Liquid Staking and Restaking Explained: A Deep Dive by Automata

TL;DR

• Traditional staking locks up your crypto, limiting its use.

• Liquid staking unlocks liquidity by providing tradable tokens (LSTs) representing your staked assets.

• Liquid restaking takes it further, letting you stake your LSTs for potentially higher returns.

• Both offer advantages like increased flexibility and accessibility but involve risks like smart contract bugs and impermanent loss.

• These innovative solutions are shaping the future of Web3 by maximizing the utility of staked assets.

Liquid Staking and Restaking are two terms that often get misunderstood and confused with one another. As the Web3 ecosystem is continuously evolving, the community is coming up with a new and innovative approach to scale it. After the Ethereum integration with the Beacon chain, the Ethereum blockchain moved from the Proof of Work (PoW) consensus mechanism to Proof of Stake (PoS).

However, to participate in the PoS consensus, validators must stake a certain number of native cryptocurrencies. In Ethereum, this number is 32 ETH. This restricts the utility of the locked tokens. However, with Liquid Staking and Restaking, we can extend its use case and unlock a higher potential. So, let’s find out what is Liquid Staking and Restaking in crypto and how it is helping the entire ecosystem flourish.

What Is Staking in Crypto?

In Proof of Stake (PoS) consensus anyone can participate and become a validator by locking up the native cryptocurrency of the network, this process is called Staking. Validators in return get an opportunity to earn rewards for their participation in securing the network, distributed in the form of additional ETH.

What is Liquid Staking?

The major problem in traditional staking is it locks up a large amount of cryptocurrency that can otherwise be used for different purposes such as trading, voting, and governance. Liquid Staking solves this problem. As the name suggests, it provides liquidity to the traditional staking mechanism by offering the equivalent amount of Liquid Staking Tokens (LST) against staked assets. Stakers can further use these LSTs in other protocols. For example, on staking ETH tokens using Lido DAO, you get an equivalent amount of stETH.

How Does Liquid Staking Work?

Stakers first decide on a Liquid Staking Pool by choosing a validator that participates in the consensus mechanism of any PoS chain and deposits supported cryptocurrencies in that pool.

Liquid staking protocols such as Lido Finance and Rocket Pool leverage smart contracts to generate an equivalent amount of LSTs in lieu of deposited crypto tokens. These smart contracts interact with the PoS blockchain, ensuring the deposited tokens are actively contributing to the network's security.

The specific mechanics may vary between protocols, but the core principle remains the same: users gain access to a tradable representation of their staked assets, enabling them to participate in other DeFi activities while their original tokens contribute to network security.

Understanding Native and Liquid Staking: What’s the Difference?

Native staking involves directly locking your tokens on the PoS blockchain, often requiring a minimum stake amount and lengthy lockup periods. While offering potentially higher rewards, it restricts the immediate usability of your assets.

Liquid staking, on the other hand, provides a more flexible alternative. Users can deposit any amount, gain immediate liquidity through LSTs, and participate in various DeFi activities while their underlying stake continues to earn rewards.

Benefits and Risks of Liquid Staking

Liquid staking offers several advantages:

• Increased Liquidity: LSTs can be traded or used in DeFi protocols, unlocking additional earning opportunities beyond staking rewards.

• Accessibility: Lower entry barriers and no minimum stake requirements make liquid staking accessible to a broader range of users.

• Flexibility: Users can easily exit their positions by selling their LSTs, providing greater control over their investment.

However, it's crucial to consider potential risks:

• Protocol Risk: Liquid staking protocols rely on smart contracts, which can be vulnerable to bugs or exploits.

• Slashing Risk: If the underlying validators associated with LSTs are penalized for malicious behavior or improper validation, there is a risk of staking penalties, potentially jeopardizing all of the staked funds. 

• Centralization Risk: If a large amount of staking power is concentrated in a few LST providers, it could lead to centralization of the network, which goes against the ethos of decentralization and could make the network more vulnerable to attacks or governance issues.

Examples of Liquid Staking Tokens and Protocols

Several prominent liquid staking protocols and their associated tokens have emerged in the crypto space:

• Lido DAO: A leading player offering liquid staking solutions for various PoS blockchains, including Ethereum (stETH).

• Rocket Pool: A decentralized staking pool protocol focused on Ethereum, known for its minimum deposit flexibility.

These are just a few examples, and the liquid staking landscape is constantly evolving with new protocols and features emerging.

What is Liquid Restaking?

Liquid restaking takes the concept of liquid staking a step further. It involves staking ETH with a liquid restaking platform and you receive both staking and restaking yield.

Liquid Staking vs Liquid Restaking Tokens

With the introduction of restaking, a new form of liquid derivatives, known as Liquid Restaking Tokens (LRTs) have gained traction.

It's important to distinguish between Liquid Staking Tokens (LSTs) and Liquid Restaking Tokens (LRTs):

• LSTs: Represent the staked native asset and its accrued rewards.

• LRTs: Represent the staked LST (including its underlying asset and rewards) and any additional rewards earned through restaking.

While both offer liquidity and earning potential, LRTs offer the potential for higher returns through compounding but may also involve additional risks associated with the underlying restaking protocol.

EigenLayer Crypto Restaking: How Does It Work?

EigenLayer is a platform that enables protocols built on Ethereum to establish a validator set to validate the transactions and data off-chain. These protocols are often not EVM compatible. However, with restaking, protocols can leverage the cryptoeconomic security of Ethereum.

LRTs secure Actively Validated Services (AVSs) on EigenLayer, including Automata's Multi-Prover AVS.

Conclusion

Liquid staking and its advanced form, liquid restaking, offer innovative solutions to maximize the utility of staked assets. This is done by offering you an opportunity to participate in supplemental DeFi activities using your LSTs such as lending, trading, and restaking.

However, it's crucial to conduct thorough research and understand the associated risks before engaging with any protocol. As the DeFi landscape continues to evolve, these innovative solutions hold immense potential for shaping the future of Web3 space.