Liquid staking, also known as soft staking, is an advanced form of traditional staking available on next-generation smart contract protocols. With liquid staking, users can access locked funds for other crypto-based activities while still earning rewards from their original deposits.
Liquid staking gained massive adoption in 2022 following the rise of decentralized finance (DeFi) opportunities. This article explores the concept of liquid staking, its pros and cons, and the top liquid staking providers in the market.
Ethereum’s Shift to PoS
The Ethereum network is central to our discussion, as it marked the beginning of 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 blockchain technology beyond value transfer.
As a result, Ethereum was designed to be a more open and fluid crypto project, enabling the development of other applications atop its core software. This was made possible by integrating smart contracts—computer code snippets that self-execute based on predefined rules. Following its success, Ethereum became the breeding ground for decentralized applications (DApps) and DeFi.
However, Ethereum initially used the same consensus mechanism as Bitcoin: Proof of Work (PoW). PoW promotes competition among globally distributed mining nodes, making it highly secure and decentralized. But this resulted in slow transactions and high network fees.
Additionally, Ethereum’s role as a facilitator of value-added services led to high gas fees, sluggish performance, and massive energy demands.
The team officially began transitioning from Proof of Work to Proof of Stake (PoS) in December 2020 with the launch of the Beacon Chain (Ethereum 2.0). The transition was completed two years later, in September 2022, when Ethereum joined the ranks of PoS 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 traditional interest-bearing savings accounts. In banks, customers deposit funds into accounts and earn a fixed percentage for keeping them there. Meanwhile, banks lend this money to businesses as debt through fractional reserve systems. In return, banks earn high interest and pay customers a nominal amount as interest.
However, staking differs from traditional savings in several ways. Crypto assets (digital assets) are staked instead of fiat currency.
Another critical difference is that users earn higher staking rewards due to the principles governing this practice. All blockchain systems are transparent and lack central authorities, so staking protocols operate without intermediaries. This way, users earn the rewards that would have settled intermediaries.
In its basic form, staking requires users to lock their crypto assets for a fixed period to secure a network. Users are rewarded with newly minted coins from the underlying network for committing their digital assets. Staking is rapidly becoming an independent industry, with over $18 billion recorded in the ecosystem.
Ethereum Staking Options
Currently, several staking offerings exist. Each option caters to specific preferences and is tailored to optimize potential growth. Below, we analyze the different staking forms and their possible limitations:
1) Self-Staking
This involves an individual becoming a validator on Ethereum’s PoS blockchain. Validators are users who stake a large amount of the network’s native asset to verify platform transactions. Instead of competing, validators take turns confirming transactions, reducing the network’s carbon footprint.
Self-staking on Ethereum includes a high threshold. To become a validator, you must stake a minimum of 32 ETH. This makes self-staking a capital-intensive exercise.
Another issue is that a validator’s staked ETH could be severely affected if network issues arise or the validator makes errors. The Ethereum network automatically slashes the validator’s staked ETH, forcing them to buy more ETH to continue operating.
Moreover, when validators lock their ETH, they can only unlock or access them after the staking period ends. This can significantly impact them short-term, as they cannot move assets to other platforms when needed.
2) Exchange Staking
A less capital-intensive option is exchange staking. Typically, this involves centralized crypto exchanges creating pools where clients deposit staking assets. The exchange then stakes these assets to become a validator.
The advantage of exchange staking is that pool contributors can easily unstake whenever they wish. This doesn’t affect the exchange’s pool due to the large volume of staked tokens.
Another benefit is that users can stake any amount of their crypto assets. They don’t need to meet the 32 ETH threshold imposed on self-stakers. In return, these exchanges reward pool contributors daily or monthly for entrusting their assets.
But this option isn’t flawless. Given the centralized nature of this system, stakers often don’t know how exchanges use their funds. They also entrust funds to a centralized party. Another risk is that platforms could be hacked or shut down due to insolvency, making it impossible for users to recover assets.
The final limitation of exchange staking is that most platforms charge withdrawal fees when users unstake funds.
3) Locked Staking
Although not a full-fledged staking system, locked staking has numerous limitations. Staked assets in this system are largely inaccessible until the staking period elapses. This is ideal for users who want to consolidate financial discipline and don’t intend to access funds for extended periods.
Locked staking typically ranges between one and three months on most exchanges. Validators who staked directly on Ethereum have a longer withdrawal window.
What Is Liquid Staking?
Liquid staking is the newest staking service. This option requires users to commit funds to secure the network but remains liquid in the sense that users can still access their funds.
Unlike traditional PoS systems, liquid staking involves storing funds in DeFi collateral deposit accounts. This allows users to access tokens whenever desired, as funds remain highly liquid.
With liquid staking, users can generate multiple income streams from crypto assets, as they can lock assets while retaining access. They can use liquid versions of their assets in other DeFi protocols and earn more from initial deposits.
How Does Liquid Staking Work?
Though liquid staking shares similarities with other staking options, its execution methods differ significantly. A new generation of protocols—liquid staking protocols—has emerged, allowing traders to increase their crypto holdings.
These protocols enable users to stake any amount of an asset and withdraw it without affecting the initial deposit. Deposits are locked on liquid staking platforms, and users receive a tokenized version of their staked assets. This derivative form holds the same value and operates 1:1 with the original asset but often carries a different emblem for identification.
For example, if a staker deposits 1 ETH into a liquid staking service and requests a derivative, they’ll receive stETH (where "st" represents staked ETH).
These new tokens can be traded outside the protocol, stored elsewhere, or spent without interrupting the initial deposit. The liquidity liquid staking services offer isn’t their only unique feature. Users earn staking rewards on initial deposits and generate additional income from derivative tokens simultaneously—creating a win-win scenario.
If stakers wish to withdraw initial deposits, they must return an equivalent valuation to access funds. Some liquid staking protocols charge platform fees, but these vary.
Benefits of Liquid Staking
Staking introduced a new experience for coin holders, allowing anyone to put idle assets to work and watch them grow. However, liquid staking takes this further. One advantage is mobility.
Locking funds long-term can become a poor financial decision due to crypto’s volatile nature. When digital coins are locked, their valuation fluctuates based on market performance. If a bear market emerges, traditional staking could result in losses. With liquid staking, users can easily withdraw tokenized versions and deploy them in income-generating systems to offset losses.
Another benefit is multiple income streams. Stakers can lock funds on one platform and use tokenized versions as collateral for crypto-backed loans. These loans can be deposited into high-growth accounts, providing compounded returns. This makes liquid staking a favorite among DeFi users.
Drawbacks of Liquid Staking
Like all financial systems, liquid staking has risks and downsides.
One risk is that tokenized assets may delink from original staked tokens. This happened on Ethereum, where stETH traded below ETH due to elastic supply from extensive derivative usage.
Another risk is that losing tokenized assets in trades means losing access to initial deposits. The only way to recover staked funds is by depositing equivalent assets.
Though innovative, liquid staking relies on smart contracts. While efficient, smart contracts can contain bugs, creating avenues for hackers to drain user funds. If exploited, users could lose all funds irreversibly.
Top Liquid Staking Providers
Liquid staking is an advanced crypto-staking service provided by select platforms. Below are leading liquid staking protocols and supported assets:
1) Lido: Overall Best Liquid Staking Platform
2) Rocket Pool: Ethereum’s Decentralized Liquid Staking Protocol
3) Tempus Finance: Fixed Income for Staked Tokens
4) Hubble Protocol: Borrow Against Staked Crypto
5) Meta Pool: Liquid Staking for Near Protocol
6) OKTC Liquid Staking: Stake and Earn OKT Effortlessly
Using Liquid-Staked ETH in DeFi
One viable way users maximize liquid staking potential is through DeFi yield farming. Staked assets can be deployed in growth-generating protocols.
Yield farming lets users lock funds and use linked asset versions elsewhere. They can use linked assets as collateral for crypto loans and trades, earning active and passive income.
Final Verdict on Liquid Staking: An Advanced Staking Strategy
Liquid staking is a next-gen system enabling users to put assets to work while retaining liquidity. Instead of locking funds indefinitely, liquid staking provides tokenized versions for use on other platforms. This makes it a favorite among users who value flexibility.
Though profitable, liquid staking is advanced and best suited for experienced stakers.
FAQs
Is Liquid Staking Risky?
Yes. Tokenized assets may delink or lose value. Users can only redeem assets by returning equivalent value. Platforms may also face security breaches.
How Does Liquid Staking Differ from Traditional Staking?
Liquid staking offers liquidity via tokenized assets, while traditional staking locks funds without derivative access.
What Are Liquid Staking Tokens?
Tokenized versions of staked deposits, tradable and transferable outside native protocols.
Is Liquid Staking Good?
Yes, for advanced users seeking flexibility. It’s less suitable for retail traders preferring long-term passive income.
Is Liquidity Better Than Staking?
Depends on user needs. Liquid staking suits DeFi-savvy users; traditional staking appeals to long-term holders.