Liquid Staking

VeradiVerdict - Issue #166

  • A core problem of Proof-of-Stake (PoS) blockchains is the opportunity cost of staking. When a user wishes to participate in network validation and earn rewards, they must stake, or lock up, assets in the network, preventing them from being utilized elsewhere. Thus, users are forced to choose between earning staking rewards while helping secure the blockchain or earning yield from various projects in the DeFi ecosystem.

  • As Ethereum migrates to PoS, those who stake assets in the network will initially be unable to withdraw them, as the initial version of the network does not support transactions or the movement of funds. This means early validators of  Ethereum will be unable to withdraw staked assets for up to a year, significantly increasing the opportunity cost of staking.

  • Lido is a liquid staking protocol for PoS blockchains that enables users to simultaneously earn staking rewards and engage with various DeFi projects using the same underlying balance.

    • When users deposit ETH into Lido, they receive an equivalent amount of the liquid staking token stETH in return; the balance of stETH represents the user’s balance of ETH that has been locked up in staking. Users can then use stETH freely across a myriad of DeFi projects (including 1inch, Curve, Balancer, and more), allowing them to earn additional yield from staked assets. 

    • User deposits are pooled by the Lido DAO and then staked with a set of trusted node operators. Lido enforces no minimum balances, and staking rewards are paid out to users regularly.  

    • Lido has also launched on the Terra and Solana blockchains, with stLUNA and stSOL respectively. 

  • Over 1.3 million ETH has been staked with Lido, representing over 1% of the token’s entire circulating supply. The project has grown to be the largest staking service on Eth 2.0, and pays out depositors an APR around 4-7% from staking. 

  • Ultimately, Lido presents a revolutionary solution to the problem of staking illiquidity. Users can simultaneously earn huge rewards from staking and earn additional yield from the DeFi ecosystem using the same underlying balance, enabling endless new financial opportunities on the blockchain. 

The Hidden Cost of Staking

One of the crypto community’s most anticipated launches is that of Ethereum 2.0 –– a better, faster, more scalable version of the Ethereum network. Ethereum 2.0 will leverage a myriad of technological developments, such as a new sharded blockchain architecture, to increase the network’s transaction capacity, helping accelerate transaction times and control gas prices to the delight of dapp developers and users everywhere. 

A key component of the migration to Eth 2.0 involves shifting from Ethereum’s current Proof-of-Work (PoW) consensus algorithm to a Proof-of-Stake consensus algorithm (PoS), where validators are elected based on how much ETH they have “staked” or locked up in the network, instead of their capability to solve computational puzzles. In the initial phase of Eth 2.0 (which launched last December), the network will not support transactions or the movement of funds –– it only consists of service data. This means that anyone who stakes assets in Eth 2.0 will be unable to withdraw those assets until transaction functionality is added to the new network (expected in ~1 year). Even after withdrawal functionality is added, staked assets cannot simultaneously be used in other applications. Users must choose to either stake their assets to validate the network (losing significant liquidity in the process) or to use their assets elsewhere (foregoing high staking rewards).  

The opportunity cost of staking has been a long-time concern for many PoS blockchains. If users can find better returns by not staking their assets and depositing them into a money market or LP pool, there is little incentive to participate in network validation, compromising the security of the underlying blockchain. To ensure that PoS algorithms can support a stable blockchain ecosystem, it’s imperative to build new ways to unlock liquidity from staked assets. 

What is Lido?

Lido is a liquid staking protocol for Proof-of-Stake blockchains. The protocol allows users to simultaneously stake their assets and earn staking rewards while using those same assets to pursue further yield-generating opportunities elsewhere. 

How does it work?

Users can deposit ETH into Lido to participate in validation of the Beacon chain (the initial phase of Eth 2.0) and earn staking rewards. User deposits are pooled and managed by the Lido DAO, which then stakes these assets with a set of trusted node operators on Eth 2.0, generating staking rewards. These rewards are paid out to depositors in real-time, allowing anyone to participate in network validation and earn rewards without needing a minimum balance or sophisticated validator infrastructure. 10% of rewards are reserved for node operators, DAO members, and an insurance fund that protects against slashed validators. 

In exchange for their deposited ETH, users receive an equivalent amount of the synthetic liquid staking token stETH. Each unit of stETH corresponds to a unit of ETH that has been staked, but unlike staked ETH, stETH can be freely transacted. Users can invest their stETH across the DeFi ecosystem, allowing them to earn additional yields on top of staking rewards from the same underlying staked assets. 

Lido also currently supports staking on Terra (where users receive stLUNA in exchange for deposits) and Solana (where users receive stSOL). The project also plans to launch liquid staking solutions for the Polkadot and Polygon blockchains in the future. 

What is the Lido DAO?

Liquid staking protocols for Ethereum, Terra, and Solana are managed by a decentralized autonomous organization (DAO) called Lido. DAO members hold the LDO governance token and help maintain the project by deploying and upgrading smart contracts, updating the protocol’s parameters, choosing node operators for staking, and managing the minting of stETH tokens (and eventually unbonding of stETH to ETH once Eth 2.0 supports withdrawals). 

How has the project grown?

To date, nearly 24,000 unique depositors have staked over 1.3 million ETH with Lido, representing nearly 1% of the entire circulating ETH supply. The protocol is the largest Eth 2.0 staking provider, supplying 15% of all currently staked assets. Users can earn around 5.0% APR on staked ETH, 3.4% APR on staked LUNA, and 6.2% APR on staked SOL. 

Largest Eth 2.0 staking services (TheBlock)

The protocol has also gained significant traction around its synthetic token stETH, enabling numerous ways for depositors to earn additional yield from staked assets. Users can utilize stETH across a variety of DeFi projects, including 1inch, Curve, Anchor Protocol, Yearn, and more. Following Lido’s recent launch on Solana, many Solana DeFi projects are adding support for stSOL as well, including Serum, Raydium, and SolFlare. 

Final Thoughts

The movement towards PoS consensus represents one of the most formative paradigm shifts in Ethereum (and more generally, crypto) history. Under this model, a blockchain can drastically reduce its energy consumption, lower barriers to entry for network participants, increase the diversity of its validators, and better support newer tech like sharded chains. 

Along with these benefits, PoS introduces its fair share of concerns –– namely, the opportunity cost of staking assets instead of utilizing them elsewhere. If users are forced to choose between staking assets to validate the network and using assets in DeFi projects, the underlying blockchain becomes endlessly caught between not having enough validators to secure the network and not having a valuable ecosystem of DeFi projects with returns high enough to draw users. 

Lido proposes a revolutionary solution to this problem, unlocking liquidity from staked assets through a tokenized representation of their ownership. Users can simultaneously earn huge rewards from staking and earn additional yield from the DeFi ecosystem using the same underlying balance. With over 1% of the entire ETH supply staked with Lido, the demand for more versatility in how a network’s tokens can be used is clear. By eliminating the either-or between staking and utilizing one’s assets, Lido advances the vision of a fully-programmable, highly-versatile money system, creating endless financial opportunities on the blockchain. Lido’s core mission is to keep staking accessible, secure, and decentralized.

- Paul V

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ABOUT ME

Hi, I’m Paul Veradittakit, a Partner at Pantera Capital, one of the oldest and largest institutional investors focused on investing in blockchain companies and cryptocurrencies. I’ve been in the industry since 2014, and the firm invests in equity, early stage token projects, and liquid cryptocurrencies on exchanges. I focus on early-stage investments and share my thoughts on what’s going on in the industry in this weekly newsletter.