What is Liquid Staking? A Quick Guide by ClayStack

What is Liquid Staking? A Quick Guide by ClayStack

Liquid staking is the process of unlocking staked capital across PoS networks. Let’s break that down. To understand liquid staking, we need to go over what staking is and why it is essential. Staking is the process of depositing your native tokens in a PoS chain to secure the network. In return you are entitled to receive what are known as staking rewards (that are given out in the network’s tokens).

Liquid staking unlocks the illiquidity of your staked assets by issuing synthetic derivative tokens (ClayStack issues csTokens) that represent your staked capital. These tokens are (in most cases) value-accrual tokens that can be utilized as base capital in other DeFi protocols. How? Let’s understand.

How staking actually works

The security of any decentralized blockchain network derives from its network participants. In the case of PoW (Proof-of-Work) consensus mechanisms, these participants solve complex computational problems using specialized (and mostly, very expensive) hardware to be selected as the synthesizer of the next block. In return, they get what are known as mining rewards.

In PoS (Proof-of-Stake) consensus mechanisms, however, these “miners” or block proposers are selected based on the amount of that network’s tokens they have “staked”. They do not need to rely on specialized hardware to get selected as the block proposer. This reduces the reliance on expensive resources such as mining hardware and opens up the possibility of several different users being able to participate in the consensus process of the network. Thus any user with the required amount of tokens can stake and earn staking rewards.

However, a crucial drawback to staking on any network is the illiquidity. In most networks (sans Cardano), when you deposit your capital to the network, it “locks” it up. What this means is that you cannot use that capital further to utilize it elsewhere.

Furthermore, if you want to withdraw this capital you must wait for a certain period of time - known as the unbonding period - to get over. The worst part is that you don’t earn any rewards during this undbonding period. Thus, stakers are faced with two major problems:

  • Capital inefficiency: They are unable to utilize their assets while they are staked. They can only earn staking rewards.
  • No rewards during unbonding periods: When they want to unstake their assets from the network, they get stuck in an unbonding period (which can last from a few days to months). Their staked capital doesn’t earn any rewards during this period.

These two problems expose the staked capital to the native asset’s volatility risk. This is where liquid staking comes in.

Why we need liquid staking

Liquid staking unlocks the liquidity of these staked assets across PoS networks by issuing tradeable synthetic derivatives that represent the underlying stake. These derivative tokens can be utilized across several applications in DeFi. Not only does liquid staking amplify capital efficiency but it also lets users utilize their value-accruing liquid-staked tokens across a plethora of DeFi applications.

Given a choice between higher-but-riskier yields and lower-but-sustainable yields, any rational profit-seeking investor would like to allocate some part of their portfolio to the former and some to the latter - subject to their risk appetite. As we have already seen in bull markets, most people would run towards these high-risk-high-reward investments. But as we have observed, these returns are highly unsustainable.

What if users were given the opportunity to get both sustainable returns and also get a chance to participate in high-yield-giving protocols? That’s what liquid staking promises. Not only are users able to earn market-independent sustainable yields from staking, but they are also able to compound their yield by participating in DeFi.

ClayStack is a liquid staking protocol that offers tradeable value-accruing liquid-staked tokens for every token that you deposit. To learn more about how ClayStack works and how the protocol is on a mission to help maximize capital efficiency for its users, check out claystack.com.

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