Welcome to Module 10- Course 2 of Mission Web3!
In this module, we’re putting liquid staking on a balance scale and letting you decide whether the benefits outweigh the risks.
Benefits of Liquid Staking
As we’ve discussed in the previous course, traditional staking requires you to lock up your tokens for a certain period, preventing you from accessing those tokens during this period. In some cases, this period could even go up to 180 days, which is a lifetime in the crypto realm.
The most meaningful advantage of liquid staking, in comparison with traditional staking, comes from having control over your assets. Let’s dig deeper into it.
Increased capital efficiency – In traditional staking, you’ll only see the yield upon the maturity of the staking period. With liquid staking, however, you can use the LST across the DeFi ecosystem and a wide variety of protocols to generate additional returns (e.g. participating in campaigns and airdrop events), therefore growing your portfolio more efficiently. As a bonus, doing so will help the overall liquidity and utility of the tokens throughout the ecosystem.
Higher flexibility – With the freedom of being able to move your assets without any constraints, you also get the advantage of better portfolio management. Effectively, this unlocks the inherent value of the staked tokens and enables the tokens to be traded or used as collateral in DeFi protocols.
Diversification – Instead of putting all your eggs (your assets) in one basket (the platform you’re staking on), you can take the LST and participate in another. Ergo, you’re not just doubling your returns during the staking period, you’re also hedging the risk of relying solely on one platform.
Risks of Liquid Staking
As promising as this concept sounds, it’s also our duty to ensure you know the relevant risks before dipping your toes into this world.
Smart contract vulnerabilities – LSTs are essentially created and managed through smart contracts, and as you might already know, bugs and tiny errors in the code can be exploited by malicious parties. If this happens, your funds will be siphoned to the malevolent party’s wallets and there is nothing you can do. To combat this, make sure you select well-audited and reputable smart contracts for better fund safety.
Slashing – In PoS networks, validators who behave inappropriately or fail to meet the requirements of the network can be “slashed”, which is a penalty that may cause the validator to lose a portion of their staked assets. Users of liquid staking services are essentially outsourcing their responsibilities as a validator. Due to this, it fully exposes them to having their assets slashed if the service provider does not adhere to the rules of the network.
Price disparity – Although the price of the LST and the underlying asset can trade very closely, it is not determined by a pegging mechanism. In other words, there is still a possibility that the price of the LST falls sharply below the price of the underlying asset in turbulent markets. This can further translate into a loss for the user at the maturity of the staked assets.