What is Liquid Staking?

Key Takeaways

Staking is one of the most popular ways to earn passive rewards with cryptocurrency. According to CoinGecko, over $82 billion is locked in various blockchains right now, with staking accounting for a large part of that total. 

It’s a pretty simple concept – you lock up your tokens and receive rewards based on the work of a validator node. However, despite the passive income potential, traditional staking is something of a trade off. You don’t have access to your staked funds until the lock-up period ends, limiting your use of your assets. How can DeFi users access the benefits of staking without losing the utility of their crypto?

That’s where liquid staking comes in.

What Is Liquid Staking?

Liquid staking is a decentralized finance (DeFi) development that builds on regular staking to offer users more control. 

Liquid staking allows you to lock your tokens into a protocol and earn passive income, while still having the ability to trade or use them elsewhere. Your crypto can be used for other financial activities like DeFi liquidity pools, increasing the overall utility of the assets and your potential to earn from them.

How Does Liquid Staking Work?

It involves three key elements: a validator, a service provider, and a liquid staking token. Let’s look at how they work together:

• When you deposit your tokens, the platform assigns those tokens to a validator. The validator helps secure the blockchain and earns rewards for their service. 
• In return, the platform gives you a token representing the value of your staked coins. This is called a Liquid Staking Token (LST). You can use this LST in other DeFi activities, like lending or trading, while still earning rewards from what you’ve locked up.

LSTs are important because they provide flexibility. They allow users to engage in DeFi markets without giving up their staking benefits. 

For example, if you stake 10 ETH in a platform like Lido, you receive an LST, stETH, representing the exact value of your staked ETH. You receive rewards for contributing to the validator who is maintaining the blockchain while using a synthetic version of your locked up crypto to interact with other protocols.

You can still trade or lend that LST in DeFi platforms, effectively making your assets work in two places at once.

Liquid Staking Tokens Explained

An LST is a synthetic asset that represents your staked crypto. When you lock up your tokens, you receive an equal amount of LSTs. These can be redeemed for your staked crypto, and can be used to interact with other DeFi protocols just like your original crypto.

The main reason LSTs have become popular is that they give you flexibility. This is an advantage if you want to engage in yield farming while also staking your crypto.

How To Receive Rewards

Let’s use Ethereum as an example.

To start receiving staking rewards on Ethereum, you need to set up an Ethereum-compatible wallet, such as MetaMask or Trust Wallet. This wallet will serve as the receiving point for your rewards, so it’s essential to set it up first and store your recovery phrase securely. Make sure the wallet supports Ethereum transactions.

Next, choose a platform that supports Ethereum staking. After creating an account and verifying your identity, transfer your ETH from your wallet to the platform. You will stake your ETH through the platform’s staking options, automatically generating rewards based on the amount staked.

Finally, the staking rewards are typically distributed periodically, such as weekly or daily, depending on the platform. You can direct these rewards to your staking balance or transfer them to your personal Ethereum wallet.

Advantages of Liquid Staking

Liquid staking has several advantages over traditional staking, making it an appealing choice for cryptocurrency holders seeking to optimize their earning potential.

Access to Liquidity

Unlike regular staking which inv wolves a lock-up period, liquid staking means you can redeem your staked assets anytime. Withdrawing your crypto is not restricted, meaning you don’t lose liquidity simply because you’ve staked your crypto. 

Flexibility and Control

Typically, the staking process takes a long time and may become disadvantageous if other investment opportunities arise. Liquid staking offers flexibility because users can sell or swap their LSTs without unstaking the original tokens.

It also reduces the opportunity cost of locking tokens, as users can still trade within the broader DeFi space. It also ensures that staked tokens continue to work, supporting the network and allowing for speculation, investment in new tokens, or market movement opportunities.

Increased Adoption and Utility

By allowing staked assets to serve as collateral or be used in secondary markets, liquid staking adds value to staked tokens.  It is also an advantage for the blockchain itself, as it encourages more people to participate in keeping the network secure, while also increasing the liquidity in the ecosystem. 

As more people participate in the ecosystem, cryptocurrencies’ popularity grows, contributing to the market’s overall expansion.

Challenges of Liquid Staking

While liquid staking offers new prospects of increased flexibility and liquidity, it also has drawbacks and issues that participants should consider.

Slashing Risk

Validators are responsible for maintaining the network’s security and stability. However, they are punished if they misbehave or fail to perform their duties effectively—for instance, if they stay online for too long or cheat.

The penalty, known as slashing, removes the validator from the network and partially removes the staked token. If you choose your validators wisely, they may keep your funds. Thorough research and due diligence are critical to minimize the chances of slashing-related losses.

Smart Contract Vulnerabilities

Liquid staking protocols rely on smart contracts to delegate assets, mint LSTs, and redeem staked assets.

Users can lose their staked amounts if bugs, exploits, or hacks breach smart contracts. Such vulnerabilities are particularly concerning because smart contract failures can impact all users engaging with the protocol, not just individuals. 

Centralization Concerns

Centralization risks occur when a few large platforms aggregate it. For instance, a single protocol holding a large share of staked assets in a PoS network could wield significant influence over the network’s governance and operations.

One significant example is Lido, which holds 30% of staked ETH. If Lido or a similar protocol experiences issues, such as a smart contract bug or governance failure, it could destabilize the entire network.

Regulatory Uncertainty

Rules around cryptocurrency yield-generating activities are still unclear. Various jurisdictions have their own rules and interpretations of crypto assets. 

As governments and regulatory bodies work to define their approach to digital assets, new regulations may emerge that affect the legal status, taxation, or conditions under which liquid platforms can provide liquidity staking services.

Users must stay informed about regulatory changes in their areas to avoid legal issues.

Market Volatility 

LSTs experience price fluctuations due to market volatility. They can become highly illiquid during periods of market stress or low liquidity. If a user tries to sell LSTs under such conditions, they may incur losses, especially if the LST price falls significantly below the value of the staked assets.

Popular Cryptocurrencies That Support Liquid Staking

Several prominent cryptocurrencies have adopted liquid staking protocols to allow users to achieve the highest possible yield on their crypto holdings, trade, lend, or utilize their staked tokens within DeFi platforms.

Below are cryptocurrencies giving users the flexibility to earn rewards while maintaining liquidity:

• Ethereum (ETH)                                                 
• Polygon (MATIC)
• Polkadot (DOT)
• Solana (SOL)
• Cardano (ADA) 
• Avalanche (AVAX)
• Cosmos (ATOM)

Ethereum (ETH) 

Ethereum is among the most popular cryptocurrencies that have embraced liquid staking. After the Merge, the Ethereum blockchain shifted to a PoS consensus model, allowing investors in ETH to stake their coins and earn rewards.

Lido enables users to stake their ETH in return for stETH, a token representing a stake in Ethereum. This liquid staking model enables investors to use stETH in various DeFi platforms, retaining their staked asset’s liquidity and income.

Polkadot (DOT) 

Liquid staking is also available in other cryptocurrencies, including Polkadot (DOT). Polkadot is a multichain network that targets compatibility and enables DOT holders to stake tokens and have voting rights to govern the network, all while retaining access to their staked assets. 

Polygon (MATIC) 

Polygon (MATIC) also adopted Liquid staking, with Lido providing stMATIC tokens. It allows users to lock their MATIC tokens, earn more tokens, and ensure they always have stMATIC available for DeFi operations such as yield farming, lending, and borrowing.

Solana (SOL)

Another blockchain that supports liquid staking is Solana (SOL). For example, Lido allows Solana users to stake their SOL and get stSOL, representing staked tokens, allowing users to retain their tokens, obtain liquidity, and earn rewards.

Cardano (ADA) and Liquid Staking

In the Cardano ecosystem, users can stake their ADA tokens to help secure the network and earn rewards while maintaining control over their assets. With Cardano’s focus on decentralization and sustainability, its liquid staking protocol aims to make staking more accessible and flexible. 

Avalanche (AVAX) and Liquid Staking

Avalanche is another rapidly expanding blockchain that has adopted liquid staking solutions to increase user convenience. As a highly liquid and low-latency blockchain, Avalanche enables AVAX token holders to lock their tokens to contribute to network security and governance. 

Different protocols provide liquid staking on Avalanche, using tokens representing staked AVAX. Users can continue using their tokens while earning staking rewards. They can then use these tokens in different DeFi platforms to enable lending, borrowing, and yield farming, among other things. 

The capability of having AVAX assets liquid while staking is in line with Avalanche’s vision of high efficiency and connectivity.

Cosmos (ATOM) and Liquid Staking

Cosmos, sometimes called the Internet of Blockchains, takes a different approach to blockchain connectivity and expansion. Liquid staking in the Cosmos ecosystem enables ATOM token holders to delegate their tokens and earn rewards while also using their tokens in other ways. 

Cosmos’ liquid staking furthers its goal of making blockchain networks more integrated and efficient, providing investors with safety and versatility.

Liquid Staking Protocols

Numerous protocols offer liquid staking services, giving users flexible crypto asset management.

Here are some of the most popular protocols:

• Lido
• Rocket 
• Pool Binance

Lido

Lido ranks as the most significant liquid staking protocol, with a total value locked (TVL) of over $12.7 billion in April 2023. 

It supports multiple blockchain networks such as Ethereum, Polygon, and Solana. Through Lido, users stake their assets and receive LSTs like stETH, stMATIC, and stSOL. 

Rocket Pool

Rocket Pool, another popular Ethereum-based liquid staking protocol, holds over $3 billion in TVL. Its decentralized approach sets it apart from other services. It provides rETH, an LST that lets users participate in Ethereum staking with less capital than required to operate a node. 

Binance

As a centralized exchange, Binance offers liquid staking services for several cryptocurrencies, including Ethereum and Binance Smart Chain (BSC) assets. Binance simplifies the process by managing all the technical aspects for the user. 

However, users must rely on Binance to manage their staked tokens securely. Binance provides LSTs, allowing users to participate in DeFi while earning rewards, though it offers less decentralization than protocols like Lido and Rocket Pool.

Conclusion

Liquid staking has changed the crypto ecosystem, allows users to stake their assets while maintaining liquidity and control of their crypto. This has opened the door for new financial strategies and innovations in DeFi, and also showcases blockchain’s commitment to continuous innovation. 

With new tools and technologies constantly emerging, it pays to understand crypto. Stay safe, and keep reading.