Analyzing Liquid Staking: The Perfect Combination of Staking and DeFi

Original title: "Should I Stake Or Should I Go? An Overview of Liquid Staking"

Original author: Cristiano Ventricelli, Messari

Original compilation: Overnight porridge, the way of the metaverse

Ethereum from PoW (Proof of Work) to PoS (Proof of Rights and Interests) is not only advertised as a game of Ethereum span> game changer, which also affects the entire crypto money space (for some time, the crypto industry has been being pushed away from the PoW consensus mechanism). According to analysts at JPMorgan Chase, by 2025, the annual revenue of the Staking industry will grow to $40 billion. Since staked tokens are held in an escrow account, increased staking will result in fewer tokens circulating in DeFi protocols. While this may have beneficial effects on protocol security, it is Investors introduce trade-offs between deciding to stake versus pursuing yield farming strategies (e.g. liquidity mining, borrowing, etc.). The emergence of liquid staking aims to provide a solution that offers the best of both worlds.

1. What is Liquid Staking?

As the name suggests, liquid staking refers to the process in which users obtain liquidity by staking their assets. The process begins with investors pledging tokens (i.e. ETH) Into an agreement, and the agreement represents the investor to pledge, and then mint the claiming right asset of the mortgage asset for the investor 1:1, and then the staking reward belongs to the liquid staking token, which is similar to the LP token of the decentralized exchange. Condition. These liquid staking tokens can be exchanged or used as collateral to borrow assets and, in fact, unlock additional revenue streams beyond staking rewards. Liquid staking tokens can be redeemed instantly, allowing investors to get back their original tokens without waiting for an unlock period. When staking tokens to mint liquid staking tokens, investors can choose a validator from those provided by the protocol being used.

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2. Market size and expected growth rate

Currently, the market size of liquid staking protocols is $10.5 billion, with a penetration rate of ( Penetration rate: staked tokens in the liquid staking protocol divided by the total value staked in the market) is about 7%. If that number seems small (and it is), the growth rate looks a little more interesting.

Assume that by 2025, staking annual rewards will reach 40 billion US dollars, and the average staking rate of return will be between 5% and 10%. This means that the total staked token market cap will be between $400-800 billion. The current market cap of all staked tokens is about $146 billion, while the total value currently locked in DeFi is $186 billion (data as of September 15th). It’s clear that liquid staking could see a wave of considerable market growth as crypto networks like Ethereum make a massive shift to Proof-of-Stake (PoS) consensus mechanisms.

The growth rate depends not only on the total value of the stake, but also on the penetration rate. The table below shows that even assuming no increase in penetration, the annual growth rate for 2021-2025 could be in the range of 17%-40%.

It is worth mentioning that as the total value of staking increases, the staking rewards per token decrease because the same The rate of inflation will necessarily involve allocating more tokens.

Thus, low staking reward rates may imply higher liquid staking penetration. In fact, if stakers receive an x% reduction in staking rewards, they will be more likely to find alternative yields to offset this x% reduction in yield without having to unstake their funds.

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3. Market composition

Currently the leading project in the Staking protocol market is Lido Finance, which accounts for more than 60% of the total liquid staking protocol market value. Since the beginning of 2021, Lido Finance has collected 17% of all ETH staked in Ethereum, and it also contributes to Terra, Solana provides liquid staking solutions, and there are many blockchains that are preparing to be connected to Lido.

Liquid staking tokens backed by ETH account for It should come as no surprise that two-thirds of the total token supply. Among other public chains, it is worth mentioning that Polkadt’s mobile staking will be controlled by < span class="alertFont">Acala (a DeFi protocol based on Substrate), and Cosmos by Persistence.

When it comes to DeFi partners, the rule of thumb is pretty simple: bigger is better.

Lido Finance is no exception, it can rely on < span class="font">Curve, Yearn, Harvest span> Project parties such as Finance and Gnosis distribute their liquid staking tokens. The largest liquidity pool of liquid collateral ETH (stETH tokens) minted by Lido Finance paired with ETH is hosted by Curve, with $4.2 billion currently deposited in the pool.

4. Flow staking Benefits

Liquid Staking brings a wide range of benefits to all stakeholders, including:

1. Improve capital efficiency: Tokens locked in escrow accounts can be used as collateral to expand revenue opportunities;

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2. Improve the security of the chain: There is no trade-off between staking and income, and there is almost no reason not to pledge tokens. In the medium to long term, this will improve the security and stability of PoS blockchains.

3. Increase liquidity: For some PoS protocols whose pledge tokens account for a higher total supply, trade may be relatively illiquid and thus may have adverse effects in terms of price discovery. And liquid staking tokens allow investors to increase the transaction volume of the protocol, which improves efficiency without sacrificing network security.

4, Cross-chain interaction: Liquid staking tokens are basically derivative contracts, so they can theoretically be chain-agnostic and circulate between different protocols.

5. Ease of use: Liquid staking tokens allow investors to participate in staking, but it does not have to involve re-staking, unstaking period, Complex operations such as reward withdrawal and delegation.

5. The risk of liquid staking

At present , Liquid staking has two layers of risk, the most obvious of which is financial risk, the other is governance risk, and the latter is the most easily overlooked risk factor.

Financial risk:

1. Liquidity risk: Immediate redemption of liquid staking tokens means that the protocol must retain a certain amount of idle tokens to satisfy early withdrawal requests. In the event of a sudden market shock, a “bank run” could occur and leave some protocols in potential liquidity distress.

2. Systemic risk: Since liquid staking tokens can be used in multiple chains, the failure of one chain may affect the Liquid staking tokens from other protocols create negative spillover effects, leading to potential systemic issues.

Governance Risk:

1. Staking centralization risk: Liquid tokens require a certain level of trading/lending activity to deploy their earning potential. Therefore, the number of liquid staking protocols will likely be limited in order to collect as much liquidity as possible to maintain the liquid tokens they issue. Since these platforms are responsible for delegating tokens to validators, the excessive centralization of liquid staking issuance can lead to centralization of staking.

2. Risk of slashing: If validators experience downtime or double signatures, their staking rewards will be slashed, and delegated Coin investors will also suffer losses. This will result in liquid tokens being backed by fewer underlying tokens than the initial tokens, which is potentially risky in the event of a liquid token redemption.

3. Misconduct by validators: In theory, validators can “short” their liquid staking tokens and Profit from malicious actions that cause the value of their liquid staking tokens to drop.

6. Conclusion

At the same time let your token Having two (or more) different places working for you seems too good to be true, however, from an ecosystem perspective, this is one of the key challenges that DeFi must overcome. And from a capital efficiency standpoint, liquid staking introduces a higher level of flexibility. This flexibility is compromised whenever agents (stakers, validators, protocols, etc.) find conditions that can exploit it with impunity. One pitfall that a proper incentive system must address is the concentration of power resulting from liquid staking. The overriding message from the cryptocurrency market leaders is that now is the time to collaborate, not compete. Liquid staking could be the perfect tool to bring the staking and DeFi industries together.

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