What Is Liquid Staking? How It Works and Advantages Explained

In this article, we’ll explore what liquid staking is, how it works, and why it’s reshaping the decentralized finance (DeFi) landscape. Let’s start by understanding the foundations of staking itself.

What Is Staking?

At its core, staking is the process of locking up crypto assets to participate in the security and operation of blockchain networks. It is a critical feature of Proof-of-Stake (PoS) blockchains, where validators are chosen based on their staked assets to confirm transactions and add blocks to the chain.

In exchange, participants earn staking rewards, which typically come in the form of additional tokens. While staking provides a predictable income stream, the locked nature of these assets often limits their utility in the wider DeFi ecosystem.

What Is Liquid Staking in Crypto?

Liquid staking is a game-changing approach in the crypto ecosystem, allowing users to stake their assets while maintaining liquidity. 

Traditionally, staking required participants to lock up their funds for a specific period, making them unavailable for other financial activities. However, with liquid staking protocols, users can earn staking rewards while still utilizing their assets for trading, lending, or investing in DeFi applications.

When assets are staked through liquid staking, users receive a derivative asset, commonly known as a liquid staking token (LST). These tokens represent the staked assets and can be freely traded or used across various platforms. This mechanism ensures that users retain the benefits of staking without sacrificing their assets’ flexibility. 

For example, Ethereum liquid staking allows users to stake ETH and receive staked ETH (stETH). This token can be used to provide liquidity on decentralized exchanges, earn yield through DeFi protocols, or even participate in collateralized lending. Similarly, Solana liquid staking provides users with mSOL, enabling them to unlock new opportunities within Solana’s active blockchain network.

Liquid staking also democratizes access to staking by reducing technical barriers, making it accessible to users who may not have the resources or expertise to run validator nodes.

What Are Liquidity Pools in Crypto?

Liquidity pools are groups of cryptocurrencies deposited in smart contracts to facilitate trading and lending on platforms. These pools help eliminate the need to manage an order book by guaranteeing that takers provide liquidity for decentralized finance (DeFi) purposes.

Liquidity staking tokens, including stETH or mSOL, can be provided into liquidity pools. Such integration enables the users to collect the transaction fees and yields while still enjoying staking services.

Why Are Liquid Staking Tokens (LSTs) Gaining Popularity?

Liquid staking tokens (LSTs) are gaining traction because they combine staking rewards with liquidity, allowing users to actively use their assets in DeFi protocols. LSTs unlock flexibility, enabling activities like lending, trading, and yield farming while still earning rewards.

Some innovative projects explore combining LSTs with NFT mechanics, further diversifying their use cases. This unique integration opens opportunities for gamified staking, digital collectibles, and cross-ecosystem rewards, enhancing LSTs' appeal. 

LSTs can be utilized across various DApps, enhancing their functionality and usability within DeFi ecosystems.

Liquid Staking vs. Pool Staking

While liquid staking and staking pools share some similarities in making staking more accessible, their operational models and benefits vary:

• Staking Pools: In a staking pool, people pool their resources so that they can fulfill the minimum staking quota to become a validator node. The network’s pooled assets are then frozen and cannot be transacted until the unstaking period is over. This option is best for users who want to stake a small amount but do not want to be able to spend it at the same time.

• Liquid Staking: On the other hand, liquid staking enables users to receive derivative tokens such as stETH or mSOL for the specific asset to be staked. They can still interact with DeFi protocols and, at the same time, earn staking rewards. These tokens act as the bond that has been staked and retain their utility value, remaining liquid.

There are also a few other key distinctions between staking pools and liquid staking:

• Liquidity: Staking pools lock funds, while liquid staking provides liquidity through liquid staking tokens.

• Flexibility: Liquid staking tokens can be used in yield farming, lending, or trading, whereas assets in staking pools are entirely locked.

• Risk Profile: Liquid staking involves smart contract vulnerabilities, whereas staking pools focus on network risks like slashing.

By addressing the limitations of traditional and pooled staking, liquid staking is emerging as a preferred option for users seeking flexibility and higher returns in the evolving DeFi ecosystem.

How Does Liquid Staking Work?

Liquid staking is made possible through a combination of innovative blockchain mechanisms and DeFi integrations. 

Here’s how it works step by step:

Validators

Validators play a crucial role in maintaining the security and operation of PoS networks. In liquid staking, platforms partner with professional node operators to handle the technical aspects, ensuring your assets are staked securely.

Consensus Mechanisms

Liquid staking relies on Proof-of-Stake (Pos), where validators are chosen based on the amount of staked assets. This ensures that the blockchain remains decentralized and tamper-proof.

Liquid Staking Tokens (LSTs)

When you stake assets, you receive liquid staking tokens, such as stETH or mSOL, which represent your staked holdings. These tokens can be used as collateral in lending platforms or traded on decentralized exchanges.

Liquid Staking Derivatives (LSDs)

Advanced protocols also offer liquid staking derivatives, which represent fractional ownership of staking rewards. These derivatives add an extra layer of flexibility for seasoned investors.

What Is Restaking?

Restaking is the process of staking derivative tokens (like stETH) to earn additional rewards.

This strategy amplifies the earning potential of staked assets.

With restaking, users stake assets like ETH via a liquid staking protocol and receive tokens stETH. Restake tokens are often staked on a secondary platform to generate further returns.

That said, restaking can have a few risks:

• Increased Complexity: Managing multiple layers of staking requires diligence.

• Smart Contract Vulnerabilities: Each additional staking platform introduces new risks.

What Are the Advantages of Liquid Staking?

Liquid staking offers unique benefits that make it a standout choice for modern investors:

Unlocked Liquidity

Unlike traditional staking, liquid staking ensures your assets are never out of reach. You can use your liquid staking tokens to access liquidity across DeFi protocols.

Multiple DeFi Protocols

Liquid staking integrates with many DeFi protocols, enabling activities like yield farming and lending, and providing liquidity on platforms such as Aave or Uniswap.

Staking Rewards

Liquid staking empowers token holders to earn staking rewards without losing access to their assets for trading or lending. Participants earn consistent staking rewards while benefiting from additional opportunities in decentralized finance.

What Are the Disadvantages of Liquid Staking?

Despite all the benefits that liquid staking has, it is still important to look at the other side so as to make informed decisions. 

Here are some key drawbacks to consider:

Slashing

The validators might receive penalties for downtime or malicious behavior, which could impact heavily on stalkers who use particular platforms.

Exploits

Like any other DeFi protocol, liquid staking applications rely on smart contracts and, therefore, are susceptible to hacking. Before using them, users should always conduct some form of research concerning the product or site.

Yield Volatility

The rewards derived from liquid staking derivatives may also vary depending on existing market rates or conditions, hence affecting profitability.

How Does Liquid Staking Work With Different Cryptocurrencies?

Liquid staking could differ in the way they are executed across various blockchains, but its main functionality stays consistent, that is, to offer maneuverability and accessibility while generating staking gains. Let’s explore how it works with some of the most popular cryptocurrencies:

Ethereum

In Ethereum liquid staking, platforms create stETH, which is an asset that tracks the staked ETH. This allows users to be rewarded through staking as they engage with the DeFi ecosystem.

Solana

Solana liquid staking refers to staking SOL to get mSOL, which can be used in lending platforms and liquid pools.

Polygon and Others 

Other chains, including Polygon, are also implementing liquid staking to increase the usefulness of their ecosystem and user activity.

Stake Your Crypto Assets With Gemini

Gemini provides a safe and convenient staking platform where you can stake your assets, including ETH or SOL. While Gemini does not currently offer liquid staking, it supports traditional staking services that allow you to earn rewards by committing your assets for a specified period. .

The Bottom Line

Liquid staking has reinvented staking by offering more liquidity compared to what traditional staking platforms provide. While the lending and borrowing process will not be the only way to utilize their tokens. Still, this new approach will allow such staking rewards and engagement in DeFi applications, among other things.

Stake smarter. Earn more. Go further! Sign up for Gemini’s staking platform now and make your cryptocurrency portfolio an even more profitable investment.