Liquid Staking Tokens: Everything to Know

Overview

Liquid staking tokens are cryptocurrencies that allow users to stake assets and simultaneously use them in decentralized finance (DeFi) applications. Staking has become a popular way for cryptocurrency holders to participate in network consensus and earn rewards. By locking up tokens in a staking contract, users contribute to network security and validate transactions, all while receiving additional tokens as an incentive. However, traditional staking models suffer from a lack of liquidity. Once tokens are staked, they are typically locked for a predetermined period, restricting holders from utilizing them for other purposes.

Liquid staking tokens aim to address this liquidity issue by introducing a new layer of financial innovation. These tokens are created by "wrapping" or tokenizing the staked assets, allowing users to hold and trade them on compatible platforms. By doing so, stakers can retain the benefits of staking, such as earning rewards and participating in network consensus while also gaining the flexibility to use their assets in other ways within the broader cryptocurrency ecosystem.

A Brief History

The concept of liquid staking tokens can be traced back to the advent of decentralized finance (DeFi) and the emergence of Ethereum-based protocols. In 2020, projects like Lido Finance and Rocket Pool gained attention for efforts to bring liquidity to staked assets. Lido Finance, for instance, introduced a liquid staking solution for Ethereum, allowing users to stake ETH and receive liquid stETH tokens in return. These liquid stETH tokens represented a user's staked ETH and could be freely traded or used as collateral in DeFi applications.

Since then, the popularity of liquid staking tokens has grown significantly, with various blockchain networks and projects exploring similar solutions. Polkadot, for example, introduced the concept of "staking derivatives" through projects like Polkastarter and Moonbeam. These platforms allow users to trade wrapped staked assets while still receiving staking rewards. Other networks, such as Cosmos and Tezos, have also witnessed the development of liquid staking solutions to enhance the usability and liquidity of staked tokens.

What are Liquid Staking Tokens?

To understand liquid staking tokens comprehensively, it's important to explore the key aspects that define them.

• Tokenization. Liquid staking tokens are typically created through a process called tokenization. This involves wrapping or minting a separate token that represents the staked assets. For example, when staking ether, a tokenized version like stETH or wETH can be freely traded or used in other applications.
• Staking rewards. One of the primary benefits of liquid staking tokens is the ability to earn staking rewards while maintaining liquidity. When staking tokens and receiving liquid staking tokens in return, investors continue to earn staking rewards on the underlying assets. This allows benefits from network participation while having the flexibility to utilize tokens elsewhere.
• Trading and liquidity. Liquid staking tokens can be traded on compatible platforms, providing users with the ability to buy, sell or exchange them as desired. This introduces liquidity to staked assets that were previously illiquid, enabling users to react to market conditions or capitalize on investment opportunities without waiting for staking periods to end.
• Collateralization. Another compelling aspect of liquid staking tokens is the potential use as collateral in decentralized finance (DeFi) applications. By leveraging liquid staking tokens as collateral, users can access loans, borrow assets or participate in various yield farming strategies. This expands the utility and value of staked assets beyond their traditional staking role.
• Risks and considerations. While liquid staking tokens offer enhanced liquidity and flexibility, it's important to understand the associated risks. As with any investment or financial instrument, there are potential risks involved, such as smart contract vulnerabilities, market volatility and slashing risks. It's crucial to conduct thorough research, evaluate the credibility of the projects offering liquid staking tokens and assess the potential risks before engaging in such activities.

Getting Started

To start using cryptocurrency liquid staking tokens, users need to possess the underlying staking asset. This typically involves obtaining a native token of a proof-of-stake (PoS) blockchain network, such as Ethereum's ETH or Polkadot's DOT. Once a user has acquired these tokens, they can proceed to a platform that supports liquid staking, such as a specialized protocol or a decentralized exchange (DEX). Users can deposit staking tokens, which will then be locked and used to generate staking rewards.

Once the staking tokens are locked, users receive a representation of their staked value in the form of a liquid token. These liquid tokens are often referred to as staked or wrapped tokens and are tradable on various decentralized exchanges and platforms. Users can freely transfer, trade or utilize these tokens within the DeFi ecosystem without affecting a staked position. It's important to note that staked tokens remain locked and cannot be directly accessed or transferred until the user decides to unstake them.

Unique Aspects

One of the key advantages of cryptocurrency liquid staking tokens is the ability to provide liquidity while maintaining exposure to staking rewards. By converting staked tokens into liquid tokens, users can simultaneously participate in staking and access the benefits of liquidity provision. This flexibility allows users to engage in various DeFi activities, such as yield farming, lending or trading. All without sacrificing the rewards earned from staking.

Additionally, liquid staking tokens introduce a new level of composability within the DeFi ecosystem. These tokens can be utilized as collateral for borrowing or lending protocols, used in decentralized exchanges for trading, or even integrated into other DeFi applications. This composability expands the potential use cases for staked assets and enhances the overall efficiency and utility of the crypto ecosystem.

Moreover, liquid staking tokens can also mitigate the trade-off between staking and liquidity. In traditional staking models, participants need to choose between locking tokens for a specific period to earn rewards or maintaining liquidity and flexibility by keeping tokens readily available for transactions. Liquid staking tokens provide a solution to this dilemma by allowing users to stake tokens and still have access to the value for other purposes. This flexibility makes staking more accessible to a wider range of participants who may have different liquidity needs or investment strategies.