Effect of DeFi on staking rewards and in liquidity boost

The birth of decentralized finance (DeFi) represents a watershed moment in the crypto industry’s history. The ability to provide highly liquid and interoperable financial services without the use of centralized intermediaries has enormous potential for lowering entry barriers to financial markets and facilitating seamless value exchange.

When looking at the rise of DeFi, it’s evident that participation in this new, open financial economy is exploding. According to DeFi Pulse, the total value locked on DeFi platforms in July 2020 was roughly US$3.6 billion; it is now US$99.6 billion. However, statistics alone do not reflect the extraordinary levels of innovation that the sector has developed in such a short period of time since its inception.

The significance of decentralized exchanges like Uniswap in driving this growth is well known, but there is an astonishing range of intriguing new use-cases being developed, such as Etherisc’s decentralized insurance applications or non-fungible token (NFT) marketplaces like OpenSea.

Such quick growth has not been without its drawbacks, including high gas fees and congestion on Ethereum, where demand frequently exceeds network capacity. While Ethereum gas fees have just dropped to a six-month low, long-term solutions are required to sustain the sector’s ability for widespread involvement.

The next step in the sector’s development is to connect DeFi to other fast emerging areas of the digital economy. Proof-of-stake (PoS) has quietly emerged to become the blockchain industry’s main consensus mechanism. The bulk of top-ranking coins are PoS, with Cardano and Polkadot recognized as industry veterans, having a market worth of around US$321.4 billion today. Another notable validation of PoS and how staking and DeFi can work together is the move to Ethereum 2.0 and PoS consensus.

Investors, both retail and institutional, have shown a strong interest in the possibilities of staking. JPMorgan recently published a bullish report on staking, predicting that the asset class may grow to a $40 billion business by 2025. Coinbase is expected to generate US$200 million from staking in 2022, up from US$10 million in Q2 of this year, according to earnings projections. The number of services available to investors looking to take advantage of this opportunity has also risen dramatically, with a variety of companies now offering institutional-grade staking-as-service.

The disadvantage of staking is the bonding period. Users must commit to locking their stake on-chain for a set length of time in order to get rewards. In the case of Ethereum 2.0, these bonding periods can run anywhere from a few days to an indefinite number of years. Such wasteful wealth may be put to far better use in the crypto economy, which is highly efficient and automated. Bridging the currently fragmented staking sector with DeFi can unlock this liquidity while also serving as an on-ramp for a whole new group of DeFi participants.

This bridging capacity is provided through liquid staking, which allows participants to free staked capital for usage in the DeFi ecosystem. This method entails tokenizing staked assets via a derivative contract, which may later be used on other protocols.

The interoperability of this architecture is crucial to its success. As previously said, DeFi has expanded beyond Ethereum’s bounds, with additional ecosystems gaining market share on the original platform. To effectively unlock the liquidity of staked assets and bring investors and their communities into DeFi, platforms that can smoothly link the staking sector with numerous distinct DeFi ecosystems are required.

This transformation will not occur overnight, but it is on its way. In the short time it has been in existence, DeFi has demonstrated a tremendous ability for creativity. I, for one, am quite interested in seeing where it goes next.

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