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Liquid staking: The DeFi upgrade

Decentralized finance (DeFi) ushered in a new era in the history of crypto assets. Unlike traditional finance, it eliminates the need for centralized intermediaries, has the ability to decrease the barrier to entry into financial markets, and allows for the smooth movement of assets.

However, DeFi is notorious for staking rewards that can lock up crypto assets for an extended period of time, limiting gains opportunities. Enter Liquid Staking, which opens up the possibility of highly liquid and interoperable financial services.

Looking at the expansion of DeFi, it is clear that this new, open financial sector is exploding. According to DeFi Pulse, the locked value of DeFi platforms has reached $100 billion in 2022. However, numbers alone do not do credit for the incredible innovation that the DeFi industry has generated in such a short time since its beginnings.

Despite this stellar track record, crypto-staking smart contracts have several serious flaws when it comes to DeFi utilization. When attempting to develop the DeFi economy, they have a specific influence on liquidity investors.

The inability to produce any interest on staked assets is one such problem. As a result, DeFi Markets have introduced liquid staking.

What exactly is Liquid Staking?

Staking in PoS protocol-based projects has traditionally aimed to lock one’s assets in a single network for an extended period of time in exchange for a fixed, predefined staking income. While it, like a bond, guarantees the investment return on staked assets, it also restricts token owners’ ability to generate greater returns on those assets via the DeFi ecosystem.

What Makes It Unique From Regular Staking?

If you’ve staked all your cryptocurrency holdings, you’re in a liquidity crisis and can’t invest or trade-in more lucrative crypto pairings on exchanges.

This system operates by tokenizing stakes, allowing token holders to utilize them as collateral in other financial applications. Tokenized stakes, also known as staking derivatives, function similarly to derivatives in that they may be freely traded across individuals, locations, and blockchains. As the name suggests, it lets you use your staked crypto assets in various available trading or investment opportunities to get the best of both worlds: the reward you expect on your staked assets and the APR, profits from new trading/investing opportunities that you find.

That is the basis behind the current surge in popularity of Liquid Staking. Several new initiatives with liquid staking are emerging in the DeFi ecosystem, and crypto token holders also want to make more on their stakes. Here, we’ll look at one such initiative that has recently gained much attention.

What does it have to do with DeFi?

DeFi is an innovation that enables you to keep your crypto assets while still profiting from their liquidity. Whether to earn interest, borrow money, or farm output. This is in stark contrast to conventional finance, in which once you have invested in a stock or other investment vehicle, you can only profit when the asset’s price increases or decreases. Liquid staking is basically an extension of that idea, with the fundamental justification being that idle assets should be able to be utilized as collateral in other financial applications.

As a result, it expands investment opportunities and, therefore, the link to DeFi. For instance, you might take the majority of the assets that are staked on a blockchain, tokenize their positions as staked, and then integrate them into other protocols. Staking investors may use this to limit risk exposure and earn extra profits on staked crypto assets.

It also enables Tokens to travel freely between users as tokenized assets, from various locations, or even on separate chains. A DAO may handle jointly tokenized stakes (decentralized autonomous organization) when everything is said and done. The rights associated with tokenized stakes might be split and held by distinct organizations that have been gathered together for a particular reason.

This asset flexibility is a crucial element of DeFi, and it has been shown to lead to increased innovation in the Ethereum ecosystem. MakerDAO, for example, offers DAI currencies that can be borrowed and loaned via the Compound protocol. This development in DeFi has given birth to new reasons for investing as well as new strategies for doing so. Essentially, it automates interactions between the two protocols, which results in token holders engaging in such transactions experiencing both increased profits and decreased risks. To summarize, tokenizing staking gives token holders more choice in controlling their crypto tokens and accelerates DeFi innovation.

What Are the Difficulties?

In principle, liquid staking is another kind of derivative that might help investors gain liquidity quickly. However, such derivatives that are staked are not necessarily fungible, and the state of the underlying risk is not taken into consideration. In reality, we consider speculation, appreciation, network adoption, and dependability while evaluating a staking derivative. Is it, as a result, difficult to price and adequately account for the risks presented by such disparities and correlations. Because it is far more involved than a simple sum, it won’t be easy to aggregate them effectively.

A validator might theoretically short its own derivative coin and benefit from price drops. Also, a validator entity might benefit from this drop when borrowing large quantities since it can pay back the borrowed tokens at a reduced price.

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Renato Zamagna

Renato Zamagna


Finance, Blockchain, Cryptocurrency, and Data Security researcher, writer, and educator.