Ethereum has transitioned to a proof-of-stake (PoS) consensus mechanism in 2022. Validators must now hold a certain amount of Ethereum and meet strict requirements. These requirements include having a 24/7 internet connection and a dedicated computer to participate in the consensus process.
Alternative staking methods, such as staking pools and liquid staking, allow users to stake smaller amounts of ETH.
Liquid staking tokens are a relatively new concept in the blockchain ecosystem. These tokens allow users to earn staking rewards on their cryptocurrency holdings. Simultaneously, users are able to use them for other purposes, such as collateral for loans or trading on exchanges.
This is made possible by creating synthetic assets representing the underlying staked asset. For example, at Hord, stakers receive a liquid token called hETH that represents their stake combined with rewards.
Essentially, liquid staking tokens enable users to "unlock" the value of their staked assets, which can be particularly useful for those who want to earn passive income while still maintaining the liquidity of their assets.
There are four primary types of liquid staking tokens. These different architectures include: rebase tokens, reward-bearing tokens, wrapped tokens, and dual token models:
Rebase tokens, such as Lido’s stETH and Binance's BETH, automatically adjust their balances based on deposits and rewards. This adjustment, known as rebase, occurs periodically, typically daily.
Rewards-bearing tokens, like rETH, cbETH, swETH, osETH, and Hord’s hETH, gain value over time. Their price tends to be above ETH because the value of the rewards is added to the token's price. The exchange rate between the derivative and the staked asset determines pricing and earned rewards. Although less intuitive than rebase tokens, holding such tokens guarantees increasing rewards, making them a convenient approach to LSD rewards.
Some rebase LSDs have wrapped forms, like wstETH and WBETH. Once wrapped, they cease rebase adjustments and become reward-bearing tokens. Unlike rebase tokens, rebased derivatives' balance modifications need actions like minting, burning, or transfers.
A dual-token model involves issuing two tokens, where one maintains a 1:1 ratio to the staked asset, and the other represents rewards. StakeWise implements this with sETH2 and rETH2, while Frax uses frxETH and sfrxETH.
Some of the most famous liquid tokens include stETH by Lido, hETH, and rETH.
stETH, in particular, has gained significant traction in the market, with a market cap of over $3 billion. This token is pegged to the value of Ethereum and allows users to stake their ETH and earn staking rewards while still being able to use their holdings for other purposes.
Another example is hETH, which is a rewards-bearing liquid staking token. This token enables users to earn staking rewards and also benefit from potential price appreciation in the value of the token itself.
rETH is another notable liquid staking token, which is designed to work with Rocket Pool, a decentralized staking platform. This token enables users to earn staking rewards and benefit from potential price appreciation while using their holdings for other purposes.
Liquid staking tokens are commonly used in DeFi ecosystems, such as their use on liquidity platforms. By doing so, the staker can generate a higher APR or more rewards than by staking alone.
Another use case for liquid tokens is the ability to use them as collateral for loans. Because liquid tokens tend to have a value that is pegged to an underlying asset, they can be used as collateral in a similar way to traditional securities or other assets. This can be particularly useful for those who want to access liquidity without having to sell their assets.
Here are some important notes about liquid tokens to keep in mind:
It is vital to conduct thorough research and due diligence before investing in liquid tokens to ensure you understand the potential benefits and risks. Consider your investment goals and risk tolerance and choose the correct token to fit your needs. Also, it is essential to follow best practices for security, such as using a hardware wallet and keeping your private keys safe.
It is important to invest only what you can afford to lose when investing in liquid tokens. Liquid tokens are subject to significant price volatility. In addition, it is essential not to ignore the risks associated with liquid tokens, including counterparty risk and regulatory risk.
One of the primary risks of liquid tokens is volatility. Liquid tokens can experience significant price fluctuations, leading to substantial gains or losses for investors. In addition, liquid tokens are subject to counterparty risk, as investors rely on a third party to hold and manage their assets. Regulatory risk is also a concern, as regulations can impact the value of liquid tokens and the ability to use them. It is essential to stay informed about regulatory changes and potential risks and to be prepared to adjust your investment strategy accordingly.
Liquid Staking tokens have made the concept of staking more accessible and appealing to many in the world of cryptocurrency. Many consider it a low-risk investment strategy that can become highly profitable using DeFi strategies.
Despite this, risks can exist. Do your research before staking, and be sure to stake with a reputable platform such as Hord, Rocket Pool, or Lido.