How to play liquid staking? From locking assets to eating more than one fish

When many people come into contact with staking for the first time, the most direct feeling is: the currency is locked in, and the people are also locked in. Traditional staking requires you to hand over your assets to the verifier or the staking contract, and you cannot move them before expiration. If the market suddenly fluctuates, you can only watch; if high-yield opportunities appear in DeFi, you can only miss them. Liquidity staking is to solve this "fish and bear's paw" problem.

How it works is not complicated: you deposit your coins into a liquidity staking protocol, and the protocol issues you a representative certificate, usually called a Liquidity Staking Token (LST). This LST can continue to be used in lending platforms, decentralized exchanges, and income protocols, and your original pledged assets are still earning pledge rewards on the chain. It's equal to one principal, and you can do two things at the same time.

There are two specific modes. The first is the "voucher issuance" mode. You pledge ETH and get an LST anchoring your ETH position. The rewards may be accumulated automatically or issued separately, depending on the protocol design. The second type is called native liquidity staking, where the assets are directly left on the chain for staking without the need to issue additional derivative tokens. Cardano's ADA is like this, and transfers can still be made in the pledged state. Binance also has its own product: after staking ETH, you get BETH. This BETH represents your pledge position and can be used in the Binance ecosystem.

Why would anyone want to stake liquidity? The most direct reason is to reduce opportunity costs. The return of traditional staking is single, and the time cost of assets being occupied is very high. Liquidity staking allows you to earn staking rewards while also using LST for lending, market making, and mining, giving you an extra layer of income. This composability is why it’s so popular in DeFi circles.

Another benefit is lowering the barrier to entry. Taking Ethereum as an example, running a validator node requires 32 ETH, which is unrealistic for most people. The liquidity staking agreement pools everyone’s deposits. You can deposit as much as you like and get LST in proportion. Small users can also participate in staking.

But don’t think of liquidity staking as a sure-fire business. Risk has several levels.

The first is slashing. If a validator commits evil or malfunctions, part of the pledged assets will be deducted as punishment. If you use a protocol that runs its own validators through a pledge pool, your deposits may be affected by the slashing events of these validators.

The second is smart contract risk. The liquidity staking agreement relies on smart contracts to manage deposits and issue LST. If there are loopholes in the contract, it may lead to capital losses. The risk of audited, long-running protocols is relatively low, but not zero.

The third is the issue of centralization. If most of the staking volume in a network is concentrated in a certain liquidity staking protocol, this entity may theoretically have an excessive impact on consensus decision-making. This is not good for network health.

The fourth is regulatory uncertainty. The rules for staking, DeFi, and token issuance are different in different regions and are still changing. It’s best to check your local regulations before using.

Going one level deeper, there is a concept called liquid restaking. It takes the logic of liquidity staking one step further. EigenLayer first proposed this gameplay: you can use LST (or native pledged ETH) to help protect other protocols and infrastructure, such as oracles, cross-chain bridges, and Rollup. You deposit LST into the re-pledge agreement and get a liquid pledged re-pledge token (LRT). This LRT can continue to be used in DeFi. The underlying assets protect multiple protocols at the same time. Re-staking at each layer may bring additional rewards, but it also adds additional risks, because your pledged position will face penalty conditions from multiple sources. After the EigenLayer mainnet expansion in 2024, this track will grow rapidly.

Some people may ask: Are the rewards for liquidity staking guaranteed? no. Staking rewards depend on network conditions, validator performance, protocol fee structure, and whether slashing occurs. The reward rate will change and will not be fixed in advance.

Others are worried about the safety of their principal. The answer is: there are risks. Slashing events may reduce the value of your underlying pledged assets, and protocol contract loopholes may also cause problems with funds. As with any DeFi activity, study the protocol carefully before using it, and only invest money you can afford to lose.

From the perspective of handling fees and rebates, liquidity staking protocols usually take a portion of the staking rewards as protocol fees, and the proportions vary. Some platforms will also rebate commissions to recommenders, but this cost may ultimately be borne by the stakers. When you compare different protocols, in addition to looking at the nominal rate of return, you also need to take into account the protocol commission, the verifier commission, and the discount and premium of LST in the secondary market. Don’t just look at the advertised APR, the actual APR may be much different.

Liquidity staking is not a panacea. It gives you liquidity, but also brings a new level of risk. If you just want to hold it for a long time without fussing, traditional staking may be more worry-free. If you want to move your assets while accepting smart contracts and slashing risks, LST is a tool worth studying. The key is to understand exactly what money you are making and who is taking the risk.

Reference: Binance Academy Original link: https://www.binance.com/en/academy/articles/what-is-liquid-staking

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