Liquid staking protocols allow users to earn staking rewards without locking up tokens or maintaining staking infrastructure. Users deposit tokens and receive liquid tokens that are tradable and transferable. The DAO-controlled smart contract uses selected node operators to stake the user's deposited tokens. Since the user's tokens are controlled by the DAO, the node operator can never directly touch or use the user's tokens.
What is the difference between staking and liquidity staking?
Traditional staking requires users to deposit funds into an escrow account operated by a smart contract for a certain period of time. Depending on the plan chosen, the lock-up period can range from a few days to a few months. During this period, investors cannot access their funds. In contrast, when investors stake their funds using the Liquid Staking service, those funds are not locked. Token holders receive receipt tokens as proof of their stake. Therefore, the main difference is that with Liquid Staking, you have full access to your funds at all times and can unstake at any time without any repercussions. Therefore, this equates to higher returns and greater market liquidity.
How Liquidity Staking Works
Liquid Staking works by depositing funds into an escrow account run by a smart contract. The platform issues tokenized versions of the staked funds in return. These tokenized versions have returns of equal value. Users still receive rewards on their staked funds, but with Liquid Staking, users can also use these tokens for other purposes. These Liquid Staking Tokens (LST) can then be transferred out of the platform, stored in another place, traded, or spent without affecting the initial deposit.
Taking ETH's liquidity staking as an example, users can provide $ETH to the liquidity staking platform instead of directly participating in traditional staking. The platform will collect the $ETH provided by participating users, package these $ETH into 32 pieces and distribute them to eligible network validators. These network validators will directly carry out traditional staking, and the income from staking will be shared by users, liquidity staking platforms, and network validators. Therefore, compared with traditional staking, liquidity staking has a lower threshold and lower yield.
Advantages of Liquidity Staking
Eliminate entry barriers and no minimum ETH holding limit: The liquid staking protocol allows token holders to participate in staking verification; for example, regardless of whether the number of ETH held by the user reaches 32, even token holders with less ETH can centrally manage funds and obtain block rewards and fees in proportion.
Improve asset liquidity: Users can seamlessly transfer and trade Liquid Proof-of-Stake Tokens, or use related derivatives to participate in other DeFi activities while retaining the benefits of proof-of-stake without locking up tokens. Derivatives bring higher capital efficiency.
Shared responsibility for equity verification: The protocol entrusts professional node operators to handle complex technical issues such as infrastructure, security, and key management, avoiding ordinary token holders from assuming related responsibilities.
Improve the efficiency of capital utilization: Users can retain liquidity-derived tokens (such as used in AMM) while carrying out productive activities, and still obtain equity verification income, further improving the level of income.
Risks of Liquidity Staking
Potential vulnerabilities and risks of smart contracts: In the Liquid Staking protocol, the smart contracts that support the equity verification pool and the issuance of derivative tokens may have vulnerabilities that can be exploited to misappropriate funds. Such incidents may result in the loss of ETH in equity verification. To ensure safety, high audit standards and rigorous testing are required. Although protocols such as Lido have undergone multiple rounds of audits, risks cannot be completely eliminated.
Centralization Trend: Liquid Staking by protocols such as Lido is becoming increasingly popular, which may bring centralization risks to the Ethereum network. As the use of major stake verification derivatives continues to grow, network effects lead to a large concentration of stakes in them. Taking Lido as an example, it accounts for about 30% of the total stake verification ETH supply. A penetration rate of more than 33% increases transaction review, security risks, and the possibility of regulators taking advantage of centralized control points. It is critical to maintain a balance of stakeholders to prevent systemic imbalances.
Governance Token Dominance: Many Liquid Staking protocols have issued governance tokens that can be used to guide protocol actions, such as Lido's LDOToken, which allows voting on updates. Tokens are highly concentrated in specific entities, which have an impact on the decisions of ETH holders who verify the stake in terms of commission rates and risk policies. In order to prevent chaebol control, governance innovation and decentralization are needed.
Market data for liquidity staking
Currently, the market value of liquidity staking governance tokens is $4,803,296,279, with a 24-hour trading volume of $284,370,572; among them, Lido DAO has a total market value of $2,353,549,399, Frax Share has a total market value of $918,622,630, and Rocket Pool has a total market value of $544,755,646.
Popular ecosystem for liquidity staking
Lido
The Lido Finance protocol was launched in 2020 and is overall the best and most famous liquid staking platform. The project started out as a viable staking solution specifically for the Ethereum network. Since then, it has expanded its capabilities to other ecosystems such as Polygon, Solana, and Kusama (KSM).
After depositing staked funds, users receive the name of the derivative in the form of "st" (e.g. stETH) and the asset code. These funds can then be withdrawn for use in more than 27 DeFi applications and crypto wallets. Lido's staking rewards range from 4.8% to 15.5%, and for its liquidity staking service, Lido charges a 10% fee.
Rocket Pool
A good alternative to Lido is Rocket Pool, a decentralized platform for staking Ethereum. Launched in 2016, Rocket Pool enables users to stake and run permissionless nodes. However, this feature allows you to stake with less than 32 ETH while earning staking rewards of up to 8.98% APY as well as RPL collateral for securing the platform. Alternatively, you can use its liquidity staking service to stake ETH and receive rETH liquidity tokens with an APY of up to 3.15%.
Hubble
Hubble Protocol allows lending and borrowing against crypto assets on its liquidity platform. It became popular after participating in the Solana hackathon, but what makes this platform stand out is its lending service. The protocol allows investors to borrow against cryptocurrencies and use the borrowed tokens as collateral on other DeFi platforms.
The USDH stablecoin is used for the platform's crypto lending service. You can mint USDH with multiple types of collateral and repay it at any time. This means Hubble supports multiple assets and allows you to deposit from different networks, providing up to 11x collateral leverage.
Summarize
Compared with traditional staking protocols, liquid staking brings many advantages to users. Investors are freed from the constraints of waiting for the lock-up period to end before they can use their funds, making operations more convenient and increasing their returns. With the introduction of liquid staking tokens, users can also obtain additional returns in other decentralized finance (DeFi) networks while maintaining normal returns from staking funds. The feature that users can cancel staking at any time makes liquid staking attractive to a wider range of investors.
