proof-of-stake networks may receive penalty scans that will have an impact on the overall staking assets. These penalties come from the system for fraudulent behavior or basic technical failures.
How to Avoid Liquid Staking Risks?
Before making hasty conclusions about liquid staking based on the mentioned risks, remember that you can fully or partially protect yourself from them by following the steps we have described below.
1. Before making a final choice of a liquid staking platform, conduct thorough research to ensure its reliability.
2. Diversify your staking assets across different protocols and networks.
3. Follow the news and keep up to date with the latest developments in the liquid staking industry.
4. Start trying out liquid staking by investing spare finances that you can afford to lose.
Liquid Staking in Different Cryptocurrencies
Regardless of the way staking is performed in different blockchains, the function of liquid staking remains unchanged, which is to provide flexibility and accessibility. Let us consider liquid staking in relation to various leading cryptocurrencies:
Ethereum is one of the top cryptocurrencies that also provides an opportunity to participate in liquid staking. Ethereum's liquid staking token is stETH, which is a tracking asset for the underlying Ethereum token ETH.
Another leading liquid staking cryptocurrency is Solana, which provides mSOL liquid staking tokens in exchange for the deposit of its SOL tokens, which in turn can be used in lending platforms and liquid pools.
Polygon and others
In fact, liquid staking is implemented in many blockchains, including Polygon. It is a popular strategy to increase the utility of the ecosystem and user engagement.
Liquid Staking Platforms
In case you have not yet decided on a liquid staking platform, we have collected for you the most popular platforms that offer unique features and support different blockchain networks.
Lido
Lido is the largest liquid staking platform with over $14 billion in total value locked (TVL). It supports such currencies as Ethereum, Solana, Polygon, and many others, offering their respective tokens.
Rocket Pool
Rocket Pool is known for its decentralized approach and community-driven model. The main focus of this platform centers on Ethereum, however, in exchange for ETH, you will receive rETH liquidity tokens.
Marinade Finance
On the other hand, a Solana-centered platform is Marinade Finance. The Solana DeFi ecosystem is tightly integrated with Marinade Finance. As a leading platform, it provides mSOL tokens in exchange for SOL.
StakeWise
The name of the StakeWise platform speaks for itself. With liquid staking of Ethereum tokens, you will receive liquid staking tokens such as sETH2, using a two-token model to split the staking reward.
Ankr
The Ankr platform stands out for its support of blockchains such as Ethereum, Avalanche, and Binance Smart Chain, providing users with aETH tokens and other high-value liquid staking tokens.
Final Thoughts on Liquid Staking Crypto
If you are interested in staking, you should definitely consider liquid staking. It is an evolutionary version of traditional cryptocurrency staking that solves the liquidity problem. Its innovation lies in providing users with the opportunity to invest their assets while maintaining liquidity, which in turn increases the efficiency of capital use.
Although it has its benefits and risks, its role and importance are expected to increase. This growth will be driven by the growing popularity of PoS networks, continuous innovation in DeFi, significance in the crypto landscape, and benefits for developers and system administrators.
In the end, it is up to you to decide which type of staking is perfect for you. Regardless of your choice, the best solution for tracking the dynamics and analytics of either coins or staking in general will be TheCoinEarn.
