So you’ve locked up your money in a bank, a deposit that’s earning you interest over time. But what if you could still reinvest that same money somewhere else at the same time and earn even more? Sounds impossible, right? In decentralized finance (DeFi), it’s not. That’s the essence of liquid staking, a concept that has opened up multiple paths in DeFi.
Before we dive into what makes staking ‘liquid,’ let’s step back for a second.
The basics: Proof-of-stake and validators
Most modern blockchains, like Ethereum after its Merge, use a system called Proof of Stake (PoS). In this model, the network doesn’t rely on massive computers solving puzzles like Bitcoin’s Proof of Work. Instead, it relies on validators, people or organizations that lock up (or “stake”) a certain amount of cryptocurrency to help verify transactions, participate in consensus and add new blocks to the blockchain.
They are essentially security guards for the network. The more crypto they lock up, the more trust the system places in them. In return, validators earn rewards, usually in the same cryptocurrency they staked. But there’s a catch: if they act dishonestly or try to manipulate the network, they can lose their staked funds.
What is staking?
For everyday investors, staking is like depositing money in a savings account, except instead of the bank paying you interest, the blockchain network does. You delegate your crypto to a validator, who uses it to help keep the network secure and efficient.
When we say “secure,” we mean ensuring that transactions are valid, that no one is spending the same coins twice, and that the system keeps running smoothly. Your staked crypto adds to the validator’s “weight,” giving them a higher chance to validate the next block and earn rewards, a portion of which they share with retail stakers.
As validators get more power and stability from your stake, this increases their chances of earning more rewards. Retail stakers, the regular users, benefit by earning passive income without needing to run complicated validator nodes themselves.
It’s a win-win setup that keeps the blockchain safe and rewards participation.
The ups and downs of staking
Pros:
• You earn passive income on your crypto holdings.
• You contribute to network security and decentralization.
• It often offers higher returns than traditional savings.
Cons:
• Your crypto is locked for a period, meaning you can’t sell it quickly if prices drop.
• You’re exposed to validator risk if they behave poorly (slashing).
• Rewards can fluctuate depending on network activity and inflation rates.
These limitations led to an innovation that solved one of staking’s biggest problems: liquidity.
Enter liquid staking
Liquid staking emerged around 2020, pioneered by platforms like Lido Finance. The idea was simple but powerful. Normally, when you stake crypto, it’s locked and can’t be moved until the staking period ends. With liquid staking, you still stake your tokens, but in return, you receive liquid staking tokens that represent your staked amount, for example, stETH represents staked Ether.
Those tokens can then be traded, lent out, or used in DeFi protocols while your original crypto keeps earning staking rewards in the background. It’s like depositing your savings in a bank but getting a certificate you can still spend or invest elsewhere.
Staking vs liquid staking
Traditional staking ties up your assets; a liquid staking protocol frees them. Traditional staking rewards are straightforward; liquid staking adds layers of flexibility, but also complexity.
Pros of Liquid Staking:
• Instant liquidity even while staking.
• Can be used in DeFi strategies for yield or even trading.
• Removes the need to run your own validator.
Drawbacks:
• Smart contract risks from the protocols issuing liquid tokens.
• Possible loss of value if the liquid token trades below its underlying asset.
• More complex to understand and manage than regular staking.
Liquid staking and the future of defi
This innovation unlocked a new wave of strategies in decentralized finance. For example, someone staking ETH through Lido receives stETH. They can then use that stETH as collateral on a platform like Aave to borrow stablecoins, reinvest, or explore yield farming opportunities. It effectively turns staked assets into working capital, compounding potential earnings.
If traditional staking was about trust and patience, liquid staking is about flexibility and creativity. It’s giving crypto holders the best of both worlds, the security of staking and the freedom of liquidity.
