“What’s the point of having cake if you can’t eat it.”
– Martin Hart, True Detective, Season 1.
At the time of this writing, Ethereum’s Shanghai – Capella upgrade is only hours away. Meaning, the 14% of ETH that’s been locked up for the last two years under Ethereum 2.0 will soon be free as birds.
Enter liquidity staking, which hit Cryptoville in 2020 and 2021. The free market invented liquid staking in direct response to ETH 2.0’s indefinite lockup period. A lot of economic value was getting locked away, and the free market wasn’t cool with it staying illiquid.
Liquid staking is an interesting crypto sub-industry, and one I believe will only continue to grow. This article explores the Ethereum-based liquid staking ecosystem, specifically:
- The key players;
- What is liquid staking, where the value comes from, what are the benefits and risks;
- the three prominent Ethereum liquid staking protocols: Lido, Rocket Pool, and Frax Finance.
Let’s dive in.
Overview of the DeFi Liquid Staking Ecosystem
Looking down at the DeFi liquid staking ecosystem at an altitude of 50,000 feet, the main components are the following:
- Liquid Staking Protocols: dApps that receive and stake users’ assets to proof-of-stake networks. These dApps issue back to users liquid staking derivatives, in proportion to the amount of assets received. These dApps ensure users’ staking rewards are accounted for and release the staked assets back to users when the derivatives are returned.
- Liquid Staking Derivatives: Tokenized receipts of the staked assets. These receipts represent users’ shares of the staked assets and accrued rewards. The free market typically values these derivatives equal to that of the underlying assets. Thus, these derivatives are “liquid”. Users can deploy them across DeFi for trading, lending, collateral, staking, and in liquidity pools.
- Protocol DAOs and Tokens: Most of these protocols are governed by decentralized autonomous organizations (DAOs). DAOs typically use direct-democracy voting via governance tokens. The free market determines the value of these tokens.
- Related Third-Party dApps: Any other third-party DeFi dApp that offers a product or service associated with the liquid staking derivative. Typical examples would be DEXs, lending and borrowing protocols, and staking or aggregator protocols.
What is Liquid Staking
Liquid staking is the process of:
- Staking ones crypto-assets through a liquid staking protocol.
- Receiving liquid staking derivatives in return
- Using those derivatives in other DeFi applications
- All while still capturing the staking rewards of the underlying asset.
Let’s look at why these derivatives have economic value, and the benefits and risks of liquid staking.
Why Liquid Staking Derivatives = Economic Value
Liquid staking derivatives have economic value because the free market says so. But why would the free market say so? It’s actually very simple:
Note: Protocols only mint and distribute these derivatives in direct proportion to the amount of underlying crypto that they receive.
Benefits
Easy. You get your cake and can eat it too.
Liquid staking derivatives allow users to receive the staking rewards from their crypto assets, while simultaneously giving users the ability to use their…
David learned about bitcoin in 2015 and has closely followed the crypto industry since then.
His professional interests center around bitcoin, layer-one blockchain protocols, decentralized finance, and clean energy.
An attorney by trade, David has held licenses to practice law in the State of Hawaii and in US federal courts.
