March 7, 2024
Liquid staking allows generating staking yields without giving up liquidity — you can stake your crypto but still trade assets freely. This unlocks wider utility for staking, allowing decentralized finance (DeFi) borrowing, payments, transfers all while earning compound rewards.
Let’s examine how liquid staking works, its current limitations, which crypto ecosystems are innovating with liquidity in staking, and why the model could proliferate further.
With traditional crypto staking, you commit or “lock up” an amount of tokens to act as a network validator, processing transactions to earn more crypto over time. However these staked assets cannot be immediately moved or used elsewhere.
Liquid staking involves issuing a derivative token representing your staked crypto that retains liquidity. This derivative — whether an IOU note, wrapped token or synthetic asset — tracks staking yields and can still be freely traded, utilized across DeFi, or sold to realize gains without interrupting compound growth from the staked capital continuing to validate and earn rewards.
Put simply, liquid staking tokens allow having your cake and eating it too! Users can earn native staking rewards while accessing flexible utility from their stake thanks to these liquid derivative wrappers.
Early Forms of Liquid Staking Workarounds
Even in the early days of proof of stake exploration, workarounds existed to regain some flexibility from locked staking:
Centralized Lending
Centralized crypto lending platforms like Celsius Network accept staked coins such as Tezos as collateral for cash loans leveraging the underlying assets while they continue staking. However centralized services can be risky.
Delegated Staking
Delegated staking pools like Everstake let users earn staking rewards without running validator nodes directly by joining node operators and taking a percentage of yields but users cannot directly interact with staked coins.
These solutions regained some flexibility but had limitations. True innovation around liquid staking required decentralized finance (DeFi) composability — to turn staked funds directly into freely usable ERC-20 tokens.
Decentralized liquid staking now allows stakers to retain custody, earn native rewards (not delegated), and unlock bonds without relying on centralized intermediaries. Providers like Lido Finance or Stader Labs make this possible in a non-custodial manner using liquid staking tokens.
For example with Ethereum, instead of staking 32+ ETH directly, users can swap staked ETH for tradeable Lido stETH on secondary markets in a permissionless fashion while continue earning ETH2 rewards.
Behind the scenes validator nodes still lock deposited ETH in custody to secure Ethereum, but the user holds fungible stETH derivatives tracking their stake value plus growth. No centralized authority can block access to the staked capital and its accrued yield.
Liquid staking tokens can interact freely across the whole DeFi ecosystem for other uses like:
All while the original PoS chain rewards continue compounding. This flexibility brings whole new utility to staked crypto.
Despite the benefits, liquid staking models come with certain risks token holders should consider:
Slashing: Network slashing penalties for validator misbehavior apply on staked assets which could devalue liquid derivatives if severe.
Contract & Technical Risk: Bugs in token issuer smart contracts or architecture could jeopardize user funds. Audit reliance helps mitigate but some endogenous risks remain.
Lack of Insurance: No deposit insurance exists currently to cover loss from contract failures or stealing of staked coins. Users must do own governance diligence.
Fragmented Liquidity: Trading spreads and depth isolation across multiple liquid staking derivatives for the same asset can emerge rather than aggregated markets.
In spite of these, the efficiency gains from unlocking staked assets for broader utility while avoiding opportunity costs appear worthwhile for most. As liquid staking matures with insurance availability, better liquidity aggregation, and slashing protection, mainstream comfort should improve.
Ethereum is the leading blockchain ecosystem with live liquid staking functionality thanks to service providers like Lido, Stader Labs, Stakewise and Rocket Pool issuing derivative tokens for staked ETH. Over 3 million ETH (~$4.2 billion) have been converted to liquid stETH tokens already, nearly 30% of all staked ether.
However, many more networks are primed to unlock liquid staking, including layer 1 chains:
Polkadot — As a multi-chain network, Polkadot and Kusama (its canary network) offer liquid DOT tokens via platforms like Parallel Finance, Stader Labs and Equilibrium.
Cardano — As the first proof of stake smart contract network, Cardano is integrating liquid staking into core protocol (not just third party services) through its Vasil upgrade allowing an eigenTrust staked eADA derivative.
Solana — Splashy solana-based liquid staking platforms like Marinade Finance allow swapping SOL for mSOL with plans to introduce metaLP staking and yield diversification.
In addition to the above base layer chains, EVM compatible sidechains can leverage liquid staking. Liquid staking platform Alluvial Finance plans launch liquid tokenization for staked assets on chains like Polygon, Avalanche, Optimism and Arbitrum.
And most new layer 1 projects are architecting in support for permissionless liquid staking from inception, rather than relying on external services to offer derivatives for native staked assets.
As more activity in the whole Web3 ecosystem moves to multi-chain architectures, infrastructure around liquid staking must evolve as well for this next stage.
Rather than having isolated and fragmented liquidity pools across project-specific derivative tokens on each chain, protocols should emerge to offer generalized staked asset derivatives representing claims across multiple chains.
These “meta-liquid” staking tokens will compound yield harvested across various proof of stake networks for efficiency and solve liquidity fragmentation.
Investors can also expect “metaLPs” — tokenized fund management protocols — to pool staked wealth similarly to TradFi fund structures. Platforms like 21.co are bringing pooled automated liquid staking services for better risk adjusted yield optimization.
Advancements in insurance availability via decentralized coverage protocols can also enhance protections for stakers against risks like slashing, theft and smart contract failures.
As liquid staking penetration increases, even ATMs and payment/credit card networks could integrate withdrawal and spending functionality with these yield generating assets.
In closing, liquid staking unlocks far broader passive income generation from crypto asset holdings while retaining flexibility to use liquidity at will. This expands the whole design space for what staked wealth can interoperate with.
Expect protocols orthogonal to staking like lending, DEXs, payments/fintech to all build deeper compatibility for liquid staked derivatives. In tandem with continued innovation in the decentralized financial layer like insured pooled staking services and meta liquidity aggregation, liquid staking engines enable the crypto runways ahead.