The question of Liquid Staking being the Future of Proof-of-Stake (PoS) is not one that can be answered in a straight forward manner without sky-diving into the concept of liquid staking and understanding what liquid staking really means to the world of Decentralized Finance (DeFi). To do this effectively, let’s talk a little about blockchain technology shall we…….
BlockChain: A Brief Build up
Picture this scenario:
Jonathan (anonymous person) is seeking a way to make payments to his brother who resides in another state. He can usually utilize a bank or a payment transfer service like PayPal as a general alternative. These solutions entail the use of third parties to complete the transaction, and as a result, a portion of his money is subtracted as a transferring penalty. Furthermore, in situations like these, Jonathan cannot guarantee the security of his funds because a hacker could interrupt the network and take his funds. Jonathan is the one who loses in both circumstances. This was the kind of event that precipitated the adoption of BlockChain technology.
In the scenario above, the adoption of the BlockChain technology was all in a bid to eliminate the involvement of central financial intermediaries (centralized finance) such as a banks or payment transfer services, as well as central banks that manage how much money is printed and circulated, thereby having more power over the economy.
This is as opposed to Decentralized Finance (also known as DeFi), which is a blockchain-based type of finance that offers standard financial instruments without the use of central financial intermediaries such as brokerages, exchanges, or banks. Rather, smart contracts on blockchains are used.
Bitcoin was the first cryptocurrency in DeFi to utilize the blockchain technology of which Proof-of -Work (PoW) was its consensus mechanism.
PoW to PoS
PoW is a mechanism that permits the decentralized network to reach a consensus like account balances and transaction sequence. This prohibits users from “double spending” their currencies and makes the Blockchain extremely difficult to hack or falsify.
The Problems with PoW
PoW blockchains have a number of drawbacks, the first of which is that they waste energy, which is terrible for the environment. Additional electricity is consumed as computers conduct additional computational work. This can quickly build up to a significant quantity of wasted electricity.
The security issue is the second main disadvantage of Proof of Work blockchains. Only if there is a vast network of miners competing for block rewards do Proof of Work blockchains provide appropriate security. If the network is tiny, the prospect of a hacker gaining a simple majority of the network’s processing capacity and staging a 51% attack still exists.
These setbacks led to the adoption of Proof-of-Stake consensus mechanism in which the validators’ staked crypto assets serve as an economic incentive to function in the best interests of the network. If a validator accepts a bad block, they will have a percentage of their staked funds “slashed” as a penalty.
While “staking” in PoS is supposed to solve the problems imposed by PoW, it still has its shortcomings.
Emergence of Liquid Staking
If Jonathan in the scenario above decided to stake his crypto asset in a project, it means that he has locked up his asset in that project’s staking platform by providing security as his own contribution to supporting the network of that project. Sadly, this also means that Jonathan will be restricted from generating even more profitable returns as he will not be able to receive incentives on these assets that are already staked (locked).
A cure to this problem which is rapidly gaining traction in DeFi is Liquid Staking, in which Jonathan enjoys benefits in terms of generation of returns by utilizing his staked assets as a collateral for other investment possibilities. The reason why Jonathan can enjoy these benefits is because his staked assets become tokenized, thereby enabling him use them as collateral in other financial applications.
These benefits above include (but are not limited to) incentives which are derived from the interest generated by his staked assets, and prospective profits from new trading or investing possibilities he discovers.
Liquid Staking Solution Categories
There are primarily 5 categories of Liquid Staking solutions, these are:
- Custodial- A centralized entity holds the private keys and issues staking reward representations under this technique. These platforms may also require users to complete a Know Your Customer (KYC) process. Stakehound is an example.
- Collateralized loan- A distinct trustless protocol is used in this approach to provide liquidity for staked assets and to enables users to mint stable coins, rendering their assets liquid. Ramp DeFi is a good example.
- Native- Protocols under this category such as Acala Network build liquidity representations for staked assets at the core protocol level, making it ineffective for other platforms to do so.
- Exchange- Binance and Kraken are perfect illustrations. Here, centralized exchanges use this method to permit token holders to interact in other products on their platform.
- ETH 2.0- These are Ethereum (ETH)-specific protocols that issue derivatives for staked assets at the core protocol level. For instance, consider the Rocket Pool.
Whereas each technique above has its own set of benefits and shortcomings, they don’t cover all of the aspects of an ideal liquid staking solution (which, in my opinion, isn’t possible to achieve, but we can get close). They’re either centralized, which means they’re obscure, or they don’t enable cross-chain communication.
Ultimately, these techniques are improving their user experience principles on a continuous basis to make the applications a lot easier to use, allowing users to optimize their rewards by engaging in both liquid staking and DeFi and ecosystems.
How pSTAKE unlocks liquidity of PoS assets for dual rewards
If Jonathan stakes his $XPRT on pSTAKE, he will receive stkXPRT tokens as a representative token. The staked token’s representative token is a clone that serves as a receipt for the staked token. The logic being that it becomes valued at the same level as the staked assets, allowing Jonathan to exchange them on DeFi markets.
Jonathan’s $XPRT and the stkXPRT which he received have a value in the ratio 1:1. The only way he can recover his staked $ATOM is with the stkXPRT. In other words, Jonathan becomes capable of earning regular benefits for staking $XPRT alongside additional incentives by utilizing the staked representative tokens for various DeFi activities ranging from borrowing, to lending, as well as LP rewards for providing liquidity).
The perfect example to back this scenario is PersistenceOne’s LP program on SushiSwap. If Jonathan was a Liquidity Provider of the stkATOM-ETH or stkXPRT-ETH and he staked his LP tokens during the campaign period, he would be among those to benefit from the 6 million $PSTAKE tokens to be distributed as rewards.
Liquid Staking can shape the future of PoS in more ways than one:
With all that has occurred in the DeFi space, I believe that Liquid Staking will shape the future of PoS because it offers users an edge when it comes to unlocking liquidity. Jonathan (as a businessman) definitely would love the idea of generating returns on assets that are already staked (locked), but this cannot be achieved via ordinary staking of his $XPRT or $ATOM. In fact, If he has staked 100% of his assets, he probably will be in total misery because of his inaccessible liquidity. While Jonathan’s net worth appears to be high in the books, illiquid assets can’t be used to invest in possibly more advantageous prospects.
But with the introduction of Liquid Staking, Jonathan finally has a reason to smile because at last, he has the luxury of killing 2 birds with 1 stone by providing liquidity via his stkTOKENS and earning normal incentives plus extra rewards as he utilizes his staked representative tokens.
In terms of enhancing the security of the PoS network, Jonathan will obviously feel more inclined to stake his asset because he is aware that he can earn double rewards. In the unavailability of a liquid staking protocol, he can stake in a PoS protocol to help secure the network and earn rewards, or he can opt to engage in the DeFi ecosystem for a higher overall incentive. As a result of liquid staking, Jonathan becomes capable of doing both, and he is encouraged to stake on PoS network, ensuring the network’s security.
On the assumption that Jonathan isn’t a holder of $XPRT but somehow gets on SushiSwap for instance, in the process he comes across stkXPRT-ETH pool or stkATOM-ETH pool, curious Jonathan would most likely want to know more about these strange pools. Consequently, he does his research and discovers the prospects of $XPRT and/or $ATOM and the projects that these tokens are native to (Persistence or Cosmos respectively). The projects are thus exposed to more and more potential users (Jonathan being one of them). This solidifies the security of the network because more prospective users means that more $XPRT or $ATOM will be acquired, giving rise to more potential LP providers, which leads to an increase in staking ratio.
Every crypto enthusiast, like Jonathan will definitely love to be a part of such an approach because Liquid Staking is a win-win for both the users and the protocol.
Due to the fact that liquid staking enables stakers to dramatically improve their capacity to earn yield, interest in liquid staking solutions has grown almost as consistently as DeFi in its entirety.
Its true that DeFi just got started, it is also evolving very quickly! Without a doubt, liquid staking will shape DeFi’s future. Platforms that enables stakers to optimize their returns will catapult DeFi into the next level of development, where collateralizing staked assets to produce more income is not only conceivable, but also simple and accessible to anyone.
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