Liquid Staking — Bringing solutions to the Proof-of-stake
It’s difficult to be in the blockchain space without coming across the term, liquid staking. A concept that is really pulling its weight out there but to really know what it means and how it affects the proof-of-stake and blockchain space, let us talk about staking.
Staking refers to an act where individuals lock up their crypto assets in a wallet or a staking platform with the aim of maintaining network security. Instead of just keeping (hodling) the assets in the wallet, they lock them out of the circulating supply. You might ask why one would want to do that. It all goes down to the Proof-of-stake consensus mechanism. What is the Proof-of-Stake?
The proof-of-stake consensus mechanism is one of the many consensus mechanisms that is used to add a block to the growing blockchain. Another consensus mechanism is the Proof-of-work, which Bitcoin works on. Now, the blockchain is a growing chain of blocks (data) held together by cryptography. Adding a new block to the growing chain is usually by any of these consensus mechanisms. For the proof-of work, users (miners) would race against time (and themselves) to be the first to solve a mathematical puzzle (hash) with the winner getting to be the one to add the next block to this growing chain. This process is incentivized as the winner gets rewards for this. The problem with the Proof-of-work is that it is energy-consuming. With the Proof-of-Stake, it is the same outcome but through a different approach. The aim is to still add a block to the growing chain but there is no mathematical puzzle to be solved. Rather, users are made to lock up their assets in a process called staking. The higher your stake, the greater your chances of being the user to add a block to the growing chain and the higher your rewards for doing so. With this, the network remains active and secure whilst running its various functions.
The problem of staking
You might wonder, “why would there be a problem with staking?” Staking is supposed to be beneficial to everyone involved. The network is able to run, securely while the stakers get incentivized for securing the network. In the blockchain space, however, things are not always as straightforward as they seem. The major problem with staking is liquidity. The coins are locked out of circulation and the users cannot make use of them while staked. In some projects, you can unstake your assets and make use of them anytime. However, in many, you would have to go through an unbonding phase (say 14 days or 28 days) during which no rewards would be received until the assets are liquid again. The second problem is the low yields from staking. Many users feel they would get better APRs in the decentralized finance space than in the staking programs. This would lead to them not wanting to continue staking. When this happens, there’s a problem as there are no tokens locked to maintain the smooth running of the network and this could lead to a crash in the network as it becomes susceptible to various attacks. This would greatly affect many networks including decentralized finance projects. So, what is the solution? That’s where liquid staking comes in.
Liquid staking is a great hedge against the seeming crisis that has been highlighted above. As stated earlier, we have two issues; lack of liquidity and low yields. Let’s explain liquid staking. I’d be using the example of liquid staking platform, StaFi Protocol. When you stake ATOM on StaFi, you effectively lock your assets in the Cosmos blockchain through StaFi. However, it doesn’t end there. If it does, it’d be like normal staking. Instead, the StaFi platform issues you staked representatives of your staked ATOM. This staked representative is pegged 1:1 to your staked ATOM meaning it is given the same value as your ATOM. That way, liquidity issues have been solved as you can now make use of your staked asset through the staked representative, rATOM. Problem 1 solved. Secondly, you can use these staked representatives for other yields in the DeFi space. An example is using the staked representatives for borrowing, lending, farming or LP Mining. I remember using my stkATOM to provide liquidity for the stkATOM-ETH pair on Sushiswap. The rewards on these DeFi activities usually have better APRs/APYs than the PoS rewards. That’s the second problem of low yield solved. Users would then be able to stake their assets to secure the network of their favourite tokens while making more yields in the DeFi space with the staked representatives.
There’s no doubt that liquid staking is transforming the Proof-of-stake sector and the blockchain space at large. There would be further features added to it to further make the process more efficient and rewarding. Projects like StaFi Protocol have created a DEX where these staked representatives can be traded seamlessly between themselves. For example you can trade rATOM (staked representative of ATOM on StaFi) for rKSM (staked representative of KSM on StaFi) easily, thus increasing liquidity. Let’s enjoy the beauty of liquid staking.
Thanks to Scallop for giving me the inspiration to write this. With Scallop, you’re looking at a platform that is bringing a faster and more efficient way to manage crypto and fiat in a single place, securely.