With the Shanghai upgrade around the corner, a new narrative has risen. Liquid staking derivatives on Ethereum have caught eyeballs among the crypto masses, but why? Today we look into why the unlock of Ethereum withdrawals has pushed this narrative into one which cannot be missed.
Before diving into the protocols leading the charge for this Narrative on Ethereum, we got to understand what liquid staking is. To do that, you must understand one of the most fundamental cornerstones of DeFi, staking.
What is liquid staking?
To stake something, you put up something you own to say you are dedicated to the “cause”. Staking is a consensus mechanic that allows users to secure the network.
By dedicating native tokens you have/bought, you are simply making the network stronger, helping to protect the blockchain. In exchange, the network rewards your contribution by letting you earn staking rewards.
By staking, you are essentially adding computational power to the network.
While there are many benefits to staking, such as earning passive income and, in some cases, allowing you to have governance rights in voting, the most significant risk with staking is capital inefficiency.
Networks impose a lock-up period to ensure stability and security. If people were to unstake their crypto whenever they wanted, it could make the network less secure, arguably prone to more hacks.
This means people who stake their tokens will not be able to unstake their crypto immediately, making staking capital inefficient.
But that is what liquid staking solves.
Liquid staking is a way to keep the benefits of normal staking while maintaining flexibility to use your assets.
Stakers receive liquid staking derivatives in exchange for staking their assets; it represents their claim on the underlying stake pool and its yield.
In contrast to traditional staking, LS improves capital efficiency; stakers can now use staked assets in the ecosystem for lending, trading and as collateral, thereby lowering the opportunity cost of locking up assets for staking.
LSD tokens allow investors to earn a staking yields while being able to use the underlying token elsewhere in DeFi.