Liquid Staking: High Level Overview

Published in

Conflux Network

10 min readNov 23, 2022

Author: Jhony

Staking. An act that has become increasingly popular and well-known even within individuals that are not familiar with the cryptocurrency industry. By locking up your cryptocurrency assets for a fixed or variable period, users are able to earn a passive income for staking and support the security of the blockchain network. However, long lock-up periods act as an important barrier of entry and reduces on-chain liquidity.

Similar to staking, liquid staking is the act of depositing your tokens for a passive income, but without losing access to your staked funds. In comparison to traditional staking methods, liquid staking drastically improves capital efficiency by increasing on-chain liquidity, as well as being more friendly for dApp users since it doesn’t require hardware.

Taking Staking to the Next Level

In September 2022, the Ethereum blockchain officially completed its transition towards the Proof-of-Stake (PoS) consensus mechanism. Validators need to stake ETH (minimum 32 ETH) on the Beacon Chain to be able to earn passive income through staking rewards. The main limitation that arises from the above operation is the immovability of staked funds, the 32 ETH (minimum) cannot be simply unstaked which drastically reduces capital efficiency because the asset is illiquid.

In this sense, liquid staking is at the forefront of the staking realm within the cryptocurrency economy. Not only it provides the foundations for DeFi activities such as lending and borrowing protocols, but also allows access to staked funds. The underlying mechanism is simple and straightforward (using Lido and Ethereum as an example):

User deposits (stakes) 2 ETH tokens on Lido.
User receives 2 stETH (Lido Staked ETH) tokens that represents their staked tokens on a 1:1 basis
User can now use the staking derivative (stETH) for other uses: trade, stake, other uses on DeFi applications…

Existing Liquid Staking Solutions

Lido is the leading liquid staking solution — providing a simple and secure way to earn interest on digital assets. By staking with Lido, user assets remain liquid (without locking assets or maintaining infrastructure) and can be used across a range of DeFi applications, earning extra yield whilst participating in on-chain activities such as lending.

When staking with Lido, users receive stETH tokens which are issued 1:1 to their initial stake. stETH is a token that represents staked ether in Lido, combining the value of initial deposit + staking rewards — penalties. stETH tokens are minted upon deposit and burned when redeemed. stETH token balances are updated when the oracle reports changes in total stake every day. These tokens can be used as one would use ETH, allowing users to earn ETH staking rewards whilst benefiting from, among other things, rewards across decentralised finance products.

Note that there are no lockups or minimum deposits when staking with Lido. When using Lido, users receive staking rewards in real-time and they also could use staked tokens across the DeFi ecosystem to compound rewards. When staking with Lido, users stake across many validators, which minimises staking risk, and smart contracts are audited by Sigma Prime, ChainSecurity, MixBytes, Oxorio and State Mind.

More information on Lido Audits: https://github.com/lidofinance/audits

LDO is an Ethereum token granting governance rights in the Lido DAO. The Lido DAO governs a set of liquid staking protocols, decides on key parameters (e.g., fees) and executes protocol upgrades to ensure efficiency and stability. By holding the LDO token, one is granted voting rights within the Lido DAO. The more LDO locked in a user’s voting contract, the greater the decision-making power the voter gets. For more information on the underlying mechanism, please refer to Lido Documentation.

Rocket Pool

Rocket Pool is a first of its kind ETH2 Proof of Stake Protocol, designed to be community owned, decentralised, trustless, and compatible with staking in Ethereum 2.0. It was first conceived in late 2016 and has since had over 5 successful public betas over the life span of ETH2 development. Its innovative liquid staking token accrues while using an increasing exchange rate, rather than rebasing which is better for DeFi and better for tax reporting.

Rocket Pool is designed to cater to two main user groups; those that wish to participate in tokenised staking using rETH using as little as 0.01 ETH and those that wish to stake ETH and run a node in the network to help generate a higher ROI than staking outside of the protocol due to commissions earned.

Nucleon

Nucleon is a liquid staking solution for Conflux PoS backed by industry-leading staking providers. Nucleon lets users stake their CFX - without locking assets or maintaining infrastructure. The goal is to solve the problems associated with Conflux PoS staking — illiquidity, immovability, and accessibility — making staked CFX liquid and allowing for participation with any amount of CFX to improve the security of the Conflux network.

When staking with Nucleon, users receive xCFX tokens on a 1:1 basis representing their staked CFX. xCFX balances can be used like regular CFX to earn yields and lending rewards, and are updated on a daily basis to reflect your CFX staking rewards. Note that there are no lock-ups when staking with Nucleon and have minimum deposits of 1 CFX to decrease DDoS risks. When using Nucleon, staking rewards will be compound in real-time, allowing for participation in the securing of Conflux without the associated risks and downside potential.

Nucleon operates on Conflux eSpace, an EVM-compatible smart contract execution environment that allows developers to deploy and execute Ethereum-native DApps and smart contracts within the Conflux ecosystem. By deploying on Conflux — a permissionless PoW/PoS hybrid Layer 1 public chain that is capable of processing 3000–6000 TPS without sacrificing decentralisation or security and with significantly lower transaction costs compared to other chains (such as Ethereum or Bitcoin), it makes Nucleon an ideal DeFi staking platform.

Fees

Nucleon applies zero staking fees and a 10% fee on a user’s staking rewards, which will be split between node service providers, the DAO, and a coverage fund. Besides, user can enjoy low gas fees as Nucleon runs on Conflux eSpace, a blockchain with much lower transaction costs than Ethereum or Bitcoin. Nucleon is also totally decentralised, allowing users to trade directly from their wallet of choice and retain 100% ownership of their own crypto.

Architecture

Nucleon has a two token model, which includes xCFX, and NUT. CFX is a unit of value on Conflux that enables token holders to pay transaction fees, earn rewards through staking, rent storage, and participate in network governance. xCFX is the interest-bearing ERC-20 token that represents CFX staked into Nucleon’s PoS pool, and its interest accrued in CFX over time. There is only one type of xCFX, with an uncapped supply determined algorithmically, and will be tradable.

Nucleon tokens are minted upon deposit and burned when redeemed. xCFX token balances are pegged 1:1 to the CFX that are staked by Nucleon. The balance and total amount of xCFX tokens are updated by the smart contract. xCFX tokens can be used as one would use CFX, allowing you to earn Conflux PoS staking rewards whilst benefiting from, e.g., Swappi, across decentralised finance products. To convert xCFX to CFX, there is a 2 days or 15 days delay in withdrawing CFX directly from xCFX. xCFX holders can also exchange their xCFX to CFX in liquidity pools such as Swappi with no delay.

When users stake CFX for xCFX after the project is live and PoS interest has been obtained, the protocol will automatically query the total CFX quantity (staked CFX and interest earned CFX) to determine the value of CFX to xCFX, thus, how much CFX the user needs to stake to obtain 1 xCFX. Beyond earning interest, xCFX will develop use cases across Conflux eSpace ecosystem including:

Swappi: Leading decentralised exchange on Conflux eSpace with features such as Swap, LPs, and Farming.
Goledo Finance: DeFi Lending and Borrowing protocol.

At network launch, xCFX is pegged 1:1 with CFX, but moving forward, each xCFX will include the basic value of staked CFX plus the interest accrued from Conflux’s PoS mechanism through xCFX’s pricing mechanism. After a user mints xCFX, via staking CFX into Nucleon’s PoS Pool, the amount of xCFX will never change, but will increase in value, as the CFX interest earned via PoS is mapped into xCFX over time via an automatic compounding process.

NUT is Nucleon’s governance token, which can be staked to vote and boost staking interest rewards. The token will be used to vote on proposals deciding the use of protocol treasury funds, boost staking returns and distributed over 4 years. The Nucleon DAO governs a set of liquid staking protocols, decides on key parameters (e.g., fees) and executes protocol upgrades to ensure efficiency and stability. Governance tokens are exciting, join Nucleon to learn more once more information is available.

Security

There exist a number of potential risks when staking CFX using liquid staking protocols, and Nucleon has implemented a plethora of solutions:

Smart contract security: The Nucleon code is open-sourced, continuously reviewed, covered by an extensive bug bounty program and the audit by Hacken is in progress to minimise this risk. In addition, there is no oracle used, all information comes from the blockchain.

Conflux PoS network — Technical risk: Nucleon is built on Conflux and there is no guarantee that Conflux PoS network has been developed error-free. Any vulnerabilities inherent to Conflux PoS network brings with it slashing risk, as well as xCFX fluctuation risk.

Risks and Rewards

The aforementioned benefits of liquid staking such as increased on-chain liquidity may be counterbalanced by the risks that this type of operation poses. There exists a number of potential risks when staking ETH (or any other token) using liquid staking protocols:

Smart contract risk: There is an inherent risk that the staking platform could contain a smart contract vulnerability or bug.
Centralisation: If a protocol is able to accumulate a large amount of governance tokens, they could centralise governance ownership and take control of the entire blockchain by forming a monopoly. This cartelisation problem has been exacerbated by the recent collapse of the cryptocurrency exchange FTX, which has underscored the importance of decentralisation. Another example is Lido, the largest liquid staking protocol on the Ethereum network, its community members rejected in May 2022 to self-limit their growth.

Technical risk: In the case of ETH and stETH, there is no guarantee that ETH has been developed error-free. Any vulnerabilities inherent to ETH brings with it slashing risk, as well as stETH fluctuation risk.
Adoption risk: In the case of ETH and stETH, the value of stETH is built around the staking rewards associated with the Ethereum Beacon Chain. If ETH fails to reach required levels of adoption, we could experience significant fluctuations in the value of ETH and stETH.

DAO key management risk: In the case of Lido, a portion of the ETH staked via the Lido DAO is held across multiple accounts backed by a multi-signature threshold scheme to minimise custody risk. If signatories across a certain threshold lose their key shares, get hacked or go rogue, there’s a risk of this portion of funds becoming locked. For more information on this topic, please refer to the Lido DAO.
Slashing risk: In the case of ETH, ETH validators risk staking penalties, with up to 100% of staked funds at risk if validators fail.
Price risk: In the case of stETH, users risk an exchange price of stETH which is lower than inherent value due to withdrawal restrictions on Lido, making arbitrage and market-making impossible. As a result, it could result in depegging, which occurred in the Terra ecosystem where the UST/TerraUSD stablecoin failed to maintain its 1:1 peg to the US Dollar and its sister token LUNA also imploded.

Closing Thoughts

Liquid staking has arrived to completely revolutionise the cryptocurrency economy; its ease of use along with the increase in on-chain liquidity allows for additional investment opportunities and the growth of the entire DeFi ecosystem.

The Terra LUNA crash along with the FTX catastrophe have severely weakened confidence in the cryptocurrency realm and risks triggering an industry-wide downturn. Hence, it is paramount that protocols such as Nucleon flourish, as they increase capital-efficiency in times where the industry is in dire need of stability.