Overview
Staking is a form of transaction verification in which users lock up their assets for a particular period to secure a network and earn staking rewards. While it guarantees return from staking assets like bonds, it also limits the chances of high returns for those assets. Because, once the tokens are staked, they cannot be transacted, traded, or used as collateral – they are illiquid.
Liquid staking solves this illiquidity problem. Liquid staking providers receive token deposits, stake those tokens and give depositors a receipt that can be redeemed for staked tokens. Receipts represent those staked tokens that can be traded or used as collateral elsewhere. For this reason, liquid staking is known as liquid staking derivatives.
Benefits of liquid staking
Locking up funds for a long time can turn out to be a bad investment decision due to the volatile nature of crypto assets. When digital assets are locked, their valuations also change based on the underlying asset’s performance. If a bear market is in full swing, staking could result in loss for investors. With liquid staking, meanwhile, investors can withdraw a tokenized version and deposit it in more income-generation systems to cover those losses.
Another benefit is the multiple income streams liquid staking affords. Stakers can easily lock their funds on one platform and use the tokenized version as collateral to receive crypto-backed loans. These loans can then be deposited into higher yield-bearing accounts, thus providing more revenue for an investment. This makes liquid staking a huge favorite among Defi-facing investors.
Disadvantages
Tokenized assets could depeg from the original staked token. This happened with the Ethereum network, where Steth traded lower than ETH. This is due to widespread use of the tokenized version, resulting in an elastic supply.
Another risk is that if a user loses their tokenized assets in a transaction, they also lose access to their deposits. The only way to get the earlier deposit back is to make another deposit equal to it.
While liquid staking is a highly innovative solution, it is powered by smart contracts. Smart contracts are highly efficient; however, they may have many vulnerabilities, creating a pathway for hackers to drain users’ funds. If this happens, users could lose all their funds with no means of retrieving them.
Top liquid staking projects
There are nearly $12 billion in TVL in over 50 liquid staking protocols across multiple blockchains, according to DefiLlama. The top 5 projects account for more than 90% TVL of all liquid staking projects, led by Lido with nearly $8.1 billion, followed by Coinbase Wrapped Staked ETH with $1.7 billion, Roketpool with $907 million USD, Parallel, Ankr, and especially Stader – the project used to have TVLs of up to billions of dollars when it first came out, but the Luna crash led to the steady decline of Stader.