Liquid staking of ETH tokens has skyrocketed in the past few months. But what is it? And why must you seriously think about it?

INDEX:

• What is Staking?

• What is Liquid Staking?

• Most Popular Liquid Staking Projects

• Risks

• Recap

If you are even remotely involved in the crypto world, you must have heard of “staking” or “liquid staking.”

Simply put staking (and liquid staking) means earning interest on your assets. Think of it as a bank account where your deposit earns a yearly interest rate or a fixed deposit that accrues an annual yield.

Both staking and liquid staking are different things. Still, they are intertwined in that liquid staking essentially removes one key entry barrier, making it easier for people to benefit from it.

But before we dive in, let’s brush up on our basics.

What is Staking?

Staking lies at the heart of every proof-of-stake-based (PoS) blockchain. It refers to depositing a certain amount of native tokens to guarantee security to those who use the chain.

Think of it as a security deposit.

According to Ethereum:

Staking is the act of depositing 32 ETH to activate validator software.

How does this guarantee security?
Security in a PoS chain means that the validators (nodes that process/add new transactions and store all the data) that make up the network do not mess up either intentionally or by mistake.

In other words, they work as intended and do not jeopardize the entire network.

If they do, their security deposit is “slashed” or reduced as a punishment and eventually, the validator can also be removed permanently from the network.

Why would anyone deposit their ETH?
This is a crucial point to understand as it is the hallmark of the entire crypto ecosystem.

If I am a validator who is willing to take the risk of getting slashed, what do I get in return?

In Ethereum, validators are paid rewards for their work.

So, on the one hand, I lock up 32 ETH tokens, which is a lot of money these days, and in return, I get paid regularly for the work I do as a validator.

Sounds reasonable.

But what if I don’t have 32 ETH tokens? Can I still get a taste of some of this regular income?

Enter liquid staking.

What is Liquid Staking?

Liquid staking enables people to come together and pool their tokens to reach the 32 ETH limit, which gets staked on the blockchain and the rewards are distributed amongst them.

There are several advantages of this approach:

• First, you do not need to have 32 ETH yourself.

• Second, you do not need to run your validator.

• And third, it also provides liquidity.

The first two points are self-explanatory, but let’s look at the third in detail.

When you stake your ETH tokens, you are essentially depositing them from your wallet into a staking pool, which means that ETH that you could have used to buy an NFT or lend to someone will now be locked away just like a fixed deposit.

In other words, your “liquid” asset has now become “illiquid.”

Liquid staking solves this problem by minting and providing you with a “staked” version of the ETH token to replace your original ETH tokens in your wallet.

This is a powerful concept.

Not only will you receive the regular rewards for your staked ETH, but you now also possess the same amount of liquid ETH.

It is as if you never parted with your ETH tokens.

You can now buy that NFT using the staked version of ETH. Or better, lend it and get lending rewards over and above everything else.

No wonder liquid staking has overtaken DeFi giants like Uniswap and Aave in TVL and is now the dominant category.

Most Popular Liquid Staking Projects

Now that you know the power of liquid staking, let’s look at some commonly used liquid staking projects where you can go and stake ETH tokens.

Note: I have deliberately kept centralized exchanges from this list, although staking through them is the easiest. Because of the market crash of 2022, I have learnt to stay away from CEXs as much as possible; that is what I also recommend.

Lido

Lido is the most popular liquid staking project and the first to create a liquid staking mechanism for ETH holders.

Lido can also be used to stake other tokens like SOL and MATIC. The picture below provides the annual percentage return you will get for staking your tokens.

The staked tokens received in exchange are denoted with an “st” prefix. For example, staked ETH will be stETH, and staked SOL will be stSOL.

stETH is a rebasing token, i.e., once acquired, the number of tokens you hold increases without requiring action. You can track the staking rewards by visiting https://stake.lido.fi/rewards and supplying your public address containing stETH.

Lido has different exchange rates. For example, for one ETH, you will receive one stETH in return.

But this is not the case for all tokens.

After the exchange, you will receive the equivalent amount of stETH (or other supported tokens) in your wallet.

Currently, Lido enjoys its position as the market leader in liquid staking, and this is what I would also recommend to beginners.

Rocket Pool

The next decentralized liquid staking project is Rocket Pool. At the time of writing, rETH has an annualized yield of 5.09%.

rETH is a value accrual token, i.e., the value of each token keeps growing in ETH denomination over time, and you will see this change in your wallet.

The yield is different for Rocket Pool; however, if we look at a historical comparison of the APY of stETH and rETH, we see some instances in the past where rETH had better APY.

And so it would be prudent, I feel, to diversify into Rocket Pool as well.

Like Lido, once you stake, you receive an equivalent amount of rETH in your wallet.

There are many other liquid staking projects, but I would not recommend these to a beginner as they are riskier.

Let’s understand this in the next section.

Risks

Every investment comes with risks, as we all know. Let’s look at the risks associated with liquid staking that you must know about as an investor.

1. Technology-related risks: Several risks emanate from the technology and its implementation itself. For example, liquid staking essentially is nothing but a bunch of computer programs (a.k.a smart contracts) that run on the blockchain. If there is a bug in the code itself, it could lead to an exploit resulting in the loss or devaluation of the asset.

2. De-pegging risk: Staked tokens are NOT pegged to the underlying asset's value. It is essential to understand that these staked tokens have their market dynamics (demand and supply), so their value depends on it. For example, in the aftermath of the Terra-LUNA meltdown, selling pressure was seen on stETH as companies scrambled to generate liquidity to pay off their debts and liabilities, which caused a dip in its value vis-a-vis ETH.

3.     Liquidity Risk: In a bearish market where there is selling pressure on a staked token, it is possible that you might not be able to exchange your stETH for ETH because of the liquidity crunch since everyone is doing it.

4.**     The risk from over-leverage**: The crypto ecosystem is known for over-leveraged trades. Every day, people invest their staked tokens into various leveraged trading opportunities to add as much additional APY on top of what they would get from simply staking their assets. The more APY you run after, the riskier your trade becomes.

Every liquid staking project has these risks, but it is more significant for projects not at the top of the liquid staking market, so I do not recommend other projects to beginners.

Recap

I will end the article with a summary.

• Staking and liquid staking are different. Staking requires 32 ETH, whereas liquid staking can be done with as low as 0.01 ETH tokens.

• Liquid staking pools all the little contributions together to make 32 ETH before staking them on the Ethereum blockchain.

• Lido and Rocket Pool are currently the best options for beginners to do liquid staking.

• Several risks exist with liquid staking, which, if materialized, could result in loss of funds.

• Lido and Rocket Pool dominate the market and are the least risky liquid staking providers.

• Centralized exchanges providing staking rewards are the riskiest among all the liquid staking providers.

I hope you liked the content. As always, this is not financial advice but only meant as educational content. Please do your research before investing anywhere, especially in crypto.

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