An Underrated Narrative: Liquid Staking

A look into the power of liquid staking and why it's an overlooked narrative in the crypto space.

Staking has been an integral part of DeFi for a long time, and a subsequent improvement on regular staking is liquid staking. As a product it is not sexy. It’s a relatively simple process which lacks any room for differentiation and ponzification. While everyone knows it exists, it doesn’t truly capture the attention of market participants due to its boring nature. The saying “less is more” is the most applicable here. Its power lies in its simplicity, but its simplicity makes most people overlook it. With this article I’m trying to bring back the attention to the underrated narrative of liquid staking.

Some Background 

The consensus mechanism of a blockchain is crucial to its security and trustless nature. Bitcoin uses the Proof-of-Work (PoW) consensus and it works for Bitcoin, but for Bitcoin only. The fact of the matter is that bitcoin fulfils a very specific set of purposes, it is a permissionless digital payments system with a clearly defined monetary policy that also has the element of provable scarcity. PoW works well for Bitcoin but it isn’t the answer for blockchains that are being designed to host a suite of DeFi & NFT applications. It is slow & unsustainable for the newer generation blockchains.

This is where Proof-of-Stake (PoS) comes into the picture. PoS is a consensus mechanism wherein users can stake their tokens to become a validator of the blockchain. The role of the validator is to order transactions in a block and produce the block after which they are added to the chain. PoS is faster, more sustainable, and has the potential to be more decentralized than a PoW system.

Ethereum is set to transition from PoW to PoS sometime this year (estimated: Q2). Other Alternative smart contract platforms have launched with PoS or PoS with some variation from the get go. So a major chunk of native tokens form various different chains will need to be staked. This creates the perfect storm for liquid staking.

So WTF is liquid staking?

If you already know what liquid staking is then skip to “The Narrative”.

It’s a fairly simple concept, when users stake their tokens with a liquid staking protocol, they get a derivative of the token they staked in return. This derivative will be the exact same price of the original staked token. The difference is that this derivative token is liquid (hence liquid staking). It can be used to trade, yield farm, make transfers, or do whatever else you please.

Let me try and explain with an example. Consider a blockchain that has token A as its native token. When this native token A is staked in a liquid staking protocol, the user will get token B in return. Token B is the same as token A but token B but it’s technically a wrapped version (so to say) of token A which can be used to participate in any activity in the crypto economy while token A continues to earn you staking rewards.

The Narrative

We all know that the markets are shaky right now and I’m no macro expert so I don’t know if things get better from here or worse. So when reading this don’t take it as financial advice (I’m literally a pleb sharing my thoughts).

Let’s begin with why liquid staking is important. To put it simply, it’s a way for all users to participate in maintaining the security of a blockchain network while maintaining or even increasing the overall capital efficiency of the ecosystem. Every user who stakes their tokens will earn some APY while still being able to retain the spending power of their tokens.

In my opinion this makes liquid staking a no brainer for users. You can literally earn rewards on a token while technically using the same token to participate in other activities. This will make liquid staking protocols potentially attract billions in TVL. Additionally, there is very little room for differentiation so the first movers for each chain are likely to be in the strongest position and remain in that position of power.

In terms of price action and activity it has been a relatively boring sector compared to the rest of DeFi. You don’t get your 69,837,384% APY and no 50x in a week followed by every fork doing a 10x. It is not the typical degen DeFi that tends to catch people’s attention.

As a medium to long term narrative I believe it has genuine legs. The growth of this sector will most likely be steady but continuous. So, let’s look at some of the projects.

Protocols and stats

Ethereum:

PoS for Ethereum is currently only live on the beacon chain, but there is still a substantial amount of ETH staked on it. At the time of writing there is 9.3m ETH staked on the beacon chain which is around $27b. Lido and Rocketpool are the biggest players in the ETH liquid staking market.

Lido ($LDO) has no minimum staking requirement. Users can stake how much ever ETH they wish to with Lido and get a proportional amount of stETH in return. There’s about 1.8m ETH staked with lido which is around $5.4b.

Users who choose to use RocketPool ($RPL) can stake their ETH and get rETH in return. Currently RocketPool has around 90k ETH staked with their platform. That’s around $264m. Both platforms offer around 4-4.5% APR on your staked ETH.

The numbers show that around 20% of all ETH staked has been staked through liquid staking services. Keep in mind that this is prior to ETH2.0 being live. Once that takes place I would expect more traffic to be driven through liquid staking services because to stake directly through Ethereum there is a minimum 32 ETH requirement. The majority of participants who would’ve been excluded but can now participate through Lido or RocketPool.

Cosmos:

Two of the most popular liquid staking protocols for the cosmos ecosystem is Stafi & pSTAKE. The most important is that they allow you to liquid stake $ATOM. For those of you who may not know. Staking $ATOM over the last few months has been a cheatcode for airdrops. Almost every new protocol in the cosmos ecosystem airdropped tokens to people who staked $ATOM. Now imagine being able to earn 12% APR + be eligible for airdrops + still be able to have that $ATOM liquid.

Stats for the amount staked in each protocol are unclear. Going off the TVL it is safe to assume they are still fairly small. pSTAKE has $46m & Stafi has $52m.

For a clearer image, Let’s assume that the amount of $ATOM that will be staked in these protocols is the same as on Ethereum (20%). Currently, 185m $ATOM is staked which is 64% of the total supply. So if 20% of that was staked with liquid staking protocols, that would be 37m $ATOM. At current prices that would be around $897m. Not to mention that pSTAKE & Stafi also accept other tokens to liquid stake.

Solana:

There are currently 3 active liquid staking protocols on Solana. Lido Finance, Marinade Finance, and Socean Finance (search socean.fi or it won’t show up). Lido has 2.1m $SOL staked, Marinade has 6.7m $SOL staked, and Socean has 667k $SOL staked. That’s a total of around 9.4m $SOL staked ($799m at current prices) which is around 1.8% of the total $SOL supply. Also important to know that $SOL has an annual inflation rate of 0.1%.

This low percentage can mean a couple things. The services are still relatively new on Solana due to which many $SOL holders may still not have caught on. There are very few DeFi products that accept these liquid staked SOL tokens to be used due to which there is no demand from users to have them. Due to SBF backing and their marketing strategies, a decent chunk of $SOL holders are normies & institutional buyers who don’t actively participate in DeFi and are just speculating on the $SOL price. Lastly, it’s a possibility that people are just unaware that liquid staking tokens exist due to which they aren’t being used.

Nevertheless, if you believe $SOL liquid staking will see demand in the future then it’s worth looking into these protocols because a cumulative 1.8% of total supply being staked with these protocols seems very low.

Avax:

Benqi Finance is the only liquid staking protocol currently available on Avalanche. There are no stats available for how much is staked with their protocol so let’s run a similar experiment to the one we did with $ATOM.

I’ll be a little more bearish and assume that 10% of the total staked supply will be staked for liquid staking. Currently there is a total of 221.7m $AVAX staked which is 55.66% of the total supply.  10% of that would mean 22.1m $AVAX staked which is around $1.5b at current prices.

Avalanche is a chain that’s filled with a lot more active DeFi degens so if Benqi manages to create meaningful utility around sAVAX, then the amount staked with them could be a whole lot higher.

NEAR:

The only liquid staking protocol available on NEAR is Metapool. Currently Metapool has 3.1m NEAR staked with them which is around $25m. 3.1m makes around 0.31% of the total supply of NEAR.

My minimal research suggests that there is very less utility for stNEAR which is one reason why the amount staked is so low. The other reason is that the NEAR blockchain had a temporary burst of users from November to January due to the ecosystem fund announcements after which the activity died down. Most of that usage was from mercenary rotatooors who were looking to plunder whatever alpha was available on NEAR until it was no more. If NEAR does end up getting more organic adoption in the future then it is likely that Metapool will too.

DOT:

The Polkadot ecosystem recently had its parachain auctions so the ecosystem is still in the process of being built out. Moonriver brought EVM-compatibility to Polkadot and with that came Lido. Currently, liquid staking is only available on Kusama with $KSM. There is a total of 423 $KSM staked with Lido which is around $55k at current prices. This makes up a miniscule 0.004% of total KSM supply

This service launched very recently so it is yet to be seen whether stKSM will be demanded or not.

LUNA:

The Terra blockchain current has only one liquid staking service available to my knowledge and that is, you guessed it, Lido again. There is currently 82m LUNA staked which is worth $4.3b at current prices. At the time of writing, there is 321m LUNA staked which is 40% of the total supply. So that means, out of the total staked LUNA, 25% has been staked with Lido.

Terra has one of the most dedicated and loyal communities in the space. The founder Do Kwon is quite a chad and builds non-stop. He knows what is needed in the ecosystem to bring adoption to UST and the other stablecoins which directly benefits $LUNA. So if the adoption and usage of the Terra ecosystem continues to increase then stLUNA will also continue to see demand.

FTM:

Liquid staking on Fantom is currently not available. However, it is coming through Stader labs & Ankr earn. These developments were announced recently, so soon enough we will have liquid staking for $FTM.

Currently, there is 1.3b $FTM staked which is 51% of the total supply. If we run the same experiment and say 10% of the total staked token will be staked with the above mentioned liquid staking protocols, that is around $195m at current prices.

Not only does this make this an attractive play if you’re someone who likes to get in early. But even as a slightly longer term play, Fantom has the much awaited launch of Solidly coming up developed by Andre Cronje. I believe this will not only bring a lot of users & capital to the ecosystem, but also a lot of new developers who will work on building out a potentially robust ecosystem. If they manage to do this, I believe there will be protocols where stFTM (or whatever they end up calling it) will be accepted thereby generating more demand for liquid staking.

Harmony:

On Harmony, users can stake their $ONE for stONE through Tranquil Finance. There is currently 167.6m ONE staked with tranquil which makes up 3% of the total staked supply. $23m at current prices. I won’t add more here regarding why it’s low or whether it will increase because the points will be the same as those mentioned above.

The risks of liquid staking

The first major risk is the obvious third-party risk that you are exposed to. You are locking your tokens in with a third party protocol. You are trusting their smart contracts (which always have non-zero risk) & general security measures. Branching off this idea, it can also bring in an element of centralization given that there is minimal room for differentiation within liquid staking. This means you will have very few protocols that will corner this market and therefore hold a major chunk of staked tokens which adds to the security risk.

The element of trust is amplified because your staked tokens are delegated to node operators who are chosen by the DAO, or for early stage projects they are often initially picked by the founding team. You are exposed to the potential of node operators acting maliciously which leads to a slashing of staked tokens thereby having a negative impact on you or other users of the protocol.

Other than trust we must also consider some hypotheticals. Let’s say that there is an inexplicable event that takes place which makes people want to swap their derivative token for the original token, if the protocol does not have enough idle liquidity for such withdrawals there can be “bank run” type scenario which will lead to a major liquidity crisis & protocol distress. The other hypothetical worth considering is that suppose a validator has staked a ton with a liquid staking protocol and now owns a lot of the derivative token. There can potentially (though unlikely) arise a scenario wherein they can short the derivative token and then act malicious as a validator thereby tumbling the price, there will be incentive to do this if the value of staked tokens slashed is less than the amount they can gain from short-selling.

Some Thots ;)

The reason I believe liquid staking is underrated as a narrative is because the derivative token that you get from these protocols can essentially end becoming the de facto base currency of the protocol, since it has the same properties as the original token but you can earn rewards while being able to use it. Now if you noticed from the stats above, the amount staked in each of these protocols is still fairly small, so if you’d expect majority of the participants to use liquid staking services because it’s the rational thing to do, then each one of these protocols seems undervalued.

However, before aping into any of these protocols it’s important to know that liquid staking is a service and buying the native token of one of these protocols doesn’t guarantee direct exposure to the protocol doing well. It’s important to do your own research into each project and how the tokenomics work and then you can decide for yourself if the value accrual to the token is appropriate enough to get sufficient exposure to the upside of the project doing well.

I hope you enjoyed reading this, if you did and are feeling generous then please considering making a donation to my ETH address: 0x43A5D9C141125Cd67B9268ef28C7c6a9dC15F3c9

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