What is liquid staking, and how does it work?

Liquid staking, explained

Frequently Asked Questions (FAQ) about Liquid Staking

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One way to rephrase this in clear and conversational English is: “With liquid staking, you can maintain the fluidity of your staked cryptocurrencies by employing proxy tokens, which enable you to generate extra returns via Decentralized Finance (DeFi) applications.”

Prior to delving into the concept of liquid staking, it’s essential to grasp the fundamentals of staking and its related challenges. Staking signifies the act of securing cryptocurrencies within a blockchain system to support its functionality. In return, stakers are rewarded with profits. However, during the staking period, assets put up as collateral usually become immobile, meaning they cannot be traded or moved.

Through the method of liquid staking, cryptocurrency owners can engage in staking activities without relinquishing possession of their assets. This innovation has significantly changed the dynamics of staking participation. Notable projects like Lido have pioneered this approach by issuing tokenized counterparts or derivatives that symbolize staked assets.

I can help you maximize the benefits of staking by allowing you to keep your tokens active in liquidity pools or validation processes, all while maintaining the ability to utilize them in DeFi apps for trading or transferring to other users as needed.

Is there a difference between delegated staking and liquid staking?

In a DPoS (Delegated Proof-of-Stake) system, network participants can cast votes for the representative of their choice. On the other hand, liquid staking enables stakers to bypass the requirements of minimum staking amounts and locked tokens.

While Delegated Proof-of-Stake (DPoS) shares foundational principles with Proof-of-Stake (PoS), its operational mechanics differ significantly. In DPoS, network participants are granted the authority to elect representatives, referred to as “witnesses” or “block producers,” for the validation of transactions. The number of active witnesses in the consensus procedure is capped and can be modified through voting processes. Network users have the ability to combine their tokens into a collective staking pool and leverage their combined voting weight to cast ballots for their preferred representative.

As a researcher studying the intricacies of blockchain technology, I’ve come across an interesting concept called liquid staking. In contrast to traditional staking methods, this innovative approach is designed to make investing more accessible and bypass the mechanism of locked tokens.

What is staking-as-a-service?

A staking-as-a-service platform acts as an intermediary, bridging the gap between blockchain networks seeking participation in their consensus process and crypto investors eager to support the network’s operation.

As a crypto investor, I’m always on the lookout for ways to maximize my returns while minimizing the effort required. One such opportunity that has gained significant traction is staking-as-a-service. This service allows me to delegate my cryptocurrency assets to trusted third parties who then handle the staking process on my behalf. In return, I pay a fee or receive a share of the rewards. According to JP Morgan’s predictions, this sector is poised for massive growth, potentially reaching a staggering $40 billion market size by 2025. Crypto staking services will be a crucial component of the burgeoning digital economy, and liquid staking – which allows me to keep my assets in a more liquid form while still earning staking rewards – will be an essential part of this evolution.

As a researcher exploring the landscape of staking-as-a-service platforms, I have observed that these platforms can be classified into two primary categories: custodial and noncustodial. The degree of decentralization is a crucial factor in determining which category a platform falls into, significantly impacting stakeholders’ security and maintaining transparency.

In simpler terms, when you use a cryptocurrency exchange for staking, the exchange takes care of the entire staking process for you. This is known as “custodial staking-as-a-service.” However, it’s essential to note that the rewards from staking are initially held by the exchange before being distributed among the stakers.

As a crypto investor, when I engage in non-custodial staking using the service model, I understand that validators levy a fee for those wishing to take part in securing the network through staking. In Proof of Stake (PoS) networks that enable native delegation, I’m pleased to know that my earned rewards are automatically sent directly to me without any intervention from validators.

How liquid staking functions Liquid staking allows token holders to participate in the staking process without setting a minimum threshold, providing an opportunity to earn returns using their liquid tokens. Through the use of smart contracts, staking pools enable users to combine multiple smaller stakes into a larger single stake. In return, they receive equivalent liquid tokens representing their proportional ownership in the pool.The mechanism removes the barrier for individuals to become stakers. Through liquid staking, stakers can generate two sources of income. They accrue returns from the tokens they’ve staked, while also earning profits via liquid tokens through various financial transactions like trading, lending, or any other activity, without affecting their initial staked position.As a researcher studying liquid staking, I’d like to explore how Lido functions as a compelling example. Lido is a groundbreaking liquid staking platform designed for Proof of Stake (PoS) currencies, catering to several PoS blockchains such as Ethereum, Solana, Kusama, Polkadot, and Polygon. By utilizing Lido, we can bypass the challenges posed by conventional staking methods in these protocols. Specifically, Lido simplifies the process of staking and reduces the entry barriers and costs associated with locking up assets within a single blockchain network.Lido functions as a sophisticated staking pool powered by smart contracts. By depositing their assets with Lido, users partake in the staking process on the Lido blockchain through this protocol. Notably, ETH holders can stake smaller fractions than the typical minimum requirement of 32 ETH to secure rewards. Once funds are added to Lido’s staking pool smart contract, users receive Lido Staked ETH (stETH), an ERC-20 compatible token, which is generated upon deposit and depleted upon withdrawal.In the Lido network, the staking protocol allocates the deposited ETH to validators as rewards for their role in the Ethereum Beacon Chain validation process. This ETH gets transferred to the Etherean Beacon Chain for verification purposes. For security reasons, these funds are held in a secure smart contract that cannot be accessed by validators. The staked ETH is further divided into groups of 32 ETH and distributed among active node operators on the network.Using a public validation key, these operators verify transactions that involve users’ staked assets. By doing so, users’ staked assets can be spread among various validators, reducing the risk of issues arising from sole points of failure or reliance on a single validator for staking.Individuals who invest their Solana (SOL), Polygon (MATIC), Polkadot (DOT), and Kusama (KSM) tokens by interacting with specific smart contracts in Lido are rewarded with stSOL, stMATIC, stDOT, and stKSM equivalents. These newly acquired tokens can be utilized for various DeFi applications such as earning yield, supplying liquidity, trading on decentralized exchanges (DEXs), and more.

Are there any risks associated with liquid staking platforms?

When engaging with liquid staking in the crypto realm, it’s crucial to consider potential technical risks and market fluctuations.

Technical threats

As a crypto investor, I’ve noticed that Proof of Stake (PoS) blockchains are still in their infancy and come with their own set of risks. For instance, there’s always a chance that protocol bugs or vulnerabilities could surface, potentially leading to asset loss or exploitation for stakers like myself. Additionally, relying on validators for staking introduces counterparty risk – the risk that the validator may not act in good faith and could potentially mismanage funds or even disappear with the staked assets.

Market risks

Staking your liquids unleashes your secured assets, allowing you to gain income from Decentralized Finance platforms. Yet, this comes with a drawback: in a bear market, you could face losses on both your staked assets and any potential market declines.

Maintaining an openly-sourceable and continually audited liquid staking platform enhances security to some degree. Additionally, offering rewards through a bounty program can effectively reduce the occurrence of bugs within the platform.

As a responsible crypto investor, I recognize the importance of conducting thorough research before making any investment decisions. To minimize risks brought about by market volatility, I delve into historical market data for valuable insights. Furthermore, I evaluate the financial health of prospective investments by scrutinizing their balance sheets and income statements. I also take the time to familiarize myself with the regulatory landscape that governs each potential investment. Lastly, I diversify my portfolio by spreading my investments across various assets and sectors to mitigate risks associated with any one particular investment.