What is Liquid Staking and How Does It Work?
What is Liquid Staking?
Liquid staking is the process of acquiring a trading asset by exchange with cryptocurrency staking in a proof-of-stake blockchain. Traditional staking lock tokens for a specified time. However, in liquid staking, the users are able to leverage the value of staked tokens and use it across decentralized finance applications for other Web 3.0 protocols.
How does Liquid Staking Work?
Crypto investors have to lock up their cryptocurrency tokens on a blockchain with smart contracts such as Solana network etc. Once it is done, the users will be able to contribute to the overall security of a trading platform and lend more power to the consensus mechanism.
In return for locking up the assets, the users are able to earn rewards in the form of additional tokens which is called yield income.
The unique aspect of liquid staking begins when investors are able to receive staked assets or staking derivatives in the form of liquid staking token or LST. LSTs denote the value of staked tokens and are usable as collateral in lending protocols. LSTs are also traded on different trading DeFi platforms for leveraged trading.
Liquid Staking on Centralized and Decentralized Platforms
Most popular centralized trading platforms such as Coinbase and Binance offer centralized liquid staking options. In this manner, investors are able to delegate cryptocurrencies on a regulated platform as custodian account and also offering staking services.
Usually, centralized platforms do not require a lot of technical knowledge and insight for liquid staking. However, investors are exposed to the dangers of counterparty risk.
In contrast, investors can also leverage liquid staking services via decentralized platforms such as Lido Finance and Rocket Pool. These types of platforms eliminate the risk of a single point of failure. At the same time, they are able to maintain sovereignty for their assets and do not need regulated platforms such as centralized intermediaries.
Some of the risks associated with decentralized liquid staking are technical skills such as the ability to navigate the complicated interface of dApps or smart contracts. Furthermore, the investors have to consider additional factors such as gas fee, smart contract risks, and delays on account of congestion.
Risks Associated the Liquid Staking
Here is a list of risks and issues that are often association with liquid staking that investors must consider before locking their funds:
Staking process often depends on smart contracts to lock the funds. Smart contracts are automation protocols that perform automated functions based on preset triggers. These smart contracts issue staked assets or staked derivatives as per the predetermined terms of the staking contract. However, in some cases the investors are exposed to smart contract risks such as technical vulnerabilities, glitches, exploits, and hacks that could lead to potential losses of their staked reserves.
Another major issue that investors working with liquid staking services have to deal with is diminishing governance rights. The rights are granted to the investors based on the total number of a given token that is present in their ownership.
However, when the investors make the choice to stake their tokens in a liquid staking protocol their total reserves decline and it can result in lapse of their voting rights in an on-chain governance protocol. It also means limiting the ability of a user to contribute in the governance decisions.
Advantages of Liquid Staking
Here is a list of some of the benefits that are associated with liquid staking.
Liquid staking is beneficial for investors as it grants them an opportunity to earn staking rewards. Furthermore, the investors gain the ability to earn derivative tokens with the help of liquid staking and results in more liquidity.
Investors are able to earn periodic staking rewards with liquid staking and derivatives tokens. Usually, these rewards are paid on a regular basis and investors are allowed to withdraw them at any time.
Liquid staking is beneficial for a network and token stability because it brings more liquidity to a token project. It means that the investors who have invested money in a given token can have confidence about stability and ease of trade for the token.
This process lends more power to a blockchain network that also generated rewards for the staked positions. The total amount of value locked in a given token is indicative of its value and confidence among investors.
Liquid staking generated yield farming opportunities. Investors can use liquid staking protocols to perform yield farming which is the process of maximizing yield income by recycling the yield reward tokens several times. Liquid staking makes yield farming possible by issuing derivative tokens as rewards.
Conclusion
Yield farming is one of the most popular and fast-growing methods of generating passive income in DeFi. Investors can take advantage of this method to increase their income and lend support to a viable digital asset project that could generate massive returns for them in the future.
