Liquid staking is an evolution of classic staking, a process that allows users to block a certain amount of cryptocurrency in a blockchain to contribute to the security of the network and, in return, receive rewards. However, unlike traditional staking, in liquid staking the user can maintain a certain ‘liquidity’ on their blocked funds. In simple terms, liquid staking allows users to staking their cryptocurrencies without giving up the ability to use them elsewhere.
Imagine liquid staking as an escrow bank deposit, but with early access to some of the capital. Instead of locking up your funds completely, you receive a ‘liquid’ token representing the amount you have staked. This token can be traded, sold or used for other decentralised finance activities (DeFi), giving you more flexibility.
But how does liquid staking work? In liquid staking, when a user stacks a cryptocurrency, they then receive a derivative token, often called a liquid staking token or liquid staking token(LST). This token represents the value locked in, including the initial amount and any rewards accumulated over time.
But let’s take a practical example to better understand. Suppose we use Ethereum for liquid staking. A user stacks 1 ETH through any liquid staking platform. In return, he receives a liquid token as stETH (that’s really what it’s called!), which represents the locked ETH. The value of stETH increases as rewards accumulate, so even if the user does not have direct access to the staked ETH, he can still sell or trade stETH on the market, maintaining a certain degree of liquidity.
If we wanted to make a comparison to something more common and traditional, we could compare it to a deposit account with interest. Let’s say you lock up your savings to get an interest rate, but the bank gives you a ‘liquid certificate of deposit’ representing those funds. With this certificate, you can get a loan or use it as collateral for other investments. Likewise, liquid staking allows you to earn rewards without giving up the possibility of using the value of your funds. Simple as that.
As with all financial opportunities, crypto or otherwise, liquid staking has advantages such as:
- Greater flexibility: you can use your funds even while staking.
- You can maximise earnings: you can generate rewards from multiple platforms.
- Increased liquidity: you can sell derivative tokens for immediate liquidity.
but also disadvantages such as:
- volatility risk is a major disadvantage: the value of liquid tokens can fluctuate.
- platform dependency: you are exposed to the risks and security of the liquid staking platform. After all, you are ‘sending’ your funds to a site that you cannot control directly.
If we were to take the most prominent example in the crypto market of liquid staking, it would certainly be Lido and stETH.
One of the most popular examples of liquid staking is, in fact, Lido, a platform that allows you to staking Ethereum in a ‘liquid’ manner. Lido allows one to deposit ETH, receiving in return stETH, a token representing the deposit made. As staking accumulates rewards, the value of stETH increases proportionally.
How to trade with Liquid Staking? Here is a simple diagram for a step-by-step understanding of how to go about it:
Liquid staking represents an interesting development in the cryptocurrency world, especially for those looking to optimise their capital without sacrificing flexibility. However, it is essential to understand the associated risks and to choose reliable platforms, such as Lido for Ethereum or other well-known solutions in the DeFi sector. Due to its accessibility, liquid staking can become a powerful but also very risky tool, especially if it is improvised.
