Liquid Staking: What It Is and How It Works

Liquid staking is a revolutionary tool allowing users to access already-staked tokens for other purposes. Here’s how it works.

Nov 15, 2023
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What Is Liquid Staking

Key Takeaways:

  • Liquid staking allows users to receive rewards by staking tokens in Proof of Stake (PoS) blockchain networks while participating in other DeFi activities at the same time.
  • Liquid staking offers increased flexibility for users to access liquidity without unstaking tokens, allowing for efficient capital allocation and greater utility.
  • Liquid staking protocols have been developed on networks like Ethereum, Avalanche, Polkadot, Cardano, and Cosmos.
  • Crypto.com offers a comprehensive liquid staking platform where users can stake various cryptocurrencies and earn rewards while maintaining flexibility.

What Is Liquid Staking?

Staking is a popular strategy for crypto users to earn interest on their holdings. It involves validating transactions on a Proof of Stake (PoS) blockchain network. Now an innovative solution called liquid staking is revolutionising the way users approach staking. 

In this article, we explain how liquid staking works and how users can participate, plus list popular cryptocurrencies that support liquid staking.

First, the Basics: How Does Staking Work?

Before diving into liquid staking, let’s understand the concept of staking and its benefits. Staking refers to validators staking the native token of a PoS blockchain for a chance to be randomly chosen to validate blocks in the blockchain network. As an incentive, the validators may earn a reward in the form of additional tokens. Staking is crucial to securing PoS blockchains and contributes to the security of the blockchain.

By requiring validators to stake their own tokens, it forces them to act in the best interest of the network. The benefits of staking include providing rewards and allowing users to help maintain and secure the network.

How Does Liquid Staking Work?

In liquid staking, native coins of a PoS chain are deposited with a staking service provider and delegated to one of many validators participating in the consensus protocol. The service provider then issues a ‘receipt’ in the form of a liquid synthetic token.

Liquid staking takes the traditional staking model further by allowing token holders to extract utility from their staked assets and enabling use of their staked assets for other activities. In traditional staking, once tokens are staked, they are locked up and cannot be used or traded until the staking period ends. However, with liquid staking, token holders can continue enjoying the value of their staked assets while still potentially receiving staking rewards.

The innovation of liquid staking opens up a world of possibilities for users, enabling them to potentially earn staking rewards without giving up liquidity.

Advantages of Liquid Staking

Liquid staking offers several advantages over traditional staking methods.

First, it provides traders with increased flexibility. By being able to use their staked assets for other financial activities, token holders can access liquidity without needing to unstake their tokens. This flexibility allows for more efficient capital allocation and the ability of holders to enjoy greater utility from their staked assets.

Second, liquid staking can reduce the opportunity cost of staking. In traditional staking, tokens are locked up for a specific period, preventing users from unlocking their assets before that time. Liquid staking may eliminate this opportunity cost by potentially enabling token holders to enjoy value from their staked assets while still potentially earning rewards. This feature may make staking a more attractive strategy for individuals who require flexibility and access to liquidity.

Finally, liquid staking may promote the growth and adoption of cryptocurrencies. By providing a mechanism for token holders to use their staked assets as collateral, liquid staking increases the utility and value of cryptocurrencies. This additional use case attracts more participants to the ecosystem, enhancing liquidity and contributing to the overall growth of the cryptocurrency market.

Challenges of Liquid Staking

While liquid staking offers numerous advantages, it is important to be aware of the challenges associated with this tool, as well.

Slashing

While the staking incentives are attractive, validators can also be penalised for bad behaviour that may negatively affect network performance. This penalty is called ‘slashing’, which results in the validator’s removal from the network and a portion of their staked tokens taken away. As users stake their crypto assets to validators, their funds can also be exposed to slashing risk if validators are not chosen carefully.

Centralisation

A single protocol with a majority stake in a PoS network — with its own set of validators — will have disproportionate power over the network, which can lead to centralisation. For example, nearly a third of staked ETH is in Lido: if the protocol is impacted, validators will be affected, which can negatively impact the wider ETH network. This is why a widespread network of liquid staking protocols is preferable.

Regulation

Additionally, the regulatory landscape surrounding cryptocurrencies is constantly evolving. Stay informed about any legal or regulatory developments that may affect staking in your jurisdiction.

Several cryptocurrencies have implemented liquid staking protocols, allowing token holders to benefit from this innovative market strategy. One prominent example is Ethereum: After ‘The Merge’, the blockchain introduced a PoS consensus mechanism, enabling token holders to stake their ETH and earn rewards while maintaining the flexibility to use their assets.

Another popular cryptocurrency that supports liquid staking is Polkadot. As a multichain network, Polkadot allows users to stake their DOT tokens and participate in the network’s governance while still accessing their staked assets. 

Other cryptocurrencies that support liquid staking include Cardano, Avalanche, and Cosmos. Each of these projects provides its own unique approach to liquid staking, offering traders various options to participate in this game-changing solution.

Liquid Staking in the Crypto.com App 

With Crypto.com, users can wrap their staked virtual assets and receive a receipt token that continues to benefit from accruing staking rewards. This provides users with access to their funds while their virtual assets are still staked.

Crypto.com currently offers liquid staking for ETH through wrapped CDCETH. Read the white paper here.

Crypto.com Staked ETH (CDCETH)

Crypto.com Staked ETH (CDCETH) is a receipt token representing a user’s staked Ether (ETH) and any accrued staking rewards. Crypto.com will wrap a user’s staked ETH to CDCETH or unwrap their CDCETH to staked ETH, without conversion fees.

Receiving Rewards

When staking ETH on Crypto.com and holding staked ETH in their account, users receive staking rewards on a regular basis based solely on the blockchain protocol. Those holding CDCETH are entitled to additional staking rewards, which will be reflected through the increase in the conversion rate of CDCETH to staked ETH (instead of receiving ETH rewards directly in their accounts).

CDCETH holders can redeem their rewards by unwrapping their CDCETH, where they will then receive staked ETH based on the conversion rate at the point of unwrapping. Since the conversion rate changes as a result of the rewards earned, over time, the user is likely to receive more staked ETH when they unwrap their CDCETH.

In addition, CDCETH is a tradeable receipt token representing a user’s staked ETH and any accrued staking rewards.

Liquid staking is available to users via the Crypto.com App in most jurisdictions. Get more details here.

Not a Crypto.com App user? Download the Crypto.com App to start liquid staking today. 

Conclusion

By combining the benefits of staking with the flexibility of accessing liquidity, liquid staking opens up new possibilities for crypto holders. The ability to harness additional utility from staked assets provides increased flexibility and may reduce opportunity costs.

As more projects implement liquid staking, and exchanges like Crypto.com make it an accessible option, the future of liquid staking looks promising. However, it is crucial for users to conduct thorough research, understand the risks involved, and stay informed about the evolving regulatory landscape. With these considerations in mind, liquid staking can be a powerful tool for individuals and institutions seeking to explore different opportunities in the dynamic world of cryptocurrencies.

Due Diligence and Do Your Own Research

All examples listed in this article are for informational purposes only. You should not construe any such information or other material as legal, tax, investment, financial, cybersecurity, or other advice. Nothing contained herein shall constitute a solicitation, recommendation, endorsement, or offer by Crypto.com to invest, buy, or sell any coins, tokens, or other crypto assets. Returns on the buying and selling of crypto assets may be subject to tax, including capital gains tax, in your jurisdiction. Any descriptions of Crypto.com products or features are merely for illustrative purposes and do not constitute an endorsement, invitation, or solicitation.

In addition, the Crypto.com Exchange and the products described herein are distinct from the Crypto.com Main App, and the availability of products and services on the Crypto.com Exchange is subject to jurisdictional limits. Before accessing the Crypto.com Exchange, please refer to the following link and ensure that you are not in any geo-restricted jurisdictions.

Past performance is not a guarantee or predictor of future performance. The value of crypto assets can increase or decrease, and you could lose all or a substantial amount of your purchase price. When assessing a crypto asset, it’s essential for you to do your research and due diligence to make the best possible judgement, as any purchases shall be your sole responsibility.

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