Staking vs Liquid Staking: High Rewards, Low Risk & More!

We are well aware of the term ‘staking’. It’s a way to earn passive income on your assets while supporting the stability & security of the blockchain ecosystem.

With digital assets evolving & new updates continuously redefining the decentralized finance [DeFi] landscape. Here comes Liquid Staking, which has kept the crypto industry hooked on it.

But what is liquid staking & is it better than the regular plain staking? What are the potential benefits or drawbacks of each? Let us dive deep into staking vs liquid staking now.

Plain staking/simple staking:

This method involves locking up your crypto assets in a protocol for a fixed amount of time. Through this staking, the token holders will earn rewards as long as they delegate their tokens to the network validators.

You can see this type of staking in the PoS networks [having Proof of Stake (PoS) Consensus Mechanism] like post-merge Ethereum, Matic, BNB, Near, Fantom & Hedera.

It is to be noted that different direct staking protocols have different rules to offer the rewards, calculating the time period & other parameters. But one constant condition is that your assets will be locked into a smart contract where you cannot sell, transfer or trade them. Hence, this becomes ‘illiquid staking’. We will see about liquid vs illiquid staking shortly.

Also Read: How to Stake ETH

Benefits of Direct Staking

• Simple, easy set-up & management: Almost many direct staking protocols are user-friendly. They do not require you to have any technical knowledge to handle them.
• Passive income/reward: Crypto investors can earn rewards without actually having to trade or manage their assets actively.
• Supports the blockchain network: Locking the tokens for a fixed period of time helps the ecosystem to be more stable & secure.

Challenges of Direct Staking

• Requires a fixed amount of assets: To do direct staking, you need to at least have a minimum amount of crypto assets/ funds in the wallet.
• Unpredictable rewards: The rewards earned through direct staking keep varying as it depends on the market conditions & other external factors.
• Liquidity is limited: Investors cannot easily trade or access their staked crypto assets if they need to.
• Validator Selection & lack of validator Diversification: You choose a single validator and have to stick with them. If the validator goes rogue, there is a risk of losing rewards and in some case even the capital.
• Rewards don’t autocompound: Staking rewards in simple staking don’t auto-compound.

Now, how can we define staking vs liquid staking? Here we go!

What is Liquid Staking?

As we saw that direct/native staking requires you to lock up the cryptocurrency for a fixed staking period of time. That can be either months or years to keep your native tokens untouched, this is where liquid staking meaning comes into existence.

How Does Liquid Staking Work?

When you deposit assets into a liquid staking protocol, then you will receive a tokenized version of your funds. This could be used widely across the DeFi ecosystem.

To understand the liquid staking meaning, let’s consider Anna wants to stake 1000 HBAR into a liquid staking protocol. This means that  Stader will mint 1000 liquid tokens that are equivalent to 1000 HBAR.

Anna will earn the regular staking rewards from the initial 1000 HBAR staked whilst still being able to use those liquid tokens for various other purposes.

Also Read: Ethereum Staking Rewards

Benefits of Liquid Staking

• No technical expertise: Liquid staking doesn't need any technical expertise. You can easily manage the entire staking process effectively.
• Diversified portfolio: Liquid staking helps investors to maintain the liquidity of their crypto assets while still earning staking rewards. So, they can take advantage of market fluctuations & make more profit along with guaranteed APY.
• Crypto-backed loans: Sometimes, you need to reshuffle your portfolio without selling any of your crypto assets to get some fiat.
• Quick access to funds: One of the major staking vs liquid staking aspects is that the latter allows you access to funds without any lengthy unbonding period [of staking & unstaking]. So, being a liquid staker, you can unstake the assets instantly.
• Increases overall/additional liquidity: When you are earning rewards on the assets staked without getting them escrowed/locked, it encourages more crypto investors to stake for a longer period. As aforementioned, access to funds is enabled. Hence, impacting the overall supply & demand cycle of the crypto in circulation. And helps maintain its stability & keeping the market volatility in check.

Challenges of Liquid Staking

• Deppeging risk: The price of the staked derivative/stake tokens may depeg from its original price. It might happen because of the lower market price of the new token.
• Centralization of the network risk: Another liquidity risk is that you have to stake the tokens on a liquid staking platform. Hence, the balance of validator shares in the network may be disrupted, opening room for the risk of undue control/centralization from more powerful validators.
• Smart Contract Risk: Liquid staking protocols use smart contracts to deploy user funds into validators. Smart contracts are vulnerable to attacks. It would be a good practice to trust smart contracts that have been battle tested before deploying funds.
• Defi Yield: The unlocked liquid tokens can be deployed into various Defi strategies like Liquidity mining, Leveraged staking, Lending, Covered call options, prediction markets, etc.

These are some of the liquidation risks despite having beneficial advantages like getting crypto-backed loans and additional rewards [with a good reward rate] for the crypto holders/stakers.

To conclude, the main point of liquid staking vs staking is that the former is an innovative method in the crypto ecosystem with a good potential to offer juicy staking benefits & rewards. And with years to come, more and more digital assets will be liquid staked by crypto users worldwide.