What is Liquidity Staking?

Liquidity staking is an innovative concept that increases the utility of users staking digital assets. This brief guide will cover the basics of liquidity staking, how it works, why it’s important, its pros and cons, and how it differs from other forms of staking.

The concept of liquidity staking and its working principle

In short, liquidity staking refers to the tokenization of pledged assets. We can think of it as an upgraded version of traditional staking.

Traditional staking not only ensures network security, but also ensures that users have a chance to earn rewards for locking their assets in a Proof-of-Stake (PoS) blockchain. However, there are pros and cons to this process, as pledged assets are generally less liquid after being locked for the staking period.

In order to solve this problem, liquidity staking has introduced a mechanism, and users’ pledge of assets will not affect liquidity. There are many ways to build such a mechanism, but as long as it can provide liquidity for the pledged assets, it can be called "liquidity staking".

In some cases, users will receive liquid staking tokens (LST) after staking their assets. For example, you can earn stETH tokens by staking ETH on platforms such as Lido. This model is also known as "liquidity pledged derivatives".

Sometimes, assets can be directly pledged without using LST. For example, consider the case of staking ADA on the Cardano blockchain. This model is called “native liquidity staking”.

With liquidity staking, users can receive staking rewards without affecting liquidity, so staking assets become more flexible and more effective.

Why is liquidity staking important?

Liquidity staking solves the liquidity problems faced by traditional staking, and users can use pledged assets more easily and flexibly.

Platforms like Lido and Cardano offer users the opportunity to earn staking rewards while trading and using staking assets in decentralized finance (DeFi) applications.

In addition, liquidity staking can also encourage users who are concerned about long-term locked assets to actively participate in staking, thus promoting the overall development and popularity of the blockchain network.

Advantages and disadvantages of liquidity staking

Advantages

1. Improved utility: Users do not need to give up staking rewards and can also use pledged assets in various DeFi applications.

2. Reduce opportunity costs: With the liquidity provided by liquidity staking, users can make full use of potential trading and investment opportunities, which is an advantage that traditional staking does not have.

3. Promote cryptocurrency adoption: Liquidity staking can not only increase the utility and value of tokens, but also promote the development of new applications and drive cryptocurrency adoption.

Disadvantages

1. Slashing risk: If a validator commits fraud, it may be removed from the network, and part of the pledged tokens held may be "slashed" (confiscated). If the validator chosen by the user is punished, the user himself may also be at risk of slashing.

2. Centralization problem: If most tokens are staked in a single protocol with independent validators, it may damage the decentralized nature of the network. In order to reduce the risk of centralization, it is best to build a diversified network with various liquidity staking protocols.

3. Regulatory Uncertainty: Blockchain and cryptocurrency regulation is changing rapidly and may also vary from place to place. Users should be sure to understand local laws before participating in liquidity staking through DeFi platforms.

Comparison between Liquidity Staking and Liquidity Re-staking

As mentioned earlier, liquidity staking involves the tokenization of pledged assets, which allows for liquidity and flexibility without waiting for the end of the staking lock-up period. “Liquidity Re-hypothecation” launched by EigenLayer further develops this concept.

Liquidity staking secures the PoS blockchain by staking assets, while liquidity re-staking provides security for oracles, aggregations, and other “external” modules and systems. Liquidity staking projects include Lido (stETH), Cardano (ADA), Binance ETH (BETH), and Rocket Pool (RETH), while liquid re-staking projects include ether.fi, Puffer, and Kelp DAO.

Conclusion

Liquidity staking provides a more dynamic and flexible method for users to participate in the staking ecosystem, bringing new possibilities to digital assets by tokenizing pledged assets and providing stronger liquidity.

The above is the detailed content of What is Liquidity Staking?. For more information, please follow other related articles on the PHP Chinese website!