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Liquid staking is an innovative concept that allows users to enhance the utility of the digital assets they stake. This quick guide explores the fundamentals of liquid staking, how it works, why it matters, its pros and cons, and how it differs from other forms of staking.
What Is Liquid Staking and How Does It Work?
In short, liquid staking is the tokenization of staked assets. We can think of it as an evolved version of traditional staking.
Conventional staking involves locking assets on a Proof of Stake (PoS) blockchain for a chance to receive rewards while contributing to the network’s security. However, this process often comes with a trade-off, as staked assets are typically illiquid (locked) during the staking period.
Liquid staking addresses this issue by introducing a mechanism where users can stake their assets without compromising liquidity. There are different ways of building such a mechanism, but as long as it offers liquidity to staked assets, we can call it liquid staking.
In some cases, users receive liquid staking tokens (LSTs) in exchange for their staked assets. For example, if you stake ETH on a platform like Lido, you will receive stETH tokens in return. This model is also known as liquid staking derivatives.
In other cases, the assets can be staked directly without using LSTs. For example, when staking ADA on the Cardano blockchain. This model is also known as native liquid staking.
Liquid staking gives staked tokens more flexibility and utility, as users can benefit from staking rewards without compromising liquidity.
Why Does Liquid Staking Matter?
Liquid staking addresses the liquidity issue associated with traditional staking, providing users with greater flexibility and accessibility to their staked assets.
Platforms like Lido and Cardano can offer users the opportunity to earn staking rewards while still being able to trade and use their staked assets in decentralized finance (DeFi) applications.
In addition, liquid staking contributes to the overall growth and adoption of blockchain networks by encouraging more active participation from users who may have been hesitant to lock up their assets for extended periods.
Pros and Cons of Liquid Staking
Pros
1. Enhanced utility: Users can put their staked assets to use in different DeFi applications without giving up on staking rewards.
2. Reduced opportunity cost: Liquid staking allows users to take advantage of potential trading and investing opportunities using liquidity that would be unavailable in traditional staking methods.
3. Cryptocurrency adoption: Liquid staking can enhance token utility and value, fostering the development of new applications and encouraging crypto adoption.
Cons
1. Slashing risk: Dishonest validators can be removed from the network and have a portion of their staked tokens “slashed” (taken away). Users may also be exposed to slashing risk if their chosen validators get penalized.
2. Centralization concerns: Decentralization may be harmed if the majority of tokens are staked in a single protocol with its own set of validators. A diverse network of liquid staking protocols is preferable to mitigate centralization risks.
3. Regulatory uncertainty: Blockchain and cryptocurrency regulation is changing constantly and may vary significantly from one place to another. It’s important to check local laws before getting involved with liquid staking and DeFi platforms.
Liquid Staking vs. Liquid Restaking
As we’ve learned, liquid staking involves the tokenization of staked assets, enabling liquidity and flexibility without waiting for the staking period to end. Liquid restaking, introduced by EigenLayer, takes the concept further.
While liquid staking relates to staked assets that help secure a PoS blockchain, liquid restaking can expand security to oracles, rollups, and other “external” modules and systems. Examples of liquid staking projects include Lido (stETH), Cardano (ADA), Binance ETH (BETH), and Rocket Pool (RETH). Examples of liquid restaking projects include ether.fi, Puffer, and Kelp DAO.
Closing Thoughts
Liquid staking offers users a more dynamic and flexible approach to participating in staking ecosystems. By tokenizing staked assets and providing enhanced liquidity, liquid staking unlocks new possibilities for digital assets.
