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How liquid staking finance (LSTfi) is shaping the new frontier of DeFi liquidity and yield

In this post:

  • Traditional staking platforms lock up users’ tokens until they are unstaked. 
  • Liquid staking offers a wider range of utility and liquidity in the DeFi ecosystem than traditional staking. 
  • There are pertinent challenges that hinder the widespread adoption of LSTfi.

There’s no doubt that Liquid Staking Tokens (or LSTs) took over the decentralized finance (DeFi) market in 2023, becoming the largest sector in the space – amassing over $26 billion by November 2023. According to DeFi Llama, the market today has over $52 billion in total locked value (TVL), with several analysts predicting LSTs will grow even further in 2024. 

Liquid Staking Tokens, popularly known as LSTs, is a crypto-specific term that refers to obtaining a tradable (usable) asset in exchange for staking a cryptocurrency on a proof-of-stake blockchain. For example, Lido Finance, the largest liquid staking platform, allows users to stake Ethereum (ETH) and in return receive stETH, the LST, which can be used across other DeFi platforms. 

For better understanding, traditional staking platforms lock up users’ tokens until they are unstaked. When staked, the user cannot access the tokens and will need to wait till the tokens are unstaked to use them. On the other hand, liquid staking allows users to retain the value of their staked tokens, which can be used across other platforms e.g. lending, borrowing, governance etc. while still providing rewards on the staking platform. 

The explosive growth and importance of liquid staking in DeFi

As you can already tell, liquid staking offers a wider range of utility and liquidity in the DeFi ecosystem than traditional staking. Adding to the security and consensus mechanism that staked assets provide liquid staking further allows users to earn additional rewards as well as provide liquidity across the DeFi ecosystem. 

On April 12, 2023, Ethereum finally allowed stakers to unstake their tokens, as it transitioned into a proof-of-stake (PoS) network. This marked the start of the growth of liquid staking and liquid staking finance. Since then, the TVL on liquid staking platforms has grown explosively from $14 billion to $52 billion, representing a growth rate of 271% during the period. Lido Finance, Rocketpool, Binance, Coinbase, Stader and many other platforms have experienced a swell in total TVL, driven by the growth of LSTs and LSTfi. 


Growth of Liquid Staking Finance TVL Jan 2023-April 2024 (Image: DeFi Llama)

The various platforms that use LST tokens form the LSTfi, or liquid staking finance, sector. LSTfi refers to the use of LST tokens across DeFi. The LSTfi sector currently boasts $52.101 billion in TVL, reaching an all-time high of  $62.1 billion in early March. 

As such, the sector has witnessed an explosive growth in the past year. 

Challenges and risks of liquid staking derivatives

Despite the massive benefits that liquid staking offers, there are pertinent challenges that hinder the widespread adoption of LSTfi. Unlike traditional staking platforms, liquid staking requires users to have some technical knowledge of DeFi, leaving them to bear the operational risk. For example, the user must understand how a specific LSTfi platform allocates rewards, how and when to withdraw and so on. 

Secondly, most LST platforms lack non-custodial services, which means the user must trust the third-party provider to disburse the correct amount of tokens. Additionally, the smart contract could be open to possible code vulnerabilities, which could be detrimental to users’ funds if exposed. 

However, the biggest risk to liquid staking is liquidity risk. The price divergence between an LST and its underlying asset could lead to wide market inefficiencies. For instance, the stETH (LST token for ETH) has seen a wide divergence in price, which has led to stETH being sold at a discount. However, this is usually solved by market forces and the liquidity needs of the market and tends to correct over time. 

Nonetheless, the entry of centralized exchanges into liquid staking has helped solve the liquidity risks, providing a more stable price for the LST via taking a consortium approach in setting prices. 

Finally, liquid staking also faces a challenge in that users only get the benefits of earning rewards and maintaining asset liquidity. The LSTs offer more capabilities and utilities than the two benefits, crucially helping to create a more fluid and efficient DeFi ecosystem.

Power of the stablecoin: A new look at liquid staking 

In this section, we discuss the technological and economic advancements that LSTfi platforms are taking to make liquid staking more efficient and economically viable. Inter Protocol is one such platform. The platform allows users to mint IST, or the Inter Stable Token, which is a fully collateralized cryptocurrency-backed decentralized stable token for the interchain ecosystem. The protocol introduces several minting mechanisms to create a dynamic stablecoin model. For example, Inter Protocol leverages its Vaults, allowing users to mint IST by staking assets to provide rewards while gaining a liquid asset which is useful for several other utilities. 

First, the LSTs can be used as collateral for borrowing its native token, $IST, enabling users to minimize the volatility risk of their tokens. This bridges the gap between staking rewards and liquidity provisions and offers a robust solution to the liquidity risks faced by traditional staking mechanisms.

In addition, Inter Protocol has also enabled LSTs to gain much more utility, allowing holders to participate in liquidity provision, lending and yield farming. For instance, a user may leverage the Inter Protocol Vaults and use their LST to mint IST, which is then supplied to various $IST pools spread throughout Cosmos, Celestia and other ecosystems. By employing this strategy, users can earn rewards on their staked assets as well as gain additional yield via their participation in minting $IST tokens. 

Another novel platform, StakeWise launched universal liquid staking of ETH. Simply, StakeWise allows any ETH holder to mint osETH, a liquid-staked ETH receipt token, on any Ethereum node. The platform aims to make liquid staking as decentralized as traditional staking methods, advancing the ethos of DeFi and allowing participants to control the staking process while earning rewards and holding liquid assets.

StakeWise’s protocol stands out by empowering anyone to mint osETH, a liquid staked-ETH receipt token, through staking ETH on any Ethereum node. By offering all Ethereum validators access to a liquid representation of their stake, StakeWise advances the DeFi ethos of decentralization and allows participants to tightly control the staking process while accessing liquidity on demand

The future outlook on liquid staking

Liquid staking shows the potential of growing into a trillion-dollar sector, despite the challenges and risks associated with it. Technological advancements such as building indexed LSTs could ease the ownership of LSTs, allowing new users to purchase a basket of LSTs at once. Additionally, new LST products could help diversify the risks of LSTs and open new avenues for users to leverage their staked assets. 

Most importantly, if regulated, the liquid staking sector could witness a huge influx in TVL, as institutions jump in to take a piece. As the sector grows, liquid staking could witness greater diversification of products, such as the entry of stablecoins with Inter Protocol. 

Disclaimer. The information provided is not trading advice. Cryptopolitan.com holds no liability for any investments made based on the information provided on this page. We strongly recommend independent research and/or consultation with a qualified professional before making any investment decisions.

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