new form of passive income has taken DeFi by storm. What exactly is Liquid Staking and what makes it better than the traditional form of Staking Crypto?
Liquid Staking protocols, such as Lido Finance (LDO) and Rocket Pool (RPL) have seen a tremendous rise in users due to the unbelievable advantages that they can provide.
Thanks to Liquid Staking, we can now freely move and use staked assets without having to unlock them. This short article will explain everything you need to know about Liquid Staking, so let’s start with how it works and what makes it so special.
How Does Liquid Staking Work?
So as you may know, traditional staking requires users to lock up tokens in order to earn staking rewards. These staked (locked) tokens cannot be used in any shape or form until they are released from their lock.
The difference between Staking and Liquid Staking is minimal but enormous at the same time. Simply put, when a user stakes a token on a Liquid Staking protocol, they will receive a separate token that represents their stake. These separate tokens are referred to as Liquid Staking Derivatives (LSDs) or Liquid Staking Tokens (LSTs) and are pegged to the token that was originally staked.
Let’s use Ethereum (ETH) as an example, to explain it better. If John stakes 1 ETH on Lido Finance, an Ethereum Liquid Staking protocol. John will receive 1 stETH (Staked Ethereum) in return, representing his stake of 1 ETH. stETH and ETH both have the same value, however, stETH has the ability to earn staking rewards while sitting idle in the wallet or also when John decides to use his stETH in a dApp.
Why Do We Need Liquid Staking?
Well, Proof-of-Stake (PoS) blockchains require users to stake large amounts of their native token to become a Validator and set up a node. Let’s take Ethereum as our example which requires users to stake and lock up 32 ETH ($50K+).
As you can see, that is clearly not achievable for the average user. That is where Liquid Staking protocols like Lido Finance come in. They allow the average user to stake any amount of ETH, with no minimum or maximum!
Not only that, users aren’t expected to lock up their tokens. Users can claim and withdraw at any given time. Unlike most staking protocols and PoS blockchains which require a minimum lock-up between seven days to one year!
What Makes Liquid Staking Special?
Liquid Staking is surging in popularity. Why wouldn’t you stake through a Liquid Staking protocol when it can offer much less risk, more flexibility and the same rewards if not more than the average staking protocol…
Thanks to the innovation of Liquid Staking protocols, anyone can afford to participate in the security of a Proof-of-Stake network and also use those tokens for anything they wish.
Do you want to swap your staked tokens for other tokens, lend out your staked tokens for extra yield or even restake your already staked tokens? No problem, LSTs give you full control over your staked assets and enable you to maximise your gains!
Problems with Liquid Staking
Nothing is perfect. It goes without saying that Liquid Staking also has its issues. So let’s go through the problems and risks with Liquid Staking.
The smallest problem for Liquid Staking is the fees. Although you will spend slightly more on fees for initially staking and interacting with the protocol, after a short amount of time you should break even and hit profits from the staking rewards.
This brings me to mention once again that Liquid Staked Tokens (LSTs) are pegged to the original token it is staked from which means there could be price volatility. If by any chance the token depegs, then the two tokens will have different values and most likely your staked tokens will be worth less, while also losing money on the staking…
Trust is always a big factor and Liquid Staking involves a lot of it. We have to trust the protocol we stake our assets with (e.g. Lido Finance). When staking, we’re using the protocol’s Validators, which if the protocol somehow tries to cheat the network, the Stake of the Validators will be slashed, as well as your delegation of Staking rewards of course…
Most importantly and sadly, exploits are always an issue in the world of DeFi, even with Liquid Staking. In order to Liquid Stake, a user must send the original token that will be staked to a smart contract that will then send the staked asset over to you. The problem here is, that users can interact with smart contracts that have vulnerabilities or exploits and potentially lose all of their assets! It’s important to be extra cautious when interacting with smart contracts you are weary of.
Liquid Staking Protocols
Here are a few of the most popular Liquid Staking protocols:
Lido Finance (LDO)
Lido is an open-source ‘Liquid Staking’ platform for Proof-of-Stake (PoS) blockchains, which first launched in December 2020 when Ethereum 2.0 (Beacon Chain) entered ‘Phase 0’.
Thanks to Lido Fi, users can stake any amount of ETH, which will reward users in stETH and is worth the same amount of ETH that was initially deposited, however is earning yield simultaneously. stETH is completely liquid and can be used on many decentralised applications.
If you’re keen to start Liquid Staking, then you can check out our tutorial on Lido Finance and Staking Ethereum on YouTube!
Rocket Pool (RPL)
Rocket Pool is the second-largest Liquid Staking protocol on the Ethereum network and launched at the end of 2021. The Rocket Pool became a huge success and is a leader in its respective sector.
Although Rocket Pool works differently to Lido Finance, the experience for users is still the same. Stake your ETH, earn from it, use it and enjoy it! If Rocket Pool is for you, then head over to their website!
Eigen Layer, the newest protocol on the block allows users to re-stake their already staked Ethereum. Users can use their Staked Ethereum from compatible protocols such as Lido Finance and Rocket pool, then re-stake it into the Eigen Layer protocol, where they will earn extra rewards on top of their rewards from Lido Finance/Rocket Pool!
Liquid Staking is technically still new. It carries some risks we are aware of, however, there are always unexpected events, so it’s important to proceed with caution. It is vital that you conduct thorough research before interacting with any smart contract.
Although it carries risks, so does everything in the world of DeFi. Liquid Staking is an innovation that can only be appreciated and is definitely positive for the crypto community, especially the Ethereum community. If you’re looking for a stream of passive income, Liquid Staking could be the perfect fit for you!