This article is simply an educative material on liquid staking and why persistence is built around it…
LIQUID STAKING: PROS AND CONS
Protocols that issue on-chain representations of staked assets on a decentralized network are referred to as liquid staking. Liquid staking protocols let users to acquire liquidity on staked assets and use staked assets as collateral in (decentralized) financial applications through tokenization. Staking derivatives and programmable staking are two other words that have been used to characterize similar methods.
Derivative staked tokens represent a claim on the underlying, illiquid staking positions, which are nevertheless subject to the protocol limits outlined above. These tokenized and thus liquid claims can be employed in a variety of financial products. As a result, stakers may be able to earn higher returns or more easily manage their risk exposure in a variety of ways, such as by reducing the risks associated with validators. After introducing our taxonomy of liquid staking options, we will expand on this form of composability and highlight the possible benefits and risks of tokenized staking positions in decentralized finance.
We observed four types of liquid staking during our investigation: native, non-native, synthetic, and custodial.
The issue of derivative tokens is implemented as part of the primary protocol at the core level of the respective network in native liquid staking systems. Because liquid staking is integrally associated with the protocol in this unique scenario, we isolate this category from other non-custodial alternatives. As a result, other organizations may not be motivated to construct liquid representations of staked assets because the protocol already addresses the limits associated with staked assets. Examples are Delegation Vouchers
Non-native staking applies to non-custodian liquid staking alternatives whereby the tokenized staking stance is issued by a different, trustless protocol. Approaches to liquid staking that are based on smart contracts custodying staked assets (DAOs27), influencing accounts from blockchain networks via interoperability protocols (e.g. interchain accounts28), or other cryptographic techniques such as secure multi-party computation are all included in this category (secure MPC29). Examples of this type of staking are Everett, Stafi, StakeDAO, Acala, Rocket Pool (from Eth2 rollout phase 2), any smart contract-based protocol.
Staking positions that are completely financially constructed are referred to as synthetic liquid staking. This class is distinct from the others in that it does not correspond to the fundamental staking protocol and its accompanying constraints, as defined above, but rather to a contractual agreement made between two (or more) participants. In an interest rate swap, this may mean parties involved agree to trade cash flows that replicate staking rewards of a specific Proof-of-Stake protocol and a few other (possibly fixed) cash flow. An example here includes Synthetic Staking Reward Swap.
Custodial liquid staking involves the procedure in which a centralized body in charge of the private keys used in staking concerns tokenized versions of staked assets, allowing users to benefit from staking while avoiding protocol constraints. Examples include but are not limited to StakerDAO, Rocket Pool (during Eth2 rollout phase 0 and 1).
It’s also worth noting that concrete deployments frequently include a combination of custodial, non-custodial, and synthetic aspects. The governance process of StakerDAO, for example, is totally on-chain, while staking activities are handled in a custodial, centralized, and controlled manner.
Risks and Benefits of Liquid Staking
The potential to use staked assets as collateral in other financial applications is one of the most compelling reasons in favor of liquid staking. Instead of having to choose from staking a staking asset and lending it in a Compound-like on-chain lending protocol, tokenized staking positions may be included into such protocols, allowing stakers to control their risk exposure while also earning additional returns on their staked assets.
Improving Staked Asset Liquidity: As previously stated, a key drawback of Proof-of-Stake protocols is the incapacity to liquidate staked assets, such as the usual unbonding period. Stakers will be able to trade a model of their staked assets using a liquid staking solution, increasing the liquidity of staked assets.
Providing Access to Advanced Financial Products: As previously stated, tokenized stake allows for permissionless development in staking assets and the development of other financial derivatives on top, letting stakers to better control their vulnerability, for example, with respect to:
· Reducing the danger of a specific validator (slashing insurance).
· Using several networks and validators to differentiate (e.g. tokenized ETF-like index products).
· More organized goods (e.g. combining tokenized staking positions with put options on the underlying token to create fixed income products).
Enhancing the User Experience: Tokenized staking holdings could come in handy in engaging in staking and facilitating the design of advanced financial products, thus improving the user experience. There’s a case to be made that simply possessing a token will improve the staking user experience by lowering complexity on numerous levels:
· Users do not need to submit the network delegation, reward withdrawal, re-staking, or other similar transactions.
· There is less of a need for ordinary users to comprehend protocol subtleties such as unbonding periods.
· Wallets and perhaps other interfaces will have easier compatibility because they will simply need to monitor token holdings and pricing. This also streamlines accounting for users and may provide tax savings due to capital gains-based taxes rather than income-based taxation.
Improving Price Discovery for Staking Assets: Tokenized staking holdings are valued by the trade, assisting in the price discovery of both intrinsic staking assets and validator-specific threat, the latter of which differs depending on the proposed model.
Systemic risk: Liquid staking, like previous financial system set-backs, may enhance systemic risk by introducing additional layer of complexity to the decentralized finance ecosystem. Given the numerous protocols and methods for interacting with cryptoassets in decentralized finance, there is a risk that the failure of one portion of the stack may cause a larger domino effect, potentially completely destroying the ecosystem as it gets more intertwined.
Centralization of stake: Proof-of-Stake networks are based on the idea that no single authority can govern the network’s consensus infrastructure. Because of this, there is a possibility of the presence of factors that could lead to increased centralization.
Incentives for Validators could be affected: The influence of a tweak in the staking logic on validator incentives is a major worry with liquid staking. Derivative tokens and the financial products created on top of them may offer novel characteristics that contradict the game theoretic assumptions that underpin a Proof-of-Stake system.
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