Decentralized finance (DeFi) is ushering in a new economic epoch. Unlike traditional finance(TradFi), it decreases the barrier to entry into financial markets, eliminates the need for centralized intermediaries, and enables effortless transfer of assets across borders.
However, staking is notorious for locking up crypto assets and limiting investment opportunities. A highly liquid and interoperable financial service is now possible thanks to Liquid Staking.
Looking at the expansion of DeFi, it is clear that this financial sector is exploding. According to DeFi Pulse, the locked value of DeFi platforms has reached $100 billion in 2022. However, numbers alone do not encompass the incredible innovation that the DeFi industry has generated in such a short time.
Despite this stellar track record, crypto-staking smart contracts have several serious flaws when it comes to capital utilization. When attempting to develop the DeFi economy, they have a specific influence on liquidity investors. The inability to produce any interest on staked assets is one such problem. As a result, DeFi Markets have introduced liquid staking.
Why is Liquid Staking so Innovative?
A traditional goal of staking in PoS protocol-based projects has been to lock one's assets for a given period of time in exchange for a predetermined staking profit. While this guarantees the investment return on staked assets, much like a bond, it also limits token owners' capacity to obtain higher returns on those assets through the DeFi ecosystem.
What Makes it Unique From Regular Staking?
If you've staked all your cryptocurrency holdings, you're left in a liquidity crisis. Meaning, you’re put in a bind such that you can't invest in more lucrative crypto pairings on exchanges. Liquid staking means that a protocol mints derivates of equal value to staked tokens, allowing users to utilize them as collateral in other financial applications. Staking derivatives, the liquid version of staked assets, operate similarly to derivatives in that they may be freely traded between parties, geographies and blockchains. As the name implies, it enables you to use your staked cryptocurrency assets in a variety of trading and investment opportunities, giving you the best of both worlds: the return on your staked assets that you expect and the APR profits from new trading opportunities that you invest in.
That is the basis behind the current surge in popularity of Liquid Staking. Several new initiatives with liquid staking are emerging in the DeFi ecosystem, and crypto token holders also want to make more on their stakes. Here, we'll look at one such initiative that has recently gained much attention.
What does it have to do with DeFi?
Investing in cryptocurrencies while profiting from liquidity is foundational to DeFi. Whether to earn interest, borrow money, or farm output- is up to you. This is in stark contrast to TradFi, in which once you have invested in a stock or other investment vehicle, you can only profit when the asset's price increases or decreases. Liquid staking is basically an extension of that idea, with the fundamental difference being that idle assets can be utilized as collateral in other financial applications.
It increases investment prospects as a result, strengthening the connection to DeFi. As an illustration, you could tokenize the majority of your assets that are staked on a blockchain, integrate them into other protocols, and then utilize them in DEXs and other DeFi protocols. Staking investors may use this to limit risk exposure and earn extra profits on staked crypto assets.
What are the Difficulties?
One of the main difficulties is that liquid staking derivatives are not necessarily fungible, and the state of the underlying risk is not taken into consideration. In reality, speculation, appreciation, network adoption, and dependability should be considered while evaluating a staking derivative. It is, as a result, difficult to price and adequately account for the risks presented by such disparities and correlations. The elastic supply pegging mechanisms that most liquid staking tokens use also possesses inherent risks. Because it is far more complex than a cause-effect risk analysis, it not always straightforward on how to assess risk of liquid staking L-tokens.