A guide to liquid staking

Crypto education

Liquid staking allows you to get the most out of your staked ETH, SOL, KSM, and other coins. Learn how to boost APY and earn extra DeFi yields with Lido Finance, Marinade, and Karura.

What is liquid staking?

Liquid staking is a tool that allows you to enjoy the utility of your assets while they are staked. The  way it works is very simple:

  • Deposit ETH (or another crypto asset) into a liquid staking dApp, such as Lido Finance;
  • The dApp stakes your assets on its own validator nodes;
  • You receive special tokens, similar to the LP tokens issued by liquidity pools on DEXes, known as “liquid tokens”
  • You can then use the liquid tokens to earn DeFi yields (through farming, lending, etc. - both with third-party protocols or the liquid staking app itself)
  • Simultaneously, you’ll earn an APY on the stake. When rewards are paid out (normally every 24 hours), your liquid token balance is rebased (increased);
  • If you want your staked assets back, you can trade the liquid tokens for the original asset via a built-in liquidity pool – for example, Lido Finance’s stETH can be traded for ETH.

The risks

Liquid staking minimizes the opportunity costs of long-term PoS staking by allowing you to both earn staking rewards and farm or lend the assets. However, it also has additional risks:

  • Liquid staking protocols can be vulnerable to hacks. They are relatively new and experimental, so they could be easier to attack than Binance or Coinbase.
  • If a protocol is hacked, the receipt tokens’ value can plummet, and you’ll sustain losses. For example, if you are using liquid tokens as collateral for a loan, you may face a liquidation.
  • You depend on the protocol to provide enough yield-earning tools to make your liquid tokens truly useful – or to enable integrations with other DeFi protocols.
  • The APR is lower, because the protocol charges a fee on the rewards.

In spite of its risks and limitations, liquid staking has been very successful, spreading from Ethereum to ecosystems like Kusama, Solana, and Cosmos. In this article, we’ll take a closer look at the key liquid staking protocols on different chains, including Lido Finance, Karura, and Marinade.

The origins of liquid staking: Ethereum 2.0

Liquid staking originally emerged on Ethereum to solve a major pain point for users who participate in Ethereum 2.0 staking. Ethereum 2.0 is the next phase in the evolution of Ethereum, implementing Proof-of-Stake (PoS) to replace Proof-of-Work mining.

The term ‘Eth2’ isn’t used by the developers anymore - now it’s called ‘the consensus layer’. But we’ll still use the name ‘Ethereum 2.0’ in this article for the sake of convenience.

Ethereum upgrade roadmap

In PoS, a user needs to stake tokens to become a validator and earn rewards for confirming transactions. The stake serves as a guarantee of good behavior: if a validator breaks the rules, part of their stake can be confiscated (“slashed”) as penalty. You can learn more from our detailed article on Polkadot and Kusama staking.

Eth2 staking became available in December 2020 with the launch of the Beacon Chain – the central ledger of the new network, which will link the various shards, or subchain. At first, validators earned up to 10% APY, though this kept falling as more participants joined. As of July 2022, there were over 400k validators, and the APY stood at 4.4%.

Problem 1: 32 ETH staking requirement

And now the caveat: you need to stake at least 32 ETH to have your own validator node – which is around $100k.

As an alternative, many exchanges quickly began to offer Eth 2.0 pools, including Binance, Kraken, Bitfinex, and Coinbase. These pools have a very low entry threshold, sometimes as low as $10. So, the 32 ETH threshold isn’t such a big issue anymore. But, once you deposit some ETH, you will need to wait until 32 ETH are collected to form a new validator node - only then can you start earning rewards. This can take time.

Problem 2: no withdrawing until Eth 2.0 goes live

There is another problem with Eth 2.0 staking: you can’t withdraw the ETH until the network is fully operational. Even worse, nobody knows exactly when this will happen. The launch is scheduled for September 2022, but there have been so many delays already that stakers might have to wait longer.

Pool operators like Binance or Kraken don’t offer any solution to the issue. As a result, stakers face significant opportunity costs and risks:

  • lacking access to one’s ETH for a few months (and for over 1.5 years for those who joined early);
  • having had to hold ETH all through the massive correction from $4,000 to $1,000: 75% of stakers were in loss in July 2022, the average unrealized loss being a whopping 55%.
  • missing out on better yields elsewhere in DeFi;
  • systemic risk due to potential hacks or exploits of the exchange.

The result is that Eth 2.0 staking is much more attractive for institutions, because they hold vast reserves of ETH and likely plan to hold them long term - or at least until the next bull market. However, if institutions end up monopolizing the staking and validation activity, Eth 2.0 won’t be truly decentralized.

So how do small holders participate in ETH staking without missing out on other, perhaps more attractive DeFi opportunities? The solution is liquid staking, and the first protocol to come up with such a product was Lido Finance.

Lido Finance: the first liquid staking protocol on Ethereum

In March, 2022, Lido Finance reported almost  $6.9 billion in staked assets across 5 chains: Ethereum, Solana, Kusama, Polkadot, and Polygon. It’s the second-biggest dApp in all of DeFi by TVL - behind Maker DAO but ahead of Aave.

Lido dominates the ETH liquid staking space: according to Dune Analytics, over 4,138,000 ETH are deposited with Lido – an equivalent of $12 billion. This makes Lido Finance the largest Eth 2.0 staking pool out there.

Credit: Dune Analytics

The current APR is 3.9%, which is lower than the ‘official’ Eth 2.0 staking APR for two reasons:

  1. Lido charges a fee on the rewards;
  2. The activation queue: new Eth 2.0 validators need to wait several days before they start earning rewards.

Instead of relying strictly on its own nodes, Lido collaborates with many other validators: Dokia Capital, Chorus One, Everstake, SyncNode, etc. This could be one of the reasons for Lido’s success. It can focus on developing new products instead of node maintenance.

About stETH

When staking ETH, Lido users receive liquid tokens called stETH (staked ether) at a 1:1 ratio. StETH isn’t pegged to ETH, but its market price is usually very close to the price of ETH. You can trade it for ETH or WETH (wrapped ether) on Curve, Gate.io and Uniswap; or for USDT on Gate.io and ByBit.  

stETH is supported by some of the biggest DeFi dApps on Ethereum, such as Curve, Aave, yearn.finance, Curve, Harvest, SushiSwap, Maker, etc. This allows you to earn additional yields through farming and borrowing.

StETH use cases

Curve

You can supply liquidity to the stETH-ETH pool and earn a percentage of the trading fees (up to 0.72% APY), plus liquidity mining incentives. Remember that you’ll need to deposit the same amount of ETH and stETH. The liquidity pool is by far the biggest on Curve with over $4.5 billion in liquidity and $7.5 million in daily trading volume.

Credit: Curve

Maker

Curve stETH-ETH LPs (liquidity provider tokens) can also be deposited in the Maker protocol to borrow DAI stablecoins. In turn, you can use DAI as collateral for other loans, deposit them in a DEX liquidity pool to earn farming rewards, lend DAI, etc.

Yearn

This yield aggregator allows you to earn a 5% APY on the Curve stETH LP tokens (crvSTETH). Yearn supplies the crvSTETH to Convex Finance (the incentives platform for Curve) to farm CRV, CVX, LDO, and other tokens – then sells the rewards for crvSTETH and re-deposits them into the strategy.

Link

Aave

Starting from March 2022, you can use seETH as collateral to take out crypto loans. As the stETH collateral grows every day through rebasing, the loan-to-collateral ratio decreases, and so does the risk of liquidation.

A popular strategy is to borrow ETH against stETH, stake it on Lido to get more stETH, use it as collateral to borrow even more ETH, and so on a few more times. This is known as recursive borrowing. You’ll end up with a much larger staked ETH position and correspondingly higher rewards. Note that the risk also increases with every iteration, and so do the gas fees.

Terra, Celsius, and 3AC: what caused Lido to lose $10 billion in TVL

In early April, Lido Finance reached a record TVL of $20 billion. Out of these, Terra ($LUNA) accounted for $7 billion. This made Lido the second-biggest DeFi protocol in the Terra ecosystem after the lending protocol Anchor ($14.3 billion TVL at the peak). Lido Finance competed with another liquid staking protocol on Terra, Stader.

Credit: DeFiLlama

But by the end of July, the TVL of the whole protocol stood at just $6.9 billion, having dropped by 60% in 4 months - and Terra had disappeared from the list of supported chains. We’ve already written a detailed article on the collapse of Terra, Celsius, and Three Arrows Capital, but it’s worth looking into how they all in turn derailed Lido.

Link

Between November 2021 and April 2022, Terra (now known as Terra Classic) emerged as the second-largest chain by TVL after Ethereum, mostly thanks to the popularity of its UST stablecoin. The price of LUNA also surged dramatically.

Staking LUNA on Lido was extremely popular at an APY of 8%, but that wasn’t all of it. What many users did was bridge stETH from Ethereum to Terra (where it was called bETH) and deposit it in the Anchor lending protocol to borrow UST, then stake the UST to earn another 20%.

When UST depegged from the dollar and panic started, users started withdrawing bETH from Anchor and bridging it back to Ethereum. They also converted stETH to ETH to protect their money. This massive selling of stETH caused its price to depeg from ETH.

Link

As $LUNA precipitated from $85+ to $0.0003 in just days, two major stETH liquidity providers found themselves deep in crisis: the lending protocol Celsius and the investment fund 3AC (Three Arrows Capital). They urgently needed money, and one of the few sources of liquidity they had were the tokens in the stETH/ETH trading pool on Curve.

Together, 3AC and Celsius withdrew almost $800m in liquidity from the pool on May 12. As it happens when liquidity becomes shallow, slippage increased, meaning that users faced unexpected price changes while swapping stETH. With this came even more panic.

It was a perfect storm for Lido: all the staked $LUNA was withdrawn or became worthless; people redeemed stETH for ETH; while 3AC and Celsius emptied the trading pools. Billions of dollars were wiped off Lido Finance’s TVL - but that wasn’t the end of Lido’s woes.

The big drop in the stETH/ETH price on June 15-17 that you can see on the chart was due to Celsius selling off its stETH. The way Celsius worked was to take user deposits, deploy them in high-yield DeFi products like UST staking on Anchor, and pay really high yields.

When faced with an avalanche of withdrawal requests from users and institutional lenders alike, Celsius had no choice but to start selling off its assets - especially stETH. That’s the dip on the chart - around the same time as Celsius paused withdrawals on June 13. You can also see a big decrease in Lido’s TVL on Ethereum around the same time.

Credit: DeFiLlama

Lido Finance on other chains

Lido’s billions on Terra may be gone, but it’s still present on Solana with over $110 million in staked SOL and a 6.1% APR. However, it’s far behind the Solana-native liquid staking protocol, Marinade Finance, which boasts more than $320 million in TVL.

Lido’s TVL on Polygon is also reasonably large: $30 million at 8.7% APR in July 2022. On Polkadot and Kusama, the TVL is much smaller: $5.8 million and $2.4 million, respectively, though at much higher APRs (16.5% and 20.8%). However, both of these ecosystems have native liquid staking dApps – and we’ll look at these next.

Karura and Acala: Liquid staking on Kusama and Polkadot

Karura and Acala are sister DeFi hubs in the ‘Dotsama’ (Polkadot + Kusama) ecosystem. As we’ve explained in our previous article, many projects first launch on Kusama, since it’s a canary (experimental) network for Polkadot. This allows developers to test their dApps in a live environment and build a community and traction before going for a parachain auction on Polkadot.

Karura won the first-ever Kusama parachain auction in June 2021, raising 500k KSM ($88 million) for its crowdloan. In turn, Acala won the first Polkadot auction in November, raising over $700m.

Credit: parachains.info

As of late July 2022, there was around $450 million staked in KSM (6.3M KSM), out of which, $13.5M in KSM were deposited in liquid staking on Karura. The APR is around 17.2%, and the liquid token you get in exchange for KSM is called LKSM.

A very interesting feature of Karura compared to Lido is that they offer other DeFi tools and strategies beyond liquid staking, so that you don’t have to use third-party protocols. In Karura, you can deposit liquidity in the KAR-LKSM or kUSD-LKSM pools on Karura Swap, kUSD being a stablecoin designed for Karura.

You can even borrow kUSD against some of your LKSM through the Mint kUSD feature - and then deposit both kUSD and LKSM in the pool to earn up to 90% APR in Karura Earn. Or you could borrow kUSD against all of your LKSM, swap half of the kUSD for KINT, and become a liquidity provider for the kUSD-KINT pool at a 190% APR. In short, there are many possibilities.

Link

Another advantage of liquid staking is that it solves the issue of long unbonding. When using regular KSM or DOT staking, if you decide to unstake, you’ll have to wait for 28 days on Polkadot and 7 days on Kusama until the assets become available. You won’t receive any rewards during this time, either. But with liquid staking, you can unbond KSM and DOT anytime for a small fee with no unbonding period and without missing out on rewards.

Liquid staking on Polkadot was launched in May 2022. Together with the arrival of LDOT, Acala launched a DEX (Acala Swap) and a new decentralized stablecoin, aUSD. Currently there is around $4.8 billion staked in DOT (630 million DOT), so LDOT will have a lot of room for growth.

Marinade Finance (Solana)

As of July, 2022, Marinade Finance was the biggest DeFi app on Solana by TVL ($320 million), closely followed by the lending protocol Solend and the Serum DEX. Our old friend Lido Finance is tenth on the list.

Of all liquid staking protocols, Marinade gets the prize for the most creatively named liquid token. When staking SOL, you get...‘marinated SOL’ (mSOL)! The protocol’ graphic design is also very cute.

mSOL is automatically rebased every time rewards accrue. The APR is 5.8%, and you can redeem mSOL for SOL anytime. The protocol charges a 2% fee on the rewards - lower than Lido or Karura.

Marinade delegates the staked SOL to 450 validators, so even if everyone suddenly switches to liquid staking, decentralization in the network won’t suffer.

Marinade has a very helpful DeFi page that lists over 30 mSOL pools on different platforms: Orca, Raydium, Serum, etc.

The strategies to earn additional DeFi yield with mSOL include:

  • Single-asset staking: stake mSOL on Marinade to earn the governance token MNDE.
  • Liquidity providing: the highest APY (over 1,0000%) is currently to be found on Crema, though Raydium also offers good yields.
  • Recursive borrowing on Larix or Solend (see the borrowing strategy description in the Lido section).

Another interesting thing you can do with mSOL is launch an NFT mint. Solana has a tool called Metaplex Candy Machine, which allows you to create and manage fair mints, where the price and the schedule is the same for everyone (i.e. no pre-sales). Candy Machine can be set up to accept mSOL as payment for NFTs.

Solana’s total DeFi TVL has fallen by 50% since its October 2021 highs, and many people have become disillusioned in the network because of constant lags and repeated crashes. However, if you are interested in trying liquid staking and don’t have any staked assets yet, Marinade is an attractive option with its low fee on rewards and many yield farms that support mSOL.

Liquid staking on other chains: Avalanche, Fantom, and Cosmos

By now you should have a good grasp of how liquid staking works and what one can do with liquid tokens. You’ll find similar products on many other chains, though outside of Ethereum, Terra, and Solana the TVLs are still small. We’ll list the main protocols here.

Avalanche

  • BENQI (mainly a lending protocol)
  • Ankr StakeFi (limited utility for the aAVAXb liquid token so far).

Fantom

  • Ankr (not much utility for aFTMb, but farming and yield vaults are planned)
  • Stader (product launched in February 2022)

Cosmos

Cosmos is a particularly interesting playground for liquid staking protocols, since over 60% of the whole ATOM supply is staked. We’ve already discussed Terra, which is part of the Cosmos ecosystem, but there are also liquid staking products for the Cosmos chain proper.

  • Persistence – not just a dApp but a whole new chain centered around liquid staking
  • pStake (native to Persistence, though Cosmos and EThereum are also supported);
  • Quicksilver (under development; created by the developers of Chronos One)

Here at Pontem Network, we are watching the developments on liquid staking platforms very closely. We build foundational dApps using Move VM and the Move language for the nascent Aptos ecosystem, and liquid staking is one of the possibilities we’re looking into. Once Aptos releases its own token, and we create more yield-bearing DeFi services for it, a Lido-like dApp could give a big boost to the adoption and liquidity on Aptos. Join us on Telegram and Twitter and don’t miss the latest updates from the multichain world!

Install our wallet and try DEX