"Staking" refers to the process of locking up native assets of a blockchain that uses the PoS (Proof-of-Stake) consensus mechanism (e.g. Ethereum) for a certain period of time to help maintain the operation of the blockchain and earn corresponding rewards.
Background#
In the traditional way of staking, one needs to become a validator on the blockchain network. Taking Ethereum as an example, becoming a network validator requires preparing hardware devices that meet certain conditions and staking 32 ETH, which has a relatively high barrier to entry. Once becoming a validator, the staked ETH will be locked in a smart contract and cannot be used for other purposes, thus reducing the liquidity of ETH. Low liquidity may end the cryptocurrency market, leading to bankruptcies of companies, traders exiting the market, and the currency losing all its value. Therefore, liquidity staking has become an alternative to traditional staking, to some extent addressing some of the drawbacks of traditional staking.
What is Liquidity Staking#
Users can participate in liquidity staking platforms by providing ETH without directly participating in traditional staking. The platform collects the ETH provided by participating users and packages these ETH into bundles of 32 ETH each to distribute to eligible network validators. These validators then engage in traditional staking, and the staking rewards will be shared among users, liquidity staking platforms, and network validators. Therefore, liquidity staking has lower barriers to entry and lower returns compared to traditional staking.
What are Liquid Staking Derivatives (LSD)#
When users participate in liquidity staking and provide ETH to liquidity staking platforms, the platform mints an equivalent amount of derivative tokens tied to the ETH provided by the user as proof of participation in liquidity staking. These derivative tokens are known as "Liquid Staking Derivatives" (LSD). Since these derivative tokens represent the user's ETH in the liquidity staking platform, they are generally considered to have slightly lower value than the original ETH. Therefore, these derivative tokens can be traded directly or used in other DeFi protocols to earn additional income. Even though the original assets are still staked, they provide liquidity to the stakers.