Exploring the Mechanics and Potential Risks of Liquid Staking in Cryptocurrency
Summary:
This article provides a comprehensive explanation of liquid staking in cryptocurrency, a mechanism that allows stakers to maintain their staked tokens' liquidity and earn extra yield through DeFi protocols. It discusses the differences between liquid and delegated staking, the role of staking-as-a-service platforms, and how liquid staking operates. The piece also highlights the potential risks associated with liquid staking platforms, emphasizing the importance of comprehensive due diligence to mitigate technical and market-related threats.
Let's examine liquid staking, a mechanism that maintains the fluidity of staked tokens while earning additional yield through decentralized finance (DeFi) protocols. Staking, the act of depositing a cryptocurrency to support a blockchain network and yielding benefits from it, causes the staked asset to lose liquidity as it cannot be moved or traded. This is where liquid staking lends a hand. Cryptocurrency owners can stake without losing possession of their assets, changing how staking is perceived. Innovations like Lido's liquid staking offer stakers tokenized assets as a representation of their staked assets, providing both the ability to stake rewards and the flexibility to trade tokens or transfer them to other users.
Are delegated staking and liquid staking different after all? Users of the delegated proof-of-stake (DPoS) network cast votes for their chosen delegate. Conversely, liquid staking is designed to allow stakers to bypass the imposed minimum staking and token-locking requirements. DPoS enables users to vote for block producers or validators, who are responsible for validating blocks. DPoS users can also contribute their tokens to a staking pool to increase the voting power for their delegate choice. Meanwhile, liquid staking lowers the investment barrier and enables stakers to sidestep the token-locking rule. Requirements for setting up a validator node, such as staking 32 Ether (ETH) on Ethereum, could be bypassed by harnessing liquid staking.
Staking-as-a-service connects the blockchain’s consensus mechanism with digital asset holders intending to reap rewards from the network. These platforms let users transfer their crypto assets to a third-party that undertakes staking on their behalf, typically for a fee or reward share. By 2025, the staking services segment could reach $40 billion. Staking-as-a-service can be custodial or noncustodial depending on the degree of decentralization, influencing stakeholders’ interests and overall transparency.
So, how does liquid staking operate? It works to remove staking barriers while allowing holders to lucratively utilize liquid tokens. Staking pools combine smaller stakes into a larger one via a smart contract, issuing corresponding liquid tokens to each staker. This approach removes the staking entry barrier and promises dual earning opportunities: from the staked tokens and from liquid tokens used in trades, lending, and more. The case of Lido, a liquid staking solution, provides a clear perspective on its functionality. With the ability to stake smaller fractions of the requisite 32 ETH, Lido offers a solution to the challenges of traditional staking.
What about risks linked to liquid staking platforms? Technical threats, such as protocol bugs or vulnerabilities, are a concern given the relative novelty of PoS blockchains. Counterparty risks emerge with a reliance on validators for staking. Market risks arise when staked assets earn from DeFi applications, possibly leading to losses during market slumps. To mitigate such risks, liquid staking platforms need to stay open-source, routinely audited, and maintain a bug bounty program. Adequate due diligence, including research on market history, regulatory landscape, and a diversified investment strategy, is crucial to manage market volatility risks.
Published At
4/27/2024 12:45:00 PM
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