Liquid staking, also known as soft staking, is an advanced form of traditional staking available on many next-generation smart contract protocols. With liquid staking, users can access their locked funds for other crypto-based activities while still earning rewards from their original deposit.
Liquid staking saw massive adoption in 2022 following the rise of decentralized finance (DeFi) opportunities. This article explores the concept of liquid staking, its advantages and disadvantages, and some of the leading liquid staking providers in the market.
The Shift from Ethereum to Proof of Stake
The Ethereum network is central to this discussion, as it ushered in a new era of financial applications. Launched in 2015 by a team of eight developers, Ethereum is an advanced version of the Bitcoin network. According to its principal founder, Vitalik Buterin, Ethereum aims to expand the use of blockchain technology beyond simple value transfer.
As a result, Ethereum was designed to be a more open and fluid crypto project, allowing the development of other applications on top of its core software. This was made possible through its integration of smart contracts—snippets of computer code that can self-execute based on predefined rules. Following its success, Ethereum became the breeding ground for decentralized applications (DApps) and DeFi.
However, Ethereum was initially built using the same consensus mechanism as the Bitcoin network: Proof of Work (PoW). The PoW mechanism promotes competition among mining nodes distributed worldwide, making it highly secure and decentralized. But this led to slow transaction speeds and high network fees.
Furthermore, Ethereum's role as a facilitator of more value-added services resulted in high gas fees, slow performance, and significant energy demand.
The team officially began transitioning from a Proof of Work to a Proof of Stake (PoS) protocol in December 2020 with the launch of the Beacon Chain (Ethereum 2.0). The transition process was completed two years later, in September 2022, when the Ethereum network joined the ranks of Proof of Stake blockchains. Commenting on the migration, Buterin noted that the network now consumes 99.9% less energy than its previous consensus mechanism.
What is Staking?
Staking draws inspiration from the traditional concept of an interest-bearing savings account. In a bank, customers deposit their funds into an account and earn a certain percentage for keeping them there. Meanwhile, the bank lends this money to businesses in the form of debts through the fractional reserve system. In return, the bank earns high interest and pays the customer a small nominal amount as interest.
However, staking differs from traditional savings in several key aspects. Crypto assets (digital assets) are used for staking instead of fiat money.
Another important difference is that users earn higher staking rewards due to the principles governing this practice. All blockchain systems are transparent and lack a central authority, so staking protocols operate without an intermediary. This way, users earn the rewards that would have been used to settle intermediaries.
In its most basic form, staking requires users to lock up their crypto assets for a specified period to secure a network. Users are rewarded with newly minted coins from the underlying network for committing their digital coins. Staking is rapidly becoming an independent industry, with over $18 billion recorded in the ecosystem.
Staking Options on Ethereum
Several staking offerings are available today. Each option caters to a particular preference and is geared toward optimizing potential growth. Below, we examine the various forms of staking and their potential limitations:
Self-Staking
This involves an individual becoming a validator on the Ethereum PoS blockchain. Validators are users who stake a large amount of the network's underlying asset to verify platform transactions. Instead of competing, validators take turns confirming transactions, thereby reducing the network's carbon footprint.
Self-staking on the Ethereum network includes a high threshold. To become a validator and be accepted into the Ethereum ecosystem, one must stake a minimum of 32 ETH. This makes self-staking a capital-intensive exercise.
Another issue with this system is that a validator's staked ETH could be severely impacted if a network problem occurs or if the validator makes an operational error. The Ethereum network will automatically slash the validator's staked ETH by half, forcing them to purchase more ETH to continue operating.
Furthermore, when a validator locks their ETH, they can only unlock or access them once the lock-up period has ended. This can significantly affect them in the short term, as they cannot move their assets to another platform if needed.
Exchange Staking
A less capital-intensive option is exchange staking. Typically, this option involves a centralized cryptocurrency exchange creating a pool where clients can deposit their assets for staking. The exchange then takes these crypto assets and deposits them into a network to become a validator.
The advantage of exchange staking is that users or pool contributors can easily unstake whenever they wish. This does not affect the exchange's pool due to the large number of tokens staked.
Another advantage is that users can stake any amount of the crypto asset they own. They do not have to meet the 32 ETH threshold imposed on self-stakers or validators. In return, these exchanges reward pool contributors daily or monthly for entrusting them with their crypto assets.
But this option is not entirely favorable. Given the centralized nature of this system, stakers often do not know how the exchange uses their funds. They also entrust their funds to a centralized party. Another problem is that the platform could be easily hacked or shut down due to insolvency, making it impossible for users to recover their assets.
The final limitation of using an exchange staking medium is that most charge a withdrawal fee when users want to withdraw their funds.
Locked Staking
Although not a full-fledged staking system, locked staking has many limitations. Assets staked in this system will be largely inaccessible until the staking period elapses. This is ideal for users who want to consolidate their financial discipline and have no intention of accessing their funds for a long period.
Locked staking typically ranges from one to three months on most exchanges. Validators who staked directly on the Ethereum protocol have a longer withdrawal window than most.
What is Liquid Staking?
Liquid staking is the newest staking service. This staking option requires users to commit their funds to secure the network, but it is liquid or fluid in the sense that users can still access their funds.
Unlike the traditional PoS system, liquid staking involves storing funds in DeFi collateral deposit accounts. This allows users to access their tokens whenever they wish, as the funds have high liquidity.
With liquid staking, users can generate multiple income streams from their crypto assets since they can lock their assets and still have access to them. They can use the liquid versions of their assets in other DeFi protocols and earn more from their initial deposits.
How Does Liquid Staking Work?
Although liquid staking shares similarities with other staking options, the methods used for its execution are quite different. A new generation of protocols, known as liquid staking protocols, have been developed to offer traders the opportunity to increase their cryptocurrency holdings.
These protocols allow users to stake any amount of an asset and withdraw it without affecting the initial deposit. This way, deposits are locked on liquid staking platforms, and users receive a tokenized version of their crypto assets. This derivative form holds the same value and operates one-to-one with the original asset. However, they usually carry a different emblem to identify them.
For example, if a staker deposits 1 ETH into one of these liquid staking services and requests a derivative, the user will receive an stETH, where "st" represents the staked ETH.
These new tokens can be transferred out of the protocol, stored elsewhere, traded, or even spent without interrupting the initial deposit. The fluidity offered by liquid staking services is not the only thing that makes them unique. Users will earn staking rewards on their initial deposits and generate more funds from their derivative tokens simultaneously, making it a win-win situation.
If a staker wants to withdraw their initial deposit, they must return an equivalent deposit valuation to access their funds. Some liquid staking protocols charge a fee for using their platform, but fees vary.
Advantages of Liquid Staking
Staking introduced a new experience for coin holders, allowing anyone to put their assets to work and see them grow potentially. However, liquid staking has taken the system even further. One of the advantages of liquid staking is its mobility.
Locking funds for a long period can become a poor financial decision due to the volatile nature of crypto assets. When digital coins are locked, their valuation also changes based on the performance of the underlying asset. If a bear market is in full swing, staking, in the traditional sense, could result in a loss for the user. However, with liquid staking, users can easily withdraw a tokenized version and deposit it into systems that generate more income to cover such losses.
Another advantage is the multiple income sources offered by liquid staking. Stakers can easily lock their funds on one platform and use a tokenized version as collateral to obtain crypto-backed loans. These loans can then be deposited into higher-growth accounts, providing greater turnover. This makes liquid staking a favorite among DeFi users.
Disadvantages of Liquid Staking
Like all financially based systems, liquid staking has its drawbacks and risks.
One such risk is that the tokenized asset may become decoupled from the original staked token. This occurred with the Ethereum network, where stETH traded below ETH. This was due to the extensive use of the tokenized version, which led to an elastic supply.
Another risk of liquid staking is that if a user loses their tokenized asset in a trade, they also lose access to their deposited funds. The only way to recover the previous deposit is to make another equivalent deposit.
Although liquid staking is innovative, it is powered by smart contracts. Smart contracts are highly efficient; however, they can be plagued by bugs, creating a pathway for hackers to drain user funds. If this occurs, users could lose all their funds with no possibility of recovery.
Top Liquid Staking Providers
Liquid staking is an advanced crypto staking service, provided exclusively by a few platforms. Below, we list some of the leading liquid staking protocols and the assets users can stake on them.
Lido: The Overall Best Liquid Staking Platform
Lido Finance, Lido for short, is the most well-known liquid staking provider. The platform, launched in 2020, allows users to stake their Ether tokens without locking them. Lido launched offering liquid staking services for the Ethereum network but has since expanded its offering to Ethereum, Solana, Polygon, Polkadot, and Kusama.
On Lido, users can stake through PoS blockchains and deploy their crypto assets in other activities. This includes accessing lending platforms like Aave and participating in other high-growth opportunities. Once users stake their funds, Lido presents them with a tokenized variant represented as "st+asset ticker." Stakers can then withdraw these derivatives and use them across more than 27 DeFi applications and cryptocurrency wallets.
Staking rewards on Lido range from 4.8% to 15.5%. Besides offering a liquid staking service, Lido also manages a decentralized autonomous organization (DAO) powered by its network token, LDO. With the digital token, users can vote on network proposals and potentially see their assets grow through staking.
For its liquid staking services, Lido charges a 10% fee.
Rocket Pool: Ethereum Liquid Staking Protocol
An alternative liquid staking service is Rocket Pool. This protocol, launched in 2016, offers a user-friendly process for users to stake their ETH tokens on its platform. Rocket Pool functions as a decentralized, intermediary-free base layer for ETH2 staking. The platform only caters to the Ether crypto asset.
Nevertheless, it offers a dual service to its clients. Users can stake their ETH directly on Rocket Pool and obtain a tokenized version of their staked asset as rETH or run a node directly within the Rocket Pool ecosystem.
Given its dual service offering, Rocket Pool rewards users separately. For those who only stake ETH in exchange for rETH, the Rocket Pool service rewards them with a potential annualized reward of 4.16%. On the other hand, those who stake ETH while simultaneously managing a node earn a potential fixed annualized reward of 6.96% plus a variable RPL premium issued by the platform for securing the Ethereum network.
With Rocket Pool, node operators do not need to send the full 32 ETH required to run a node before operating in the Rocket Pool space. Instead, Rocket Pool allows validators to start with half, which is 16 ETH. This makes it a more cost-effective option for node operators on the Ethereum PoS protocol.
Tempus Finance: Fixed Income for Tokens
The next most important liquid staking protocol for DeFi users is Tempus. This next-generation DeFi tool allows users to earn fixed income with their tokens. This way, users can obtain a fixed amount of passive income from their digital assets across all protocols where they deploy them.
According to the Tempus team, its multi-chain solution can be deployed in three different use cases.
- Users can fix their future growth on their crypto assets.
- They can also speculate on the pace of their future growth.
- They can deploy their tokenized assets in liquidity pools and earn trading fees.
Tempus is compatible with most reward tokens from the Ethereum and Fantom blockchains, including stETH, yvDAI, xSUSHI, and aUSDC. Meanwhile, the protocol also operates an automated market maker (AMM), facilitating liquidity provision in yield-bearing tokens.
The protocol does not charge staking fees. However, users have to pay swap fees to provide liquidity in the AMM pools.
Hubble Protocol: Borrow Against Staked Crypto
The Hubble Protocol gained momentum after participating in a Solana hackathon. Since then, the new liquid staking platform has gained massive popularity.
The Hubble Protocol has become popular thanks to its lending services. Users can borrow against their cryptocurrencies and use the borrowed tokens as collateral on other DeFi platforms. This way, users can multiply their staking exposure, as they earn from both their initial deposits and the loans they can access. The USDH stablecoin plays a crucial role in the Hubble protocol, as it is used in crypto lending services.
Hubble supports multiple assets and allows users to deposit from different networks. The platform then offers leverage of up to 11x on the collateral, which users can utilize for trading. This exponentially increases the potential growth of their deposits.
Hubble charges a 0.5% fee on loans.
Meta Pool: Liquid Staking for Near Protocol
Meta Pool caters to the Near smart contract network. The liquid staking service allows users to stake their Near assets and obtain stNEAR in return. stNEAR can then be used for DeFi activities in the broader Near ecosystem and its yield aggregation system, Aurora.
Meta Pool delegates user deposits to over 65 validators who oversee the performance of the deposited assets. In return for locking funds in the DeFi protocol, Meta Pool rewards users with a potential annualized reward of 9.76%, excluding staking rewards from other yield activities. If the tokenized asset is deployed on the Aurora protocol, users can also earn a 9.76% reward.
Like all protocols discussed in this article, Meta Pool provides immediate unstaking of assets. However, this incurs a 0.3% surcharge.
OKTC Liquid Staking: Stake and Earn OKT Easily
OKTC Liquid Staking is a cutting-edge liquid staking solution on OKT Chain (OKTC). Provided by OKX, it allows users to stake and earn OKT tokens while maintaining liquidity.
In exchange for staking OKT, users will receive staked OKT (stOKT), a versatile KIP-20 token that can be traded and used freely within the OKTC ecosystem. Additionally, users can earn swap fees by providing liquidity to OKTC Swap.
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Utilizing ETH Liquid Staking in DeFi
One of the most viable ways for users to leverage the potential of liquid staking is its use in DeFi. It is largely executed through yield farming, as staked assets can be used in yield-generating protocols.
Yield farming allows users to lock their funds and use a linked version of their assets elsewhere. As a result, they can use their linked assets as collateral to obtain crypto loans and execute trades, earning income both actively and passively.
Final Verdict on Liquid Staking: An Advanced Staking Strategy
Liquid staking is a next-generation system that allows users to put their assets to work and see them grow potentially. Instead of locking their funds without access, liquid staking provides users with a liquid version of their assets to use on other platforms. This makes the staking service a favorite among users, as they can easily redeem their assets whenever they wish.
Although the process can yield profits, liquid staking is an advanced strategy and should only be used by experienced stakers.
Frequently Asked Questions
Is Liquid Staking Risky?
Yes, liquid staking carries risks. The tokenized version could easily become decoupled from the original asset or lose its value. Another issue is that users can only redeem their assets if they return the equivalent value of their initial deposit. Meanwhile, these liquid staking platforms can be easily hacked if poor security measures are applied.
What is the Difference Between Liquid Staking and Staking?
The main difference between liquid staking and staking is that the former is more liquid. Liquid stakers receive a tokenized version of the deposited crypto assets, which they can use on other platforms. However, staking does not offer this privilege.
What are Liquid Staking Tokens?
Liquid staking tokens are tokenized versions of user deposits. Once the initial deposits are locked, users receive liquid staking tokens, which can be traded, transferred, and used on other platforms.
Is Liquid Staking Good?
Liquid staking can be a viable method of generating yield from digital assets. This staking method allows users to access their tokens while securing the network with them. However, it is more suitable for advanced stakers due to its inherent complexities.
Is Liquid Staking Better Than Staking?
This largely depends on the user's needs. Liquid staking may be a better option for experienced DeFi users. Conversely, staking is better for retail traders interested in making their idle crypto assets work for them long-term.