Liquidity staking protocols allow users to earn staking rewards without locking tokens or maintaining staking infrastructure. After depositing tokens, users receive tradable and transferable liquid tokens. Smart contracts controlled by DAO use selected node operators to stake the tokens deposited by users. As the users' tokens are controlled by DAO, node operators cannot directly access or use the users' tokens.
Difference between Staking and Liquidity Staking
Traditional staking requires users to lock funds in a smart contract-operated custodial account for a period. The lock-up period may vary from days to months depending on the chosen plan. During this period, investors cannot access their funds. In contrast, when investors use liquidity staking services to stake their funds, these funds are not locked. Token holders receive receipt tokens as evidence of their equity. The main difference is that with liquidity staking, you can fully access your funds at any time and cancel staking without any impact, resulting in higher returns and greater market liquidity.
Operation Process of Liquidity Staking
The working principle of liquidity staking is to deposit funds into a custodial account operated by a smart contract. The platform issues tokenized versions of staked funds as rewards. These tokenized versions have equivalent value returns. Users can still earn rewards from staked funds, but in liquidity staking, users can also use these tokens for other purposes. The liquidity staking tokens (LST) can be transferred out, stored elsewhere, traded, or spent without affecting the initial deposit.
Example of ETH Liquidity Staking
In the case of ETH liquidity staking, users can provide $ETH to the liquidity staking platform instead of directly participating in traditional staking. The platform collects the $ETH provided by participating users, packages these $ETH into batches of 32 and distributes them to eligible network validators. These validators then engage in traditional staking, and the profits from staking are shared among users, the liquidity staking platform, and network validators. Therefore, liquidity staking has a lower threshold and lower returns compared to traditional staking.
Advantages of Liquidity Staking
Eliminates entry barriers, no minimum ETH holding requirement: Liquidity staking protocols allow token holders to participate in staking validation. Even token holders with fewer ETH holdings than 32 can consolidate funds and proportionally receive block rewards and fees.
Enhances asset liquidity: Users can seamlessly transfer and trade liquid staking validation tokens or participate in other DeFi activities using related derivatives while retaining staking rewards without locking tokens. Derivatives bring higher capital efficiency.
Shares staking responsibilities: The protocol delegates complex technical issues such as infrastructure, security, and key management to professional node operators, avoiding ordinary token holders taking on related responsibilities.
Improves capital utilization efficiency: Users can retain liquid derivative tokens (e.g., using them in AMM) while engaging in productive activities and still earn staking rewards, further enhancing overall returns.
Risks of Liquidity Staking
Smart contract vulnerabilities and risks: In Liquid Staking protocols, there may be vulnerabilities in smart contracts supporting staking pools and derivative token issuance that could be exploited to misappropriate funds, potentially leading to loss of staked ETH. To ensure security, high audit standards and rigorous testing are required, although risks cannot be completely eliminated even with multiple audits, as seen in protocols like Lido.
Centralization trend: The popularity of Liquid Staking protocols such as Lido may introduce centralization risks to the Ethereum network. With the growing use of major staking derivatives, network effects result in a concentration of staking, e.g., Lido holding about 30% of total staked ETH. A penetration rate exceeding 33% increases the possibilities of transaction censorship, security risks, and regulatory exploitation of centralized control points. Maintaining a balance among stakeholders is crucial to prevent systemic imbalances.
Governance token dominance: Many Liquid Staking protocols issue governance tokens that guide protocol actions, like Lido's LDO token, allowing voting for updates. Token concentration in specific entities impacts decisions regarding commission rates and risk policies for ETH holders. To prevent conglomerate control, innovative governance and decentralization efforts are necessary.
Market Data for Liquidity Staking
Currently, the total market value of governance tokens for liquidity staking is $4,803,296,279, with a 24-hour trading volume of $284,370,572. Among them, Lido DAO's total market value is $2,353,549,399, Frax Share's total market value is $918,622,630, and Rocket Pool's total market value is $544,755,646.
(Total Value Locked ETH LSDs)
Popular Ecosystems for Liquidity Staking
Lido
Launched in 2020, Lido Finance is an overall leading liquidity staking platform. Initially focusing on providing a feasible staking solution for the Ethereum network, Lido has expanded its functionality to other ecosystems such as Polygon, Solana, and Kusama (KSM). After depositing staking funds, users receive derivative tokens in "st" form (e.g., stETH) and the asset's name. These funds can be withdrawn for use in over 27 DeFi applications and crypto wallets. Lido's staking rewards range from 4.8% to 15.5%, and the platform charges a 10% fee for its liquidity staking services.
Rocket Pool
A good alternative to Lido, Rocket Pool is a decentralized platform for staking Ethereum. Launched in 2016, Rocket Pool enables users to stake and operate permissionless nodes with less than 32 ETH, earning staking rewards of up to 8.98% annual interest and RPL collateral for platform protection. Alternatively, users can use its liquidity staking service to stake ETH and receive rETH liquidity tokens with an annual interest rate of up to 3.15%.
Hubble
The Hubble protocol allows users to collateralize encrypted assets for lending on its liquidity platform. It gained popularity after participating in the Solana hackathon, with its standout feature being lending services. The protocol allows investors to borrow using cryptocurrency as collateral and uses the borrowed tokens as collateral on other DeFi platforms. USDH stablecoin is used for the platform's encrypted lending services. Users can mint USDH with various types of collateral and repay at any time, supporting multiple assets and providing up to 11x collateral leverage.
Conclusion
Compared to traditional staking protocols, liquidity staking brings many advantages to users. Investors can escape the constraint of waiting for the lock-up period to end to access their funds, achieving more convenient operations and increased profits. While still earning rewards from staking funds, users can gain additional income in other decentralized finance (DeFi) networks with the introduction of liquidity staking tokens. The ability to cancel staking at any time makes liquidity staking attractive to a wider range of investors.
For more analysis, please follow Aibit's media account for real-time updates! This article is for reference only, does not represent any position, and is not intended as investment advice. Investment is risky, caution should be exercised.
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