With a technology as powerful as liquid staking, it is easy to get ahead of your skis and go all in. Trust me, I am tempted; however, it is crucial to evaluate not just what the benefits are of this innovation, but also look at the risks.
So, let’s start there and see what kind of obstacles could possibly stand in our way.
Understanding the Risks
One of the first concerns that I have with liquid staking is that one protocol is able to successfully consolidate a large amount of governance tokens within the confines of its smart contracts. If successful in attracting many stakers and delegating these tokens to a relatively small group of hand-picked validators, the protocol could centralize governance ownership and essentially take control of the blockchain. This is especially important in light of the fact that not every liquid staking protocol allows the user to retain governance voting rights.
No evaluation of risks can ignore the possibility of the underlying smart contracts being exploited. The reliance on carefully audited code and multiple waves of testing practices are crucial.
The balance of validator shares for blockchains joining the liquid staking innovation will likely be upset, as users redeploy their assets to take advantage of the additional rewards. This is especially the case for those protocols that choose to launch with a small number of hand-picked validators or those locking users out from choosing their own validators. It will be important to monitor the resulting concentrations of delegations amongst the validators to ensure that a decentralized balance is maintained or restored.
Since many of the derivative tokens rely on trading pegged to the native token, a depegging risk also exists. A significant imbalance with the native token could lead to additional selling and cascade these negative effects. We witnessed this play out with multiple derivative versions of major tokens just five months ago across several dApps in the Terra ecosystem.
Once users deploy the derivative tokens in DeFi , there are significant risks that come along with this. Once you lose your liquid token, you lose your staked token. They can be lost as a result of bad trades, rebalancing losses when farming in liquidity pools, and liquidations at lending protocols.
The Benefits are Plentiful
As the major blockchains in the Cosmos are maturing, inflation schedules are scaling back. While this is great for the future financial health of these profit generating businesses, it also means that the amount of staking rewards are falling. As a result, early adopters, new participants, investors, and even institutions will be seeking other ways to earn the high level of rewards that we have become accustomed to. And, they have been out-of-this-world lucrative! The main benefit of liquid staking is just that then: the opportunity to boost rewards by staking the derivative token.
However, it doesn’t end there. Having a derivative token in your possession adds enormous flexibility. If you need or want to unstake, you do not need to wait the mandatory 14-28 days. You can swap the derivative at a slight discount and have your staked token back.
And, then there are the waves of new dApps launching constantly in the Cosmos. Using the derivative token to participate with these novel products is a benefit not to be underestimated. Besides the opportunity for additional profits, the teams launching these products are also more likely to see engagement with their products increase significantly.
Liquidity across the blockchains of the Cosmos will also improve as staked tokens are now able to fund new financial products with their derivatives. Lending protocols can attract collateral, AMMs can fill up their liquidity pools, and founders can lock-up tokens in their blockchains while allowing users to engage with their dApps.
An Autumn of Innovation
Several of the new liquid staking protocols that are launching now have thoroughly evaluated the risks discussed above. They are kicking off this new era in the Cosmos with validator sets perfectly positioned to achieve and maintain decentralized security and governance. They are also allowing the delegators to retain their governance voting power.
Price discovery of derivative tokens is going to be interesting to monitor and I expect it to also create a number of arbitrage opportunities. And, as more and more DeFi applications launch we will undoubtedly witness some questionable practices; however, when I scroll through the lists of exciting dApps launching on Osmosis, Secret, Kujira, and Juno (just to name a few), I honestly can’t wait for the explosion of innovation that is going to sweep across the Cosmos.
I experienced an “Autumn of Innovation” last year and this feels like we are heading into another exhilarating season! With so much more diversification, such a large variety of application specific blockchains, wiser business professionals, and many more experienced teams of talented developers, I am hopeful that this time we will continue to flourish from the seeds that are sown here and now.
Wordt vervolgd – Opa.
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Awesome Oupa, mooi so. I staked some crypto in some yield farms and earned nicely on Fantom before the crash. Some others paid out good yield initially but the asset itself was massively depreciating in value so it wasn't worth the effort. Let's hope the uptrend in bitcoin will resume and pull the alts up with it.
Best wishes from The Garden Route, South Africa.
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