Liquid Staking: The Next Big Thing in Crypto?
It hasn’t been the best time for the crypto peeps for a long time now cause the market as was seen was decapitating slowly due to various reasons. But as they say not everything goes down at once so there was something that was growing exponentially during this time and as the Shanghai update is near there’s a new hype word around. Any Guesses? and Yes, that’s the Liquid Staking Market.
You must be having many questions in your mind like, What’s the hype around it? What are LSDs? Who are the Major Players? What does the shanghai Update have to do anything with it?
Well, don’t stress over it much I am here to take you through this journey answering questions from the basics to taking you to the future. Through this article, I will guide you and answer your questions about LSDs, So lets begin with the most basic question…
WHAT IS LIQUID STAKING?
Brushing of the basics, Staking tokens is a process where token holders agree to lock up their assets for a certain period of time to secure the network and earn rewards. However, traditional staking can be inflexible and may prevent token holders from using their assets for other purposes.
Now what liquid staking does is it solves the problem by allowing token holders to stake their assets while still being able to use them as they please. This provides token holders with the benefits of staking rewards and network security without having to give up control of their assets.
In simpler terms, liquid staking is a way for token holders to earn rewards and support the network while still having the flexibility to use their assets.
WHAT ARE LIQUID STAKING DERIVATIVES (LSDs)?
Liquid staking derivatives are a game-changer for those who want to stake their tokens but don’t want to be tied down. These derivatives provide a representation of a token holder’s staked assets, and they confirm the staker’s participation in the staking pool.
But here’s the really exciting part — these tokens can be used for lending, trading, and collateral in the world of decentralized finance (DeFi). This means that you can get the benefits of staking your tokens without having to give up the ability to use them in other ways. It’s a win-win situation that offers unprecedented flexibility and efficiency.
Derivatives may sound complicated, but they’re actually a pretty common concept in finance. Let me explain it to you in simple terms. They’re contracts between two entities that allow them to speculate on the future value of an underlying asset.
In the world of cryptocurrencies, derivatives can be used to contractually speculate on the future value of a cryptocurrency at a specific date. This presents an opportunity for potential profits if the value of the cryptocurrency changes. Liquid staking derivatives take this a step further by allowing participants to enjoy the benefits of staking their tokens while also being able to participate in derivatives trading.
This is made possible through tokenization, which simplifies the process and makes it more accessible. It’s an exciting development that offers even more potential rewards and opportunities in the world of cryptocurrency. Sounds interesting but still might be confusing to some, lets us understand it better further
HOW DOES LSD WORK?
As you all know that to “stake” your tokens, it means you’re putting them away for a while, usually to help make a blockchain network more secure but the downside as mentioned earlier is that you can’t use those tokens while they’re staked, which is inconvenient.
Liquid staking our problem solver lets you use your staked tokens in other parts of the DeFi (decentralized finance) world, while still earning rewards for staking them. This is done by tokenization.
So, instead of just sitting idle, your staked tokens can be put to use in other ways, and you can still earn rewards for helping to keep the network stable and secure. It’s an exciting development that could motivate more people to stake their tokens and get involved in the world of DeFi.
IS LSD AN ALTERNATIVE TO STAKING POST-MERGE?
LSD although a game changer but is it an alternative for staking on Ethereum post-merge? Maybe or Maybe not.
Let’s go back in time a bit here, Back in December 2020, Ethereum tested a new way of verifying transactions called “proof of stake” on its Beacon Chain. This required users to stake 32 ETH to become validators, but their staked assets would be locked for a period of time.
Fast forward to September 2022, and the entire Ethereum network successfully transitioned from the old “proof of work” protocol to the new “proof of stake” protocol. This meant that miners were replaced by validators staking their ETH tokens. However, users were unable to withdraw their staked tokens due to the lock-up period.
But fear not! The upcoming Ethereum Shanghai upgrade, set to launch in March 2023, will allow existing stakers to withdraw their locked tokens. This is great news for Ethereum users, as it will provide them with greater flexibility and control over their assets.
While the ability to withdraw staked ETH is a tempting prospect for new stakers, not everyone has the means to stake the required 32 ETH. However, staking has proven to be a viable way to earn passive income, so users are looking for alternative options that do not compromise their liquidity. This has led to the emergence of liquid staking protocols that allow users to stake smaller amounts of ETH while still retaining liquidity.
One of the most popular liquid staking protocols is Rocket Pool. It enables ETH holders to stake as little as 0.01 ETH in exchange for ERC-20-compliant liquid staking derivatives that are backed one-to-one. This means that users can enter or exit the market at any time, and since the tokens are derivatives, investors gain access to additional markets. Liquid staking protocols provide a lower barrier to entry for more ETH holders to stake their tokens, contributing to the enhanced security and stability of the Ethereum network while retaining the flexibility to manage their assets.
LET US LOOK AT THE PROS AND CONS
Before starting with the pros and cons of LSD, you need to be aware of its potential impact on your finances. While liquid staking derivatives have advantages, they also have some downsides that must be carefully considered. Like other aspects of cryptocurrency, it’s important to weigh the pros and cons before diving in. By taking the time to understand how liquid staking works, investors can make informed decisions about whether or not it’s the right approach for them.
PROS
ENCOURAGES STAKING
Staking your cryptocurrency can help make the network more secure and stable while also earning you rewards. Liquid staking derivatives offer the solution to the problem of locked tokens by providing liquidity to staked tokens. This means that token holders can continue to trade or use their tokens even while they are being staked. As a result, more people may be willing to contribute to the network through liquid staking, which ultimately benefits everyone involved.
ACCESS TO ASSETS
Instead of being unable to use their tokens while they are staked, you receive liquid staking derivatives that you can still use as collateral in decentralized finance yield farming protocols. This means that you can earn passive income through staking rewards while still having access to your liquid assets. In contrast to traditional staking, liquid staking solutions offer a more flexible and versatile approach to earning rewards.
CONS
SLASHING
One major concern is the possibility of “slashing,” which can result in a financial loss for node operators on a proof-of-stake (PoS) network. This mechanism is put in place to prevent validators from misbehaving and to ensure the security and stability of the network. Misbehavior can include actions like double signing or downtime. If a validator’s misbehavior is detected, even if it was not intentional, they may lose a portion of their staked tokens. Therefore, investors need to consider the risks before deciding to participate in liquid staking protocols.
LOWER YIELD
Staking your cryptocurrency tokens like ETH can help support the network while earning rewards for doing so. With liquid staking, you can withdraw and trade your tokens at any time, but the rewards may be lower due to the flexibility it provides. However, this flexibility can also allow you to use your staked tokens as collateral for other investments, potentially leading to other profitable opportunities.
POOR SMART CONTRACTS
Another major con for the Liquid staking derivatives is that if the smart contracts that handle these derivatives have some or any type of loophole or bug in them that the hackers can bypass or exploit then all the amount that is staked on those contracts as well as the derivatives could get lost permanently
THE FUTURE OF LSD
With the launch of Ethereum 2.0, the network is undergoing a significant shift towards a Proof of Stake consensus mechanism. This change has brought about a new opportunity for liquid staking derivatives (LSDs) to thrive, with the potential to transform the staking landscape on Ethereum.
LSDs allow users to stake their ETH while still being able to utilize their staked assets in other decentralized finance (DeFi) protocols. This provides greater capital efficiency and the potential for higher yields. However, until recently, there has been a lack of competition in the LSD market, with few established protocols providing this service.
But with the upcoming Shanghai upgrade to Ethereum, the competitive landscape for LSDs is set to shift. With increased capacity for staking, users will have greater choice in selecting their validators, providing them with greater security and flexibility.
This shift will also see a rise in new LSD protocols, providing enhanced features such as permissionless validation, slashing protection, and tax efficiency. These new protocols will enable a wider range of users to participate in staking, even those with lower capital requirements, and offer increased customizability for institutional investors.
The growth of LSDs also brings a new opportunity for the broader DeFi ecosystem. As more users participate in staking, liquidity will be directed towards LSDs, creating greater liquidity in DeFi protocols that utilize LSDs. This increased liquidity will provide more opportunity for yield farming, liquidity provision, and other DeFi strategies, making the overall ecosystem more robust and efficient.
In addition, LSDs provide a new avenue for investors to gain exposure to ETH without the risk of holding the underlying asset. As more institutional investors enter the market, the use of LSDs as a way to gain exposure to ETH without holding the asset outright is likely to increase.
Overall, the future of LSDs on Ethereum is bright, with the potential for increased competition and enhanced features. As more users participate in staking, the broader DeFi ecosystem will benefit, providing new opportunities for investors and the potential for greater efficiency and innovation in the space.
THE COMPETITORS
Well, it looks like the liquid staking game is heating up, and it’s not just about who can offer the highest yield anymore! No, no, no, in this new era of maturity, it’s all about product design!
So, what makes a successful liquid staking protocol? Well, let me tell you, it’s all about those features, baby! You’ve got your validator choice for stakers, permissionless validation, slashing protection, capital, and tax efficiency, and who knows what else they’ll come up with next!
But fear not, my friends, because there are some non-custodial protocols out there that are ready to compete in this new, cut-throat world of product design. Who will come out on top? Only time will tell, but you can bet it’s going to be a wild ride! Let’s look at some of the competitors to the major player out there.
LIDO
Lido is currently the largest provider of liquid staking services, with over $12 billion in staked ETH. The protocol’s design is simple, with users depositing ETH to receive a tokenized representation of their stake. The staking process is handled by Lido’s validators, with users earning a yield on their staked tokens in return.
Lido being a rapidly growing player in the world of liquid staking derivatives offers users a way to earn a yield on their staked ETH without sacrificing the liquidity of their assets. With the recent news that Ethereum’s move to proof-of-stake which occured in the first quarter of 2023, Lido benefitted from the increased demand for liquid staking solutions.
One of the key features of Lido’s protocol is its use of a decentralized network of validators, ensuring the security and decentralization of the network. This also allows for more efficient capital allocation, with staked ETH being used as collateral to generate additional yield in DeFi protocols.
Another important aspect of Lido’s offering is its accessibility, with users able to stake any amount of ETH, regardless of whether they hold a full 32 ETH required for solo staking. This democratizes the staking process, allowing anyone to participate and benefit from the security and yield of staking on the Ethereum network.
With a growing market share and a commitment to decentralization and accessibility, Lido is well-positioned to continue its impressive growth trajectory in the world of liquid staking derivatives. As Ethereum moves closer to the update and the demand for liquid staking solutions increases, Lido is likely to play an even more important role in the DeFi ecosystem, offering users a reliable and efficient way to participate in the staking process while retaining the liquidity of their assets.
Capital Efficiency
One of Lido’s biggest advantages is its capital efficiency. Unlike other protocols that require users to provide collateral for validation, Lido’s validators are fully collateralized by staked ETH. This allows users to maximize their returns by minimizing their capital requirements.
Decentralization
Despite its large size, Lido maintains a strong emphasis on decentralization. Any user can become a validator by staking 32 ETH and going through a verification process. This ensures that the protocol is secure and permissionless, and provides protection against centralized control.
ROCKET POOL
Rocket Pool is blasting off as one of the leading providers of liquid staking services in the crypto space. Its mission? To decentralize staking and make it more accessible to the masses.
One of Rocket Pool’s rocket-fueled features is its permissionless validation, which allows any node operator to participate in network validation. To unlock this feature, validators need to post 16 ETH collateral and an RPL bond worth at least 1.6 ETH. This creates a built-in slashing protection mechanism that keeps users’ investments safe from the hazards of staking.
But that’s not all! Rocket Pool’s rETH takes a unique approach to reflecting staking rewards by appreciating in value, making it more tax-efficient than other protocols. This approach avoids a launchpad full of taxable events, providing investors with a more attractive option.
However, Rocket Pool does have its weak spot. Its high collateral requirements can be a significant barrier to entry for validators. But fear not, for the upcoming LEB8 proposal aims to reduce this requirement to 8 ETH. Still, it remains to be seen if this will be enough to attract new validators as it scales.
Despite this challenge, Rocket Pool has had an impressive lift-off, capturing a significant share of both total and liquid staking deposits. As it continues to improve and expand its user base, it’s likely to remain a star player in the rapidly growing liquid staking market. So buckle up and get ready to ride the Rocket Pool to the moon!
Tax Efficiency
Rocket Pool’s rETH is designed to reflect staking rewards by appreciating in value, making it more tax-efficient than other protocols. This feature avoids the creation of numerous taxable events, which is attractive for investors looking to minimize their tax liability.
Capital Inefficiency
One of the biggest weaknesses of Rocket Pool is its capital inefficiency. The high collateral requirements for validators make it difficult for new users to participate in the network. However, the upcoming LEB8 proposal aims to reduce this requirement to 8 ETH, which could make it more accessible to a wider user base.
STAKEWISE
StakeWise is bringing its A-game with the upcoming launch of its V3 protocol, which promises to disrupt the staking world order. While its incumbent two-token model was impressive, the modular architecture of V3 takes things up a notch, giving users the power to stake into segregated vaults and select their preferred validator. After all, Lido, Coinbase, and Rocket Pool, there’s a new player in town.
The ability to isolate slashing risks to a single vault gives users greater peace of mind, and the additional slashing protection through over-collateralization means they can mint osETH, the LSD of the protocol, against only a fraction of their stake. That’s some serious protection, and it shows that StakeWise knows how to keep its users safe while still giving them the flexibility and freedom they need.
Of course, launching a brand new protocol is no easy feat, and StakeWise V3 does carry some execution risk. But hey, no pain no gain, right? And if V3 takes off like we think it will, it will make Lido look like a relic from a bygone era.
But let’s be real for a minute. While V3 does offer some exciting new features, it also adds some complexity for end-users. Those who choose to liquify their stake will need to keep a close eye on their collateralization ratio to avoid liquidation. It’s not for the faint of heart, but for those who are up for the challenge, StakeWise V3 is the perfect playground.
Slashing Protection
StakeWise V3 provides enhanced slashing protection through overcollateralization, where users can only mint osETH, the protocol’s liquid staking derivative, against a fraction of their stake. This feature allows validators to join the network with low capital requirements, while providing greater isolation of slashing risk.
Execution Risk
Despite its promising features, StakeWise V3 faces significant execution risk, as it is launching what is essentially a brand new protocol. The added complexity for end-users, who will have to manage their collateralization ratio to avoid liquidation, could also make it less accessible to some users.
FRAX FINANCE
Frax, the stablecoin issuer, has made a bold move into the liquid staking space with its latest offering, Frax ETH. And it’s not just growing, it’s growing like a lush, green forest! With 44,707 ETH deposits and a 0.7% share of the LSD market, Frax ETH is quickly making a name for itself.
The protocol uses a clever design similar to that of StakeWise V2, allowing stakers to earn rewards while retaining their original ETH deposit. This approach not only offers greater capital efficiency but also allows stakers to explore multiple assets within the DeFi ecosystem to maximize yield.
Despite its impressive growth, Frax ETH still faces several hurdles that could impact its long-term success. One major challenge is the inefficiency of the two-token model, which can increase incentive costs and fragment liquidity. Furthermore, the current centralized nature of the protocol, with validators solely run by the Frax team, could deter some users.
Nevertheless, Frax ETH has a significant amount of CVX at its disposal, which should help attract liquidity on Curve, and the team is committed to making the protocol more decentralized over time. So watch this space, because Frax ETH is definitely a project to keep an eye on!
- TVL (total value locked) as of February 18, 2023: $5.8 billion
- Frax (FX) price as of February 18, 2023: $1.00
- Circulating supply of Frax (FX) as of February 18, 2023: 302.4 million FX
- Frax (FX) market cap as of February 18, 2023: $302.4 million
- Frax ETH TVL as of February 18, 2023: $565.8 million
COINBASE
Coinbase, a major player in the cryptocurrency space, has entered the liquid staking market with its Coinbase Staking program. The program offers users the ability to stake their ETH and earn rewards in the form of staked ETH (stETH).
Coinbase Staking has quickly gained significant traction in the market, due in part to its reputation as a trusted and secure platform. Its user-friendly interface and seamless integration with other Coinbase products have also made it an attractive option for retail investors.
In addition, Coinbase Staking’s innovative design allows users to trade their stETH on the open market, providing greater liquidity and flexibility than traditional staking protocols. This has led to explosive growth, with Coinbase Staking capturing a significant share of the total and liquid staking market.
However, the program does have some weaknesses. Coinbase Staking's high minimum deposit requirements may make it difficult for smaller investors to participate, and its centralized validation model raises concerns about security and censorship.
Despite these concerns, Coinbase Staking's impressive growth and strong market position make it a key player in the rapidly expanding liquid staking market.
- TVL (total value locked) in Coinbase's staking pools as of February 18, 2023: $27.8 billion
- Number of cryptocurrencies supported by Coinbase staking as of February 18, 2023: 20
- Annual percentage yield (APY) for staking Ethereum on Coinbase as of February 18, 2023: 5%
- Annual percentage yield (APY) for staking Solana on Coinbase as of February 18, 2023: 8%
- Annual percentage yield (APY) for staking Polkadot on Coinbase as of February 18, 2023: 12%
CONCLUSION
Liquid Staking Derivatives are here to stay for a long time now, especially as the Shanghai update comes closer as this will open a window to more people as the fear factor gets reduced. And as for the competitors there is and always will be competition in every field, it's up to us to choose our poison. So the best option before going into such things is to Do your Own Research (DYOR).
