Staking is quite a popular DeFi application that allows investors to earn passive income with cryptocurrency. Staking is very important for many blockchains (particularly Proof-of-Stake “PoS”) blockchains where validators are required to lock down (stake) their assets for a particular period.
During the lockdown period, individuals who have staked tokens cannot access their tokens to trade, swap, or carry out any transactions. Instead, it is locked in a smart contract, like traditional fixed deposit bank accounts, where users lock funds for years.
As much as staking offers rewards and yields, many have reservations about it, and rightly so. The cryptocurrency market is earmarked for its volatility. An asset could be $100 today and could fall badly to $10 within a month; similarly, an asset could make significant upward moves in a few hours. Hence, locking down tokens for an extended period may be dicey.
In short, staking tokens long time can see you accrue extra tokens that would amount to huge profits in a bull run – something you wouldn’t have had if you merely held. However, if the market enters a bear season, the principal tokens, in addition to the extra tokens received, may be worth far less than your initial investment, leading to a substantial loss. As a result, to mitigate the drawbacks of standard staking, Liquid staking was created.
What is Liquid Staking?
Liquid staking is a form of staking that allows people to enjoy staking benefits without locking down assets for long periods. Hence, users can interact with their funds and carry out transactions while earning staking benefits.
Unlike pure staking, where assets are inaccessible for the “lock-up” period, liquid staking allows investors to participate in other DeFi activities like lending/borrowing and yield farming.
How Does Liquid Staking Work?
In contrast to the typical staking, where users lock up their tokens to earn validating rewards, liquid staking involves keeping funds in an escrow application where the user can still access it. The user who deposits their tokens in a DeFi escrow account will receive a tokenized version of their funds.
For example, if you have 10 ETH that you want to stake for rewards, rather than joining an existing PoS protocol, you can look for a liquid staking platform to participate in. The moment you stake your 10 ETH, you will receive 10 sETH (staked-ETH) tokens in return, valued equivalently to ETH.
Hence, the liquid staking protocol will recognize your ETH stake while giving you room to explore DeFi applications with sETH. Now, with the sETH, you can trade and participate in DeFi lending, yield farming, or any activity of your choice as you would with your regular ETH tokens. When you are ready to regain your tokens, you will be required to return the sETH to the liquid staking pool (sometimes with interest).
Every liquid staking pool has different terms, so be sure to understand them before committing your funds.
Difference Between Liquid Staking and Centralized Exchange (CEX) Staking
CEX staking involves locking up tokens in a centralized exchange for rewards. Some people erroneously regard CEX staking as liquid staking; however, despite sharing a few similarities with Liquid staking, they are different.
CEX staking involved committing your tokens to a CEX staking protocol, locking it up for rewards. However, unlike Proof-of-Stake, you aren’t required to be a delegate or a validator. Tokens staked on a CEX can be unlocked at any time; however, the user will not get full staking rewards for unlocking before the agreed time.
Liquid staking works differently; it gives tokenized funds back to the user (similar to a loan), which can be used to participate in other transactions while staked. However, with CEX staking, your staked tokens cannot be used for anything until you unstake. The plus side of CEX staking is that it allows users to unlock their funds at any time; hence, they can avoid a huge loss of value due to volatility.
Where To Carry Out Liquid Staking
Liquid staking can be carried out with several protocols with various levels of decentralization. Users who intend to stake tokens can deposit their tokens into a smart contract to receive tokenized funds (e.g., ETH for sETH). The ETH you receive is distributed to validators who participate in the Proof-of-Stake consensus. As a result, it appears as though you have delegated your tokens to these validators while having an equivalent of the token to spend.
Some Platforms where you can carry out Liquid staking include:
1. Lido (Ethereum, Solana)
2. Acala (Polkadot)
3. Ankr (Ethereum, Solana)
4. Karura (Kusama)
5. Marinade Finance (Solana)
6. PStake (Ethereum, Cosmos, Persistance)
7. Stakewise (Ethereum)
8. Stakefi (Polygon, Avalanche, Kusama, Polkadot)
9. SharedStake (Ethereum)
10. Stafi (Ethereum)
Risks Involved in Liquid Staking
Liquid staking is typically low risk, high-reward venture. You may trade your tokenized staked assets against stablecoins to hedge against inflation or invest in yield farming, crypto lending, or any other protocol. However, you must ensure that your new venture remains profitable because you won’t be able to redeem your funds without the tokenized versions.
For example, if you use your 10 sETH in an unprofitable yield farm and are left with 8 sETH, you will be required to get the remaining 2 sETH to fully unlock your tokens. Hence, Liquid staking may appear to some people as zero/low-interest loans.
Liquid staking provides a way for investors to make the most of their tokens while earning staking rewards from them; hence, they provide investors more room to explore the cryptocurrency world.
Remember that all Liquid staking platforms have various terms and limitations on how you can spend tokenized funds; hence, ensure to understand the terms before committing tokens.
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