2. Introduction

Liquid staking protocols provide an innovative solution to existing staking options like solo staking or centralized exchanges. These existing options present multiple issues discussed in section 4. Most importantly, they present capital inefficiency issues and the inability to maximize liquidity for the user. For example, tokens that get staked through non-liquid staking protocols are locked and cannot be used for the selected lock period. This means you are locked into a sole source of leverage on the locked asset with zero flexibility.

Liquid staking attempts to solve this liquidity issue and maximize the leverage on the asset by tokenizing the deposited asset and issuing a derivative token. For example, if I deposit ETH into a liquid staking protocol, those tokens are in essence lent to that protocol for use. In return for these funds, the protocol issues a derivative token, $stETH as example in the Lido protocol. This derivative token is transferred to the user as a 1-to-1 liquid value to the parent staked token, ETH in our example. This derivative token can then be leveraged elsewhere in DEFI to multiply the available liquidity that the original tokens held. The original ETH is then utilized by the protocol to earn staking revenue for the user who initially deposited.

Liquid staking offers a solution to the high opportunity cost of staking while maintaining the stability and security of the network it operates on. No longer are you forced to lock your ETH for ‘X’ amount of time to receive ‘X’ amount of APR. There is also no financial barrier to entry, with most liquid staking protocols allowing deposits as small as 0.01 ETH access to staking rewards. Removing both the technical and financial requirements of something like solo staking and reducing the custodial risks centralized exchanges present is where liquid staking protocols create an innovative solution.