Headline: What is liquid staking?

Body:  OK, in the past, we have explored the Proof of Work consensus model of early Bitcoin network.   In essence, it required miners to solve very complicated computational hash functions, and the first one to the right solution, would receive a reward denominated in Bitcoin.  This worked but was extremely inefficient, requiring massive amounts of electrical power to run the boot-strapped supercomputers, and there were more than one actual fires and explosions.  So, it was a step, when Ethereum came along and used a consensus model of Proof of Stake for its validators.   These validators need to have a minimum of 32 ETH to become a validator, or they can work with others in a “staking pool.”  It should be noted that some validators can earn quite a high APY for their staking activities.

This is exciting!!  So, what’s the downside?

There are 3 main problems with staking Ethereum:

  1.  Minimum amount is highà  Currently, 32 ETH is required to be a validator and as of 5/7/2023, this would be in the neighborhood of $61,000 USD.   So, it is quite an investment that is required.
  2. Individual responsibilities are weighty
  3. The assets are immovable until the transactions are enabled and added to the blockchain.  So, the validator cannot sell or transfer these ETH once they are staked to help process a transaction.  This process can sometimes take a long enough time that the price per ETH has moved markedly. To get past this problem, some investors try to stake transactions through a centralized exchange.   But, they should know that the exchange might charge a considerable fee for the liquidity that they gain.

So, what is one to do?

We have seen something like this before.   Remember Mortgage Backed Securities?   When placed into tranches of increasing risk, the mortgage backed securities can be grouped into collateralized default options, essentially a derivative of mortgage backed securities.  (Remember how incredibly successful those were in 2009?)  Liquid staking allows one to place their ETH into a staking situation and receive daily staking rewards.   But, in liquid staking, the validator also gets tokens representing their interest in the staking pool.    So, they can transfer this token however they would like, and it is purchased, sold or transferred, just like an ETH.   (Before you jump up and down, screaming “I found a loophole!” you should realize that this is a type of debt until the transaction has been added to the blockchain.  Thus, liquid staking is a leveraging of cryptocurrency.  This is extremely risky.  (Remember my illustration of derrivatives in cryptocurrency?   It is like trying to change a light bulb on the ceiling by standing on 2 stacked rolling chairs.   This is not recommended.)

That said, there are services out there today, designed to help you become involved in this liquid staking.   For instance, there is a service called Lido (currently holding over 75% of the world liquidity staking activity), and they will help you to execute your liquid staking on the Ethereum blockchain.   And, there must be many others as well because more than $14 Billion USD is represented in these liquid staking paradigms.  (One investor has over $500 Million involved in liquid staking arrangements already)  These services are even honing their marketing materials effectively, as they emphasize the investor maintaining their sovereignty over the cryptocurrency.  As a result, after the Shanghai upgrade to ETH, liquidity staking is expected to increase markedly.

What is liquidity staking versus exchange staking?

OK, liquidity staking was explained as a form of derivative instrument above.   It allows one to use the tokens for whatever purpose they desire, regardless of use case, and not restricted by exchange.   Exchange staking is just like liquidity staking, BUT, you keep all tokens and coins within one exchange.  This can be convenient, BUT, be aware that the exchange is now a counterparty to your transaction, and they might restrict what you can do with your assets.

Top 3 Ethereum Liquid Staking Protocols

What are the Top 3 Ethereum Staking Protocols?   I will explain them briefly below, but, please be aware that Lido is by FAR the largest,  holding about 75% of the liquidity staking market in cryptocurrency.

Exchange ProtocolWhat is received by investor?What is the native cryptocurrency of the algorithm?What is the size of this protocol?
LidostETH tokens are received by the investor on a 1:1 basis.   stETH are minted immediately and burned when redeemed.The native cryptocurrency of this protocol is the LDO$7.68 Billion
Rocket PoolSimilar to the above.The native cryptocurrency of this protocol is the RPL$800 Million
AnkrSimilar to the above.The native cryptocurrency of this protocol is the ankrETH token.$153 Million

The Verdict

There is an idea in investing that, to obtain the  potential for reward, one must also stomach an equivalent amount of risk.  To be sure, the potential rewards for liquid staking can  be very enticing.    The risks that accompany these potential rewards are so numerous, it doesn’t seem that there is equity between the two.   Further, on the equity markets generally, when buying a stock, the potential losses are limited to the amount invested.   But, because of the derivative, the losses related to this investment, are unlimited.    Overall, it appears to be a sub-optimal investment.


Liquid Staking and Its Benefits: A Deep Dive by Lido | CoinMarketCap

Liquid Staking Replaces DeFi Lending as Second-Largest Crypto Sector (coindesk.com)

Liquid Staking Takes DeFi By Storm With $240 Million Lido Inflow, Apparently From Justin Sun (forbes.com)

What is Ethereum Liquid Staking and Why It Is Crucial As Shanghai Upgrade Approaches? (cryptopotato.com)

Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice.   Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.


Leave a comment

Your email address will not be published. Required fields are marked *

Share via
Copy link
Powered by Social Snap