Key Takeaways
- Liquid staking tokens provide users with a derivative token while staking.
- Each liquid staking token earns yield while it can be used in DeFi.
- The utility of liquid staking tokens adds an additional layer of smart contract risk.
Decentralized finance (DeFi) is constantly finding new ways to maximize capital efficiency. One recent and extremely capital-efficient development in DeFi has been liquid staking tokens, and there are now several projects working on offering liquid-staked assets.
In Hubble's last article on Crypto Basics, the protocol discussed staking tokens and how to stake tokens on Solana. For users who are unfamiliar with how staking works, read about the basics first, so this article on liquid staking tokens will make more sense.
What are Liquid Staking Tokens?
When staking tokens on a PoS blockchain, users lose the ability to use those tokens until they unstake them. For example, when users stake SOL with a Solana validator, the validator will use those tokens to help secure the network and finalize transactions. While those tokens are being used for this purpose, they cannot do other things, like participate in DeFi.
On the other hand, liquid staking tokens let users have their cake and eat it too. When users deposit SOL with a liquid staking protocol, they will receive a yield-bearing token like Marinade SOL (mSOL) from Marinade Finance, or Lido-staked SOL (stSOL), from Lido Finance, and can use this token for DeFi.
To retrieve SOL, users can trade mSOL and stSOL for vanilla SOL through a decentralized exchange (DEX), or they can burn their liquid staking tokens to withdraw SOL from the liquid staking pool. For example, if the rate for staking SOL is 6% APY, users should be able to exchange or burn their liquid staking token for around 0.06 more SOL after a year.
Let's review what this means:
- SOL tokens are staked and help secure the network.
- Staked tokens are earning Solana staking rewards.
- Users have a token, like Marinade SOL, that accrues rewards over time.
- Users can use mSOL as collateral for a DeFi loan.
- Users can get back their initial SOL with interest earned from staking.
Through the magic of DeFi composability, so much is possible. Liquid staking tokens are perhaps one of the most magical developments yet!
How Does Liquid Staking Work?
When users stake tokens with a validator, they should do their due diligence to determine which ones are reliable, have the best rates, and help improve the overall decentralization of the network they're supporting. Unfortunately, this research can take a lot of work, and users may be left with doubts about whether or not they chose the best validator for themselves and the network.
When users participate in liquid staking on Solana, Marinade or Lido Solana will do all the calculations on behalf of users to choose the best validators. These liquid staking pools take into account reliability, rates, and how well adding to a validator's stake contributes to the decentralization of Solana.
Marinade and Lido pool users' resources to ensure enough tokens are available for withdrawal while the majority are being staked with validators. It's highly improbable that every user taking part in Lido staking on Solana will simultaneously burn their stSOL for SOL, allowing Lido to delegate the majority of pooled SOL towards validators.
How Can Users Obtain Liquid Staking Tokens?
Users can trade for liquid staking tokens on a DEX, but what's arguably the best way to get mSOL or stSOL is to deposit SOL directly with Marinade or Lido. By depositing additional SOL into the liquid staking pool, more tokens can be spread to different validators that will help increase Solana's Nakamoto Co-efficient.
The process for staking with Marinade and Lido is very similar:
- Navigate to the Marinade Finance or Lido Finance staking page.
- Connect a wallet.
- Enter how much SOL to stake.
- Click "Stake" and approve the transaction.
- You're finished! You will find mSOL or stSOL in your wallet.
Once receiving liquid staking tokens, users can begin participating in DeFi with them. Users can earn additional rewards for depositing these tokens on different platforms for yield, or they can borrow stablecoins by using them as collateral.
How are Liquid Staking Tokens Used in DeFi?
The price of mSOL and stSOL will necessarily be higher than that of SOL, since it constantly reflects the rewards earned from Solana staking. For instance, at the time of writing, mSOL is valued at $33.51, stSOL is valued at $33.35, and SOL is valued at $31.48.
It's possible to hold mSOL in a wallet and watch it grow, but that wouldn't be much different from staking SOL directly with a validator. Liquid staking tokens can be put to good use! They can be used as collateral for borrowing, and since mSOL and stSOL are earning APY while being used as collateral, they can sometimes negate the costs of borrowing.
Users can also provide liquidity on a DEX for liquid-staked SOL and vanilla SOL to earn fees from traders. This is a way to maintain exposure to SOL, earn rewards from staking, and earn fees from providing liquidity. In addition, since mSOL and stSOL are pegged to SOL, there is very little impermanent loss (IL) when providing liquidity.
On many Solana DeFi protocols, mSOL and stSOL can be used the same way as SOL. Using liquid staking tokens is a much more capital-efficient way to participate in DeFi while also helping a network operate more effectively and securely.
What Else Should Users Know about Liquid Staking?
There are a few additional risks associated with liquid staking tokens. First, liquid staking is a technological innovation in DeFi, and this innovation is powered by smart contracts, which means another layer of smart contract vulnerability is added to positions when using tokens like mSOL or stSOL for DeFi.
In addition to smart contract risk, liquid staking tokens introduce the risk of de-pegging. Like all pegged assets on an open market, their price can be affected by market forces pushing the asset off its peg for several reasons.
Fortunately, if a liquid staking token drifts from its peg, it can still be redeemed for the correct amount of its underlying asset. That's one of the magical things about liquid staking tokens—just one token can represent more than one token!
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