Liquid staking tokens were firstly introduced by Lido Finance in December 2020 when Lido offered staked-Ether (stETH) for staked Ethereum. These tokens pegged 1:1 with the staked token and can be used in the DeFI ecosystem with DApps. Let’s see why are they important and how they work.
Understanding Liquid Staking Tokens (LSTs)
Liquid Staking Tokens (LSTs) represents a fusion of liquidity and staking mechanisms in the crypto sector. LSTs allow users to stake their tokens on a blockchain that uses proof-of-stake consensus mechanism, and receive a token in return. This new token symbolizes the original staked token but with added liquidity benefits.
The Role of LSTs in Crypto and DeFi
Staking is a concept in PoS blockchains, where users can “lock” their tokens to support network security and utility. Staked assets are illiquid, so it cannot be traded or used until unstaked. LSTs solve this by allow users to maintain liquidity even while their assets are staked.
In simple terms, when you stake, for example, ETH (Ethereum), through a liquid staking protocol, you receive a corresponding LST, like stETH in Lido’s case. This LST can then be used in other DeFi applications.
Liquid Staking Protocols (LSP)
These protocols are systems that enable the creation and functioning of Liquid Staking Tokens (LSTs). They works as the bridge between the traditional staking mechanisms on blockchains and the innovative concept of liquidity in staking.
How Liquid Staking Protocols Work
They uses smart contracts to automate the staking process, minting of LSTs, and distribution of staking rewards. Smart contracts are predefined auto executed contracts.
In the process as we discussed before, a user stakes a native token of a blockchain (like ETH for Ethereum or SOL for Solana) via the protocol. The protocol then mints an equivalent amount of LSTs. This process is minted and governed by predefined rules set in the smart contract.
Key Features of Liquid Staking Protocols
These protocols focus on decentralization, making sure that no single entity has complete control over the staking process. This feature is compatible with the broader ecosystem of blockchain and DeFi.
As they handle users’ assets, security is key for these protocols. They implement different steps, like encryption and multi-signature verification, to protect staked assets and guarantee the integrity of the staking process.
Many liquid staking protocols are compatible with different blockchains and DeFi applications, increasing their usability and user reach.
Transactions and staking operations are traceable and verifiable, building trust among users.
Leading Liquid Staking Protocols
Several protocols have become leaders in the liquid staking space, each with unique features and benefits:
- Lido: Lido is one of the most popular liquid staking protocols, mainly for staking Ethereum. It allows users to stake ETH and receive stETH.
- Swell: Swell allows users to stake their cryptocurrency and receive a representative token. This token can be used in the wider DeFi ecosystem, offering both liquidity and the opportunity to participate in yield-generating activities.
- Rocket pool: Rocket Pool is a decentralized staking pool. It lowers the entry cost of staking for ETH, making it accessible for smaller stakers. In Rocket pool the rewarded token (for the staked one) can be utilized across the DeFi ecosystem, mirroring the liquidity and utility functions of tokens provided by other liquid staking protocols like Lido.
The Impact of Liquid Staking Protocols
Liquid staking protocols impacted how users interact with PoS blockchains. They have democratized access to staking, allowing more participants to help secure the network without sacrificing liquidity. They have also opened up new ways to earn rewards and participate in the broader DeFi ecosystem.
Validator Involvement and Network Support
When you stake your tokens, they are combined with others and used by validators. These are network nodes that use your staked tokens to help secure the blockchain through the consensus mechanism. This is like a voting system where validators agree on which transactions are valid. By doing this, they keep the blockchain reliable and secure and also rewarded by transaction costs. Then these rewards will be divided between the validator holder and its stakers.
Benefits and Risks of Liquid Staking
The main advantage of LSTs is the increased liquidity they provide. Stakers can use their LSTs for yield farming and participating in various DeFi opportunities. This makes these tokens an attractive option for those looking to maximize their crypto holdings’ utility.
However, liquid staking also has its risks. One of them is called ‘slashing’. Slash happens when validators act incorrectly or maliciously. If they break the rules or make errors, a part of their tokens might be lost as a penalty. This is a way to enforce good behavior among validators. Remember: you delegate your tokens to a validator, so it’s your job to choose the right one.
Another problem could be a bad programmed smart contract. Of course the dev team behind a blockchain always trying to solve these kind of issues, but the risk is real. However nowadays as DeFi is broadening there are less smart contract problems. As an average method to start a blockchain starts with its testnet phase, where the developers and participants test most of the cases.
Future of Liquid Staking Tokens
Looking to the future, Liquid Staking Token will likely grow along with the DeFi world and blockchains that use proof of stake. More people will use LSTs to join in these networks in a better way. LSTs let them help keep the network safe and still use their tokens in different DeFi activities.
Also, as tools for liquid staking like Lido keep improving, and as people get more interested in blockchains that are open and can grow, LSTs should become more popular.
