Liquid Staking: A Game Changer for Financial Institutions

There’s a famous saying: when something sounds too good to be true, it’s because it is. And staking can, sometimes, appear as fitting this stereotype to the uninitiated. 

The initial part of one’s introduction to staking protocols and their potential economic upsides is usually all smiles. After all, a cleaner alternative to mining that doesn’t require thousands of dollars in equipment as a start-up cost (not even bringing the sky-high electricity bills of 2022 into the equation) while guaranteeing similar returns is hard to turn down. And with most adopters of cryptocurrency being individuals interested in long-term investment strategies and passive yield, it’s hard to imagine many would be content with an appreciation profile that relies entirely on unpredictable and sometimes irrational price movements to produce wealth. 

The ‘too good’ part comes crashing down right after though: most of the time, funds staked will be inaccessible for long periods of time (sometimes even over undefined timelines depending on technical development progress), exposing their owner to price fluctuations beyond their control and putting their fate in a centralised entity’s hands. Hardly the promise of financial freedom that many see in crypto. 

There should then be no wonder felt when looking at the stark growth Q1-Q3 of 2022 has shown in a groundbreaking new sector that promises to tackle the issues we discussed: the liquid staking industry.

Self-Staking and Exchange Staking: The Uncertain Past

In order to understand why liquid staking is such a game changer, we need to wind the clock back a little bit and take a look at the other, previously popular forms of staking out there.

The original, basic, and raw form of staking is called ‘self staking’. This is where people become validators of a specific chain by putting together a minimum amount of a selected currency (in the case of Ethereum, this is 32 ETH) and locking it away in an immovable staking pool. Until a specific phase of that chain’s evolution, those coins are then permanently locked into place. 

This form of staking is plainly not accessible, as it has a big start-up cost, and is only suitable to those with very long-term plans and a very patient and calm disposition. Having funds locked away in such a manner means complete and total exposure to price fluctuations without any chance to reduce or increase fund allocation – essentially proving worthless to anyone who is into crypto with a speculative approach, and as we know that is not a small percentage of its users by any means. 

Exchanges and third-party service providers in the industry were quick to notice these issues, and quickly developed an ‘exchange staking’ alternative model to provide access to staking for those cut out of it, in exchange for a fee and control of its users’ assets. 

By grouping several small investments together, exchanges were thus able to bypass minimum staking amount requirements. They also allow users to stake and unstake their funds at any given time, in exchange for percentual commissions on the rewards earned up until that point.

This came with a big drawback, however: the complete loss of decentralisation features and the destruction of any transparency involved in the process. The absence of these characteristics bred a very toxic environment with high-stake bets placed by shady exchanges with funds owned by their users. 

An environment like this, while already dangerous and morally questionable (the only type of questions that can be raised if regulations remain almost entirely absent), was still somewhat sustainable after a period of extended growth and bull runs on most crypto markets. As soon as things started getting hairy on the macroeconomic scale, things turned south and the subsequent downfall of many centralised yield-generating financial providers in the space left long-lasting scars on customer confidence. 

The Improvement Crypto Deserves: Liquid Staking 

piles of physical gold coins with various crypto logos embossed on them fill up half the image on the right

Even before this crisis materialised, however, developers and fintech professionals had already birthed a new, revolutionary model: liquid staking. 

The concept is simple: rather than handing over their crypto to a third party and getting reassurances and promises in return, liquid staking users receive a tangible token. 

For each coin deposited, they are rewarded with an actual representative asset (in the case of Ethereum, this is usually sETH), almost a form of derivative, which can be transferred, stored elsewhere, spent, and traded exactly like the cryptocurrency value it represents. 

It truly represents the best of both worlds: earning staking rewards through the Ethereum owned and staked by the liquidity provider, and still having complete control and freedom of financial operation. There is no years-long commitment required, and one can rest assured they won’t be denied access to their funds by anyone. 

This new protocol is not beneficial just for the user, as well. Encouraging staking means encouraging the safety of a staked chain, and its efficiency of operation – all improvements which are likely to significantly impact providers of financial services in that space. 

Institutions Charge Ahead

Several big players quickly established themselves in the space over 2022, with Lido Finance taking the lion’s share of the market and Rocketpool following behind at a distance.

Several risks remained, such as poor management of smart contracts or liquidity gaps, and it’s impossible to deny that liquid staking’s uncertain early days were part of the facilitators of some of the most egregious collapses of the sector in 2022. 

Celsius’ liquidity crisis of June 2022, to bring up a prominent example, was the result of a bank run triggered by the depegging of stETH, the tokenization of staked ETH via Lido Finance. Despite this, the industry and users keep seeing a lot of promise to balance out the risk of human error and mismanagement, and it’s safe to say the current price and market cap downturn across the sector is weeding out many bad apples.

As can be seen via the numbers: the amount of Ethereum staked through liquid staking services grew 25% in Q2 of 2022, leading to a total 33% of all staked Ethereum going through liquid protocols. 

A Stellar Lineup Ahead: Future Liquid Products

The space is undoubtedly in its infancy days, with most protocols yet to celebrate their first birthday, but its quick rise to prominence means we have a good view of exciting future projects

Marinade, Solana’s LSP (Liquid Staking Protocol), has been live for just over 12 months but has achieved a $260M pool in that short time. Both Acala, Polkadot’s provider, and Benqi (Avalanche’s) have breached the $50M mark within less than 6 months from launch. 

Polygon, Near, and Cosmos are other exciting cryptocurrency projects which have or will soon have similar offerings as part of their ecosystem, and the list is sure to grow a lot in the near future.

It’s now hard to deny that liquid staking will be the tenet of the next generation of financial Web3 products, and users are advised to start exploring it as soon as possible.

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