Wednesday, May 29, 2024

What is Liquid Staking. And How to Make Money on it ?

How derivative assets work in staking services and why their own tokens are growing in price?

Liquid staking services have grown strongly in popularity among investors, with the two largest of them, Lido and Rocket Pool, collectively gaining the largest market share among decentralized solutions. The rate of native Lido (LDO) and Rocket Pool (RPL) tokens has increased by 144% and 98%, respectively, since the beginning of the year, which formed its own narrative on the crypto market and led to an increase in the prices of tokens of their less popular competitors.

LDO Price Chart

The second largest crypto exchange Coinbase entered this market and quickly burst into the lead due to its own staking service and the associated cbETH token. According to Dune Analytics , decentralized staking protocols Lido and Rocket Pool hold 76% and 3.5% of the market in terms of the amount of ETH staking on their platforms, while Coinbase quickly gained 17% of the market.

Liquid Staking is a type of staking mechanism that allows holders of a cryptocurrency to earn staking rewards while still being able to freely trade their tokens on an exchange. This is in contrast to traditional staking, where tokens are locked up in a specific wallet or node for a certain period of time in order to earn rewards.

How Did the Demand?


In December 2020, the Beacon Chain parallel network was launched in the Ethereum ecosystem. The main Ethereum blockchain still continued to work on the Proof-of-Work (PoW) algorithm, transactions in the network were processed by miners, and the developers were just getting ready to transfer the network to the Proof-of-Stake (PoS) algorithm, which did not require their participation. But even then, those who wished could place their ETH coins on the Beacon Chain network, which initially supported staking, and act as so-called validators even before The Merge update on September 15 last year led to its literal “merger” with the main network.

Those who want to independently participate in Ethereum staking require special equipment with fast and stable Internet to maintain their own network node (node) and a minimum of 32 ETH collateral (more than $50 thousand at the rate at the time of publication). By becoming one of the validators in this way, you can earn income in the form of a block reward for a new issue of coins and several side sources of payments in ETH. The return on staking decreases as more validators connect to the network. Now it is 5.4% per annum with a total of 16.2 million ETH placed in staking.

The important thing is that despite the successful transition of Ethereum to the PoS algorithm in September, those who currently have staking coins cannot withdraw them yet. Such an opportunity will appear with an update under the working title Shanghai, which is expected to happen in March this year. It is the inability to withdraw your own funds that has become a powerful trigger for the growth of liquid staking services.

One of the main benefits of Liquid Staking is increased liquidity for the underlying cryptocurrency. By allowing holders to trade their tokens while still earning staking rewards, more people may be inclined to hold and trade the currency, leading to increased demand and potentially higher prices. Additionally, Liquid Staking allows for more flexibility in terms of how much of a token one is willing to stake, as opposed to traditional staking where the entire balance of a wallet or node must be locked up.

Derivative Assets


Members of staking pools can place any amount in them and receive income from staking in proportion to the invested funds. Pools for miners work similarly, combining the power of the equipment of thousands of devices of their users.

The pool stakes user coins in an Ethereum staking contract, and they remain technically locked until the Shanghai update. Pool operators at the same time issue a derivative token, backed in equal proportions by assets placed by users on the platform. Lido pool investors receive stETH tokens, while Rocket Pool contributors receive rETH. They also accrue income from staking in the pool.

These tokens give users liquidity to their underlying positions, allowing them to be traded or used to generate additional income through various strategies in Decentralized Finance (DeFi) protocols.

With the advent of Lido, Rocket Pool, Stakewise, a service from Coinbase, and other liquid staking operators, the amount of ETH staked in pools has grown by over 2,000% from 265K ETH at the beginning of 2021 to over 6.9 million ETH in January, which is equivalent to 5.6% of all existing coins.

There are also potential downsides to Liquid Staking. One is that it may be more complex to implement and operate than traditional staking, as it requires a more sophisticated system to track and distribute rewards to stakers. Additionally, there may be concerns about the security of tokens that are being actively traded, as they may be more vulnerable to hacking or other types of attack.

Prices are Rising


Liquid staking services have formed decentralized autonomous organizations (DAOs) to manage and reward native tokens of participants with different roles. Recently, Coinbase announced its intention to join the Oracle DAO of the Rocket Pool project. As a DAO member, Coinbase will be responsible for providing real-time ETH price data, running Rocket Pool nodes, and voting on protocol upgrades. For these services, Coinbase will receive RPL tokens as a reward.

It is around such tokens that one of the most popular narratives on the crypto market has been formed since the beginning of the year. Even in relatively small services, domestic tokens showed growth along with the most capitalized leaders. In addition to Rocket Pool’s own tokens (RPL) and Lido DAO (LDO), the price increase by tens of percent was shown by the coins of the Stake Wise (SWISE), Stafi (FIS), Stader (SD) projects and other tokens that aggregators classify as “Liquid staking » . The listing of RPL on the Binance exchange led to an additional jump in the price of the token by more than 30%.

cryptorank.io

When staking withdrawals are allowed with the Shanghai update, a significant influx of ETH coins into the market could potentially put pressure on their price. On the other hand, the possibility of withdrawing coins can attract new participants to staking, for whom this was a fundamental point, which, on the contrary, will increase the amount of coins in staking and smooth out potential pressure on the market.

Among the leading PoS cryptocurrencies, Ethereum has a relatively low staking ratio of around 14%. In comparison, Solana has 71% of existing coins staked, Cardano 72%, and BNB 97%. This suggests that many more ETH holders could potentially join the ranks of network validators – on their own or by participating in pools.

Overall, Liquid Staking is an innovative way to increase the liquidity of a cryptocurrency while still allowing holders to earn staking rewards. It is a new technology and it is yet to be seen how it will be adopted by the crypto communities and projects.

How Can You Earn?


Those who want to earn income from staking Ethereum should take into account the peculiarities of the operation of centralized and decentralized platforms. Centralized services require users to register and go through Know Your Customer (KYC) procedures. In addition, the responsibility for holding assets also falls on the platform, which implies the same risks that are inherent in traditional crypto exchanges.

Decentralized services such as Lido or Rocket Pool do not store user keys, and you can stake assets through them directly from your non-custodial wallets, such as Metamask or Ledger. However, such platforms carry the same risks as DeFi projects, such as vulnerabilities in smart contracts that can be exploited by attackers.

Popular platforms also provide liquid staking solutions for cryptocurrencies other than Ethereum. For example, Lido supports staking Solana, Polygon, Polkadot, and Kusama with their respective derivative tokens stSOL, stMATIC, stDOT, and stKSM.

More sophisticated “yeild farming” strategies through DeFi protocols can help maximize returns if tokens are managed wisely. You can earn additional income by providing liquidity on decentralized exchanges (DEX), for example, by placing your stETH and the equivalent amount of ETH in the stETH-ETH pool. Such services are available on Uniswap, Sushiswap, Curve and other similar services. You can lend interest-bearing staking tokens or use them as collateral for loans on decentralized lending platforms like Aave or Compound.

It is important that before investing in such tools, one should conduct their own review of strategies and protocols, as well as be aware of their inherent risks, such as vulnerabilities in smart contracts or significant fluctuations in the price of tokens.

**What are the risks of Staking ?

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