Liquid Staking vs. Direct Staking: A Deep Dive into the Dynamics, Pros and Cons | by Leon Okwatch | December 2022

Understand how to maximize the rewards from your crypto assets

Photo by GuerrillaBuzz Blockchain PR Agency on Unsplash

Staking is one of the most popular ways to earn passive income without actively trading on exchanges. As digital assets continue to evolve, new innovations are redefining the DeFi landscape. Liquid staking is one of the latest trends in the industry.

This article will dive deep into the world of staking and examine the main differences between direct staking and liquid staking. We’ll also look at some of the existing liquid staking protocols on the Solana network and how you can use them. Let’s begin.

Direct staking involves locking crypto assets in a log for a set period of time to earn rewards. Staking allows token holders to delegate their tokens to network validators. Direct staking is only supported on networks using the Proof-of-Stake (PoS) consensus algorithm. PoS networks include post-merge Ethereum, Solana, Cardano, Cosmos, and Tezos.

Different direct staking protocols implement different rules and parameters. Direct staking rewards, time periods, and other conditions vary for each protocol. A constant stipulation of direct staking is that once the funds are locked into a smart contract, token holders cannot transfer, sell, or trade their assets. Essentially, staked tokens become “illiquid” until the staking period expires.

The rewards an investor receives from direct staking depend on several factors, including the amount of liquidity they have injected into the pool, the overall size of the pool, and the current market conditions for the cryptocurrency being staked.

• Easy to set up and manage: Most direct staking protocols are easy to use and require no technical know-how to set up and manage.
• Passive Income: Investors can earn rewards without having to actively trade or manage their wealth.
• Helps support the network: By participating in the direct stake, investors contribute to its security and stability.

• Requires a minimum fund: In order to participate in direct staking, investors must have a minimum amount of the chosen cryptocurrency in their wallet. For example, investors need at least 32 ETH to invest on Ethereum.
• Rewards can be unpredictable: The number of rewards earned from direct bets may vary depending on market conditions and other factors.
• Limited Liquidity: Investors cannot easily access or sell their deployed assets when needed.

Traditionally, staking required users to freeze their cryptocurrency for a set period of time, often several months to years. This meant users had to sacrifice the liquidity of their holdings to earn staking rewards.

Liquid staking offers a way around this problem. It allows users to earn staking rewards without having to sacrifice their liquidity.

“Liquid staking solutions like Marinade contribute to greater decentralization while creating new opportunities for users through staking derivatives.”

– Anatoly Yakovenko, CEO of Solana Labs

How does liquid staking work?

When a user deposits their wealth into a Liquid Staking protocol, they receive a tokenized version of their funds to use across the DeFi ecosystem. So let’s say Bob wants to stake 1000 SOL in a liquid staking protocol.

The protocol mints 1000 stSOL which equals 1000 SOL. Bob will earn rewards from the initially wagered 1000 SOL while continuing to use the stSOL tokens for other purposes. In order for Bob to get his initial 1000 SOL back, he must have 1000 stSOL. The terms and conditions vary depending on which protocol he is using.

• Portfolio diversification: The most significant benefit of liquid staking is that it allows investors to maintain liquidity in their cryptos while earning staking rewards. Investors can take advantage of market fluctuations by using their wealth to earn more profit while still enjoying their guaranteed APR.
• Crypto-Backed Loans: Sometimes investors may need to rebalance their portfolio without selling their assets. Suppose a SOL holder needs fiat but doesn’t want to sell their SOL (no pun intended). The investor can stake the SOL, get some stSOL, and sell that stSOL for fiat. Essentially, investors will continue to enjoy staking rewards while benefiting from a SOL price increase.
• Allows quick access to funds: Unlike direct staking, liquid staking allows users to access their funds without lengthy un-staking processes or early un-staking penalties. Liquid stakers can immediately withdraw their wealth by swapping their staked tokens for regular tokens.
• Increasing/maintaining the overall liquidity of the cryptocurrency market: By allowing users to earn rewards for their holdings without having to freeze them, it encourages more people to hold on to their cryptocurrencies for longer periods of time. This can help increase the overall supply of cryptocurrencies in circulation, which in turn helps reduce volatility and improve market stability.

• Requires more technical know-how: Liquid staking requires a certain level of technical expertise to effectively manage the staking process. This can be a stumbling block for some investors, especially those who are new to the world of crypto investing.
• Deppeging Danger: The price of the derivative used may deviate from its original price. This can happen because the new token has a lower market price. For example, SOL may be priced at $100 while stSOL is priced at $80.
• Risk of losing derivative tokens: If an investor loses their liquid token, they lose their staked token. This can result from bad trades, rebalancing losses when farming in liquidity pools, and liquidations on lending protocols.
• Risk of network centralization: Token holders will likely choose to stake their tokens on liquid staking protocols. As a result, the balance of the prover shares participating in the network can be disturbed, leaving room for undue control by more powerful provers.

There is a growing number of platforms and tools designed to make liquid staking easier and more accessible for investors. These platforms provide liquid staking opportunities and help investors manage staking rewards. Liquid staking platforms on Solana include Lido, Marinade Finance, Parrot and Socean.

Lido was launched in 2020. According to crypto intelligence agency Messari, Lido’s current TVL is $5.79. Lido is unique in that it enables interoperability between multiple networks, including Solana and Ethereum. When you stake your tokens on Lido, mint stSOL tokens at a 1:1 ratio to the original tokens. These tokens can be used across the DeFi ecosystem for actions like lending and borrowing.

Parrot offers a range of products built around its stablecoin called PAI. It offers liquid staking services and generates prtSOL when SOL is deposited for liquid staking. Socean and Marinade Finance, other Solana-based platforms, also offer similar liquid staking services.

Overall, liquid staking is a new and innovative strategy with the potential to offer investors significant benefits in terms of portfolio diversification, flexibility and higher returns.

It is likely to grow in popularity in the coming years as investors look for ways to take advantage of the crypto market opportunities.

Learn Crypto Trading, Yield Farms, Income strategies and more at CrytoAnswers
https://nov.link/cryptoanswers