Staking has become a prominent concept in the blockchain ecosystem since the rise of the proof-of-stake (PoS) consensus mechanism. This shift from the energy-intensive proof-of-work (PoW) consensus model has improved capital efficiencies and contributed significantly to environmental sustainability. Since the beginning, Ethereum, one of the leading blockchain platforms, has been actively working towards adopting PoS as its primary consensus mechanism. The article at hand delves into the innovative concept of liquid staking and its transformative impact on the blockchain industry.
The Rise of Proof-of-Stake (PoS)
Proof-of-Stake emerged as an alternative to the energy-consuming and ecologically harmful PoW system. Following Bitcoin's introduction of PoW, other blockchain networks, including Ethereum, Dogecoin, and Litecoin, followed suit. However, Ethereum's developers were determined to transition to PoS to achieve higher energy efficiency, enhance the platform's sustainability, and make it more collective. In December 2020, the successful implementation of PoS on Ethereum's beacon chain prompted users to deposit their ETH, participate in staking to secure the network and receive staking rewards. This shift is expected to greatly enhance security, reducing energy consumption by approximately 99.95% (according to ethereum.org). With the merge that happened on September 2022, Ethereum became a fully PoS-operated chain. Currently, staked Ether reaches around 22.5 million, which keeps growing daily.
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Proof-of-Stake (PoS) networks like Ethereum rely on validators to secure the network and validate transactions. Th
ese validators are required to lock up a certain amount of native coins as collateral to participate in the network's consensus mechanism.
Traditional staking had its challenges, especially for individuals lacking technical expertise. Setting up a node is complicated for non-technical people, and the requirement to lock a significant amount of 32 ETH made it inaccessible to many due to the high value of ETH. While staking can be lucrative due to the rewards earned, it comes with the downside of reduced liquidity since staked tokens are locked up for a specific period. Locked assets cause capital inefficiencies, as they cannot be utilized in other opportunities like decentralized finance (DeFi) protocols, liquidity pools, or as collateral for borrowing.
Liquid Staking
Liquid staking is a revolutionary solution addressing staking’s illiquidity. Through a liquid staking provider, users deposit tokens staked on their behalf. In return, they receive redeemable receipts known as liquid staking derivatives, tradable and usable as collateral elsewhere. This innovation enables flexibility, access to liquidity, and integration into decentralized finance (DeFi) ecosystems, fostering wider participation and driving staking asset attractiveness in blockchain networks.
Staked Ether through liquid staking platforms currently makes up 40% of the total number of staked ETH. Lido Finance dominates the liquid staking market by 74%, and the second biggest actor in the ecosystem is Coinbase, by owning the %11 of the pie. Last but not least, Rocket Pool is the third contender with a %8 market share.
Enter Lido Finance, a liquid staking provider solving illiquidity caused by traditional staking. Founded after the introduction of the beacon chain in late 2020, Lido became one of the most popular decentralized applications (dApps) in the blockchain industry.
The process of staking through Lido is relatively straightforward. Users send their PoS tokens to the Lido contract, which then stakes them with a selected set of validators. The stETH tokens received in return are liquid and can be traded on decentralized exchanges (DEXs) or used in various other DeFi applications, just like any other ERC-20 token. This creates a bridge between the PoS and DeFi ecosystems, allowing users to access the benefits of staking without sacrificing liquidity.
Currently, Lido Finance commands a dominant position in the liquid staking industry, with an impressive 74% share of the staked ETH, amounting to approximately 8 million ETH, facilitated through liquid staking platforms.
Lido DAO constitutes the core of Lido Finance, assuming responsibility for the management of the treasury and the governance of Lido to uphold its operational efficiency and stability. Participation in Lido DAO's governance, entailing influence over matters detailed below, necessitates ownership of Lido DAO token (LDO):
Overseeing node operator management
Executing deployments and updates of pivotal parameters for liquid staking
Sanctioning grants to incentivize entities contributing to the DAO's future
Facilitating compensation for full-time DAO contributors
Addressing security concerns and bug bounties
Managing the accumulation of service fees generated by Lido Finance.
Coinbase Staking
Coinbase, one of the foremost and widely recognized centralized exchanges globally, offers users the opportunity to stake their PoS coins. Coinbase's staking platform introduces a notable enhancement by providing a liquid staking derivative of ETH known as Coinbase Wrapped Staked ETH (cbETH). With cbETH, users can now actively participate in DeFi applications while simultaneously earning rewards through staking.
Following the cToken model, cbETH operates on a floating conversion rate, which dynamically adjusts based on the underlying staked ETH's activity, including staking/unstaking, rewards, penalties, and fees. This flexible conversion allows users to easily switch between ETH and cbETH, ensuring smooth transactions even in fluctuating network conditions. Notably, ETH and cbETH are not pegged or interchangeable; as the underlying staked ETH continues to accumulate rewards, each cbETH token will represent an increasing amount of staked ETH, leading to potential divergence in asset prices over time.
Notably, cbETH is currently operational on several chains, including Ethereum, Polygon, Arbitrum, and Optimism. Given its liquid staking derivative nature, cbETH proves valuable in the DeFi landscape, finding utility in popular applications like Uniswap, AAVE, Curve Finance, and more. According to DefiLlama, the total value locked (TVL) within the cbETH contract has surpassed 1.2 million ETH, equating to approximately $2.27 billion.
Rocket Pool is renowned as one of the most decentralized liquid staking providers on the Ethereum Network. It offers users the opportunity to stake their ETH and receive rocket pool Ether (rETH) in return—a value-accruing token denominated in ETH. Established in November 2021, Rocket Pool has swiftly risen to prominence as a prominent liquid staking platform within the Ethereum Network. Boasting a total of 1.01m ETH staked and 3.1k node operators, it stands as the most decentralized platform of its kind.
What sets Rocket Pool apart is its unique approach to node setup requirements. Unlike the Ethereum network's typical 32 ETH deposit mandate for node operators, Rocket Pool permits a minimum deposit of 8 ETH alongside 2.4 ETH worth of Rocket Pool token (RPL) as collateral. This distinct offering allows node operators to earn ETH staking rewards and benefit from RPL rewards stemming from RPL inflation, distributed every 28 days. While ETH rewards are contingent upon Ethereum Network issuance rates, RPL rewards are influenced by the rate of staked RPL tokens. Moreover, RPL owners can participate in governance discussions and decide the future of Rocket Pool by voting.
Challenges and Risks
While liquid staking presents numerous opportunities, it also comes with its set of challenges and risks. Centralization remains a critical concern as a significant portion of the circulating ETH is staked through liquid staking platforms. Ensuring decentralization and promoting wider participation will be essential to maintain the blockchain's integrity and security.
Moreover, liquid staking is still a relatively new concept, and its smart contract risks are being closely monitored by the community. Regular audits and ongoing development efforts are necessary to minimize potential vulnerabilities and ensure users' funds' safety.
Additionally, regulatory uncertainty poses challenges for liquid staking platforms. The SEC's recent action against Kraken's staking operations highlights the need for clear guidelines and collaboration between blockchain projects and regulators to create a stable and compliant environment for liquid staking.
Conclusion
Liquid staking has undeniably revolutionized the staking landscape on Ethereum, providing accessibility, liquidity, and expanded opportunities to users. However, challenges such as centralization and regulatory uncertainties must be addressed to ensure the long-term sustainability and growth of the liquid staking ecosystem. As the industry evolves, stakeholders, developers, and regulators must work collaboratively to strike a balance between innovation and responsible governance in this dynamic and promising field. The future of liquid staking holds immense potential to drive further growth and adoption of blockchain technology, making staking a cornerstone of the decentralized future.
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This post does not contain financial advice, only educational information. Cryptocurrencies are volatile assets, so do your own research before investing in them.
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