Staking is a way to help secure proof-of-stake blockchain networks like Ethereum. Network participants can run a validator node by putting tokens “at stake,” which can then be “slashed” (taken away as a penalty) if the node commits any malicious actions or is unreliable. While there are many solo node operators, anyone can stake tokens through staking as a service (SaaS) provider—exposing them to the same risks and giving them the opportunity to share in rewards. However, staked tokens cannot be transacted or used as collateral to earn yield across the DeFi ecosystem.
Liquid staking service providers solve this liquidity problem by minting a new token—representing a claim on the underlying staked asset—which can then be traded or deposited in DeFi protocols. For example, a user could deposit ETH to the Lido staking pool and receive stETH (staked ETH) tokens in return, then deposit the stETH to Aave to earn yield. Essentially, liquid staking builds upon existing staking systems by unlocking liquidity for staked tokens.
In this post, we’ll explore exactly what liquid staking is, the opportunities and risks it brings, and how Chainlink underpins the use of liquid staking tokens throughout Web3.
What Is Staking?
Staking is the locking up of cryptocurrency tokens as collateral to help secure a network or smart contract, or to achieve a specific result.
Most broadly, staking is a cryptoeconomic model that incentivizes the correct behavior of network participants using penalties and rewards in order to strengthen its underlying security. It is used by a range of Web3 protocols, including proof-of-stake blockchain networks like Ethereum and individual DeFi applications like MakerDAO.
What Is Liquid Staking?
Liquid staking provides all of the benefits of traditional staking services while unlocking the value of staked assets for use as collateral across the DeFi ecosystem.
Liquid staking providers take user deposits, stake those tokens on behalf of users, and provide them with a receipt in the form of a new token, which is redeemable for the tokens they staked (plus/minus a share of rewards and penalties). This new token can also be traded or used as collateral in DeFi protocols, thereby unlocking the liquidity of the staked assets.
Traditional Staking vs. Liquid Staking
|Traditional Staking||Liquid Staking|
|Contributes to cryptoeconomic security||Yes||Yes|
|Liquidity||No (locked tokens)||Yes (tokenized receipts)|
|Methods||Run a validator, staking as a service, pooled staking, centralized exchanges||Liquid staking as a service|
|Rewards||Staking rewards||Staking rewards and the opportunity to earn additional yield in DeFi|
|Risks||Penalties||Penalties and additional smart contract risk|
Benefits of Liquid Staking
Tokens staked in a network such as Ethereum are locked and cannot be traded or used as collateral. Liquid staking tokens unlock the inherent value that staked tokens hold and enable them to be traded and used as collateral in DeFi protocols.
Composability in DeFi
By representing receipts for staked assets as tokens, they can be used across the DeFi ecosystem in a wide variety of protocols, such as lending pools and prediction markets.
Traditional staking provides users with the opportunity to receive rewards for verifying transactions. Liquid staking enables users to continue receiving these rewards while also earning additional yield across various DeFi protocols.
Outsource Infrastructure Requirements
Liquid staking providers enable anyone to share in the rewards of staking without having to maintain complex staking infrastructure. For example, even if a user doesn’t have the minimum 32 ETH required to be a solo validator in the Ethereum network, liquid staking enables them to still share in block rewards.
Risks and Limitations of Liquid Staking
Users of liquid staking services are essentially outsourcing the maintenance of running a validator node. This fully exposes them to having their funds slashed if the service provider acts maliciously or unreliably.
Depositing tokens to a liquid staking service provider places those funds at risk if a node operator’s private keys are compromised or the protocol has any smart contract vulnerabilities that lead to an exploit.
Secondary Market Volatility
The price of liquid staking tokens is not pegged to the underlying asset they represent a claim on. While they may trade at the same price or at a very slight discount most of the time, they can drop below the price of the underlying asset during liquidity crunches or when unexpected events occur. Because the trading volume for staked tokens is generally lower than that of the underlying assets, market shocks can also have an outsized impact on the volatility of staked tokens.
Liquid Staking Tokens and Protocols
Liquid staking protocols are the service providers and liquid staking tokens (LSTs) are the tokens that represent a claim on the staked assets.
Lido is currently the largest liquid staking protocol, with over $12.7B TVL as of 19 April 2023. Users can stake their tokens and receive daily rewards without having them locked or having to maintain their own infrastructure. It offers stETH (staked ETH) LSTs on Ethereum, stMATIC on Polygon, and stSOL on Solana.
Rocket Pool is another popular liquid staking protocol on Ethereum, with over $1.4B TVL. There is no minimum deposit requirement to access Rocket Pool’s rETH LSTs. However, to operate a minipool validator, users must deposit a minimum of 8 ETH plus 2.4 ETH worth of RPL.
Centralized vs. Decentralized Liquid Staking
Along with decentralized liquid staking protocols like Lido and Rocket Pool, centralized providers such as an exchange can also offer liquid staking services to their customers. The key difference is that decentralized services are non-custodial, while centralized services will be in full control of users’ staked assets. While decentralized services are vulnerable to smart contract exploits, centralized services come with their own risks.
Chainlink Price Feeds Enable Secure DeFi Markets Around LSTs
Chainlink Price Feeds publish highly accurate and reliable data for various LSTs, which enables DeFi protocols to accept them as collateral. For example, there are various stETH/USD and stETH/ETH Price Feeds across Arbitrum, Ethereum, and Optimism. Ultimately this is critical for deepening the liquidity of LSTs and helping secure the protocols they’re traded on, which makes Chainlink critical infrastructure for liquid staking throughout Web3.
Disclaimer: This post is for informational purposes only and contains a general overview of staking and liquid staking protocols within Web3. There may be other risks not covered in this article, and any use of liquid staking should be done at your own discretion.