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Over the years, staking has emerged as a cornerstone of DeFi, offering investors an avenue to participate in blockchain networks while earning rewards for validating transactions. Traditionally, staking involved locking up assets in smart contracts, often sacrificing liquidity to earn staking rewards. However, with the advent of liquid staking and restaking, new paradigms have emerged, revolutionizing the staking experience for participants.
In this blog, we delve into the intricacies of liquid staking and restaking, two innovative approaches that have captured the attention of crypto enthusiasts worldwide. We’ll explore the concepts behind these strategies, dissect their advantages and considerations, and provide insights into their potential implications for the future of DeFi.
What is Liquid Staking
Liquid staking refers to the process of staking digital assets in a way that allows them to remain liquid and tradable while still participating in a Proof-of-Stake (PoS) network. In traditional staking, tokens are locked up in a smart contract for a predetermined period, rendering them illiquid. However, with liquid staking, staked assets can be used in DeFi protocols or traded on exchanges, providing flexibility to token holders.
How Does Liquid Staking Work?
Users begin by staking their tokens in a liquid staking platform, where they receive liquid staking tokens (LST) representing their stake. These LST tokens are fungible and can be freely traded or transferred while still earning staking rewards. This innovative approach provides users with the flexibility to capitalize on the benefits of staking without sacrificing liquidity.
In return for staking their tokens, users earn staking rewards as their staked assets contribute to the security and operation of the PoS network. These rewards are typically distributed proportionally to the amount of tokens staked by each participant. By participating in liquid staking, users can optimize their investment strategy by earning rewards while maintaining the ability to access and trade their staked assets as needed.
Key Statistics
The TVL in LSD protocols has surged from ~ $7.5 Bn to ~ $34 Bn on a YoY basis. Lido dominates the market with a ~ 64.6% share and a staggering ~ 327K stakers, followed by Rocketpool, which has a ~ 8.4% share with ~ 3.5K node operators.
What is Restaking
Re-staking, on the other hand, involves continuously compounding staking rewards by reinvesting them back into the staking pool. Instead of withdrawing rewards, token holders choose to restake them, allowing for exponential growth in their staked assets over time. This approach maximizes the potential returns generated from staking activities.
How Does Restaking Work?
EigenLayer stands as the major protocol that allows restaking. On EigenLayer, native restaking is exclusively accessible to users who operate an Ethereum validator node. Governed by smart contracts, this restaking mechanism manages staked assets under a validator’s node, bolstering the crypto-economic security it provides.
Alternatively, liquid restaking employs liquid staking tokens (LST). Stakers stake their assets with a validator, receiving tokens representing their stake. Subsequently, these LST tokens are staked on the restaking protocol. Following deposit, users can explore Actively Validated Services (AVSs) on EigenLayer to re-stake their tokens, providing these dApps with security infrastructure through restaking.
Key Statistics
Since the inception of EigenLayer in June’ 23, it has garnered ~ 78K users who have staked ~ 938.3K ETH ($2.1 Bn) through EigenLayer. Around 459K ETH have been staked through its native restaking Beacon chain, followed by ~ 195K ETH staked through Lido.
Comparison Between Liquid Staking and Re-staking
| Aspect | Liquid Staking | Restaking |
| Liquidity | Provides liquidity, allowing staked assets to remain tradable and accessible. | Sacrifices liquidity for potential higher returns by continuously compounding staking rewards. |
| Accessibility | Offers flexibility, enabling token holders to use staked assets in DeFi protocols or trade them on exchanges. | Requires assets to be continuously staked without withdrawal to maximize compounding rewards. |
| Impermanent Loss | Exposes users to potential impermanent loss in DeFi protocols due to fluctuations in token prices. | Less susceptible to impermanent loss since rewards are continuously reinvested in the staking pool. |
| Yield Optimization | May offer lower overall returns compared to restaking due to the focus on liquidity. | Potentially generates higher returns over time through compounding staking rewards. |
| Risk of Slashing | Generally lower risk of slashing penalties as tokens remain liquid and accessible. | Possibility of slashing penalties if validators fail to meet network requirements. |
| Flexibility | Provides flexibility for users to adjust staking strategies based on market conditions or investment goals. | Requires commitment to continuously restake rewards, limiting flexibility in accessing staked assets. |
Risks and Considerations
- Smart Contract Risks: Liquid staking and restaking protocols rely on smart contracts to manage staked assets and distribute rewards. Any vulnerabilities or bugs in these smart contracts could potentially result in the loss of funds or exploitation by malicious actors.
- Slashing Penalties: Validators participating in restaking programs may be subject to slashing penalties if they fail to meet network requirements or engage in malicious behavior. Slashing penalties can result in the loss of a portion of the validator’s staked assets as a form of punishment for non-compliance.
- Market Volatility: Both liquid staking and restaking involve exposure to the volatility of cryptocurrency markets. Fluctuations in token prices can impact the value of staked assets and potential returns, leading to financial losses for participants.
- Regulatory Uncertainty: The regulatory landscape surrounding staking activities, especially in DeFi, is still evolving. Participants in liquid staking and restaking protocols may face regulatory challenges or compliance issues, which could affect the legality or viability of these activities in certain jurisdictions.
- Centralization Risks: Some liquid staking and restaking protocols may rely on centralized components or governance structures, which could introduce centralization risks. Participants should be wary of protocols that centralize control over staked assets or governance decisions, as this may undermine the decentralization principles of blockchain networks.
Future of Staking
The early success of protocols like EigenLayer indicates a promising future for the restaking ecosystem, with rapid adoption and expansion on the horizon. As awareness and understanding of staking mechanisms grow among both institutional and retail investors, we can anticipate wider adoption across the cryptocurrency landscape. This trend is likely to be fueled by the increasing recognition of staking as a viable means of generating passive income and participating in blockchain networks’ governance.
Moreover, as the blockchain space evolves, interoperability between networks will emerge as a crucial factor in the staking landscape. Cross-platform staking solutions will enable users to stake assets seamlessly across multiple chains, unlocking new opportunities for diversification and maximizing returns. This interoperability will facilitate the integration of staking into broader DeFi ecosystems, enhancing liquidity and efficiency across decentralized finance platforms.
Furthermore, decentralized identity solutions will play a pivotal role in enhancing the security of staking protocols. Identity-based staking mechanisms will enable users to interact securely with different staking platforms, ensuring trust and accountability in the ecosystem. By leveraging decentralized identity solutions, participants can safeguard their assets and mitigate risks associated with malicious actors or fraudulent activities.
Conclusion
Liquid staking and restaking represent compelling strategies for participants looking to capitalize on the potential of staking in the crypto landscape. While liquid staking enables flexibility and accessibility by allowing staked assets to remain tradable, restaking presents the potential for exponential growth through continuous compounding of rewards.
Both approaches have their merits and considerations, and the choice between them ultimately depends on individual preferences and risk appetite. As the adoption of staking continues to expand, it’s crucial for participants to stay informed about the evolving dynamics of the market and to exercise caution when engaging in staking activities.
