Staking basics

What are Liquid Staking Derivatives?

Shivendra Singh

Apr 13, 2023 • 8 min read

Liquid staking derivatives (LSDs) are a kind of token that symbolizes staked assets. LSDs are issued by the Liquid Staking protocols, which allows the user to stake their assets without the need to lock them up. It gives the users flexibility to use their staked assets in other DeFi protocols, while still earning from staking rewards.

LSDs are typically issued on a 1:1 basis with the underlying staked asset. Which means that for every LSD a user holds, they have 1 unit of the underlying asset staked. LSDs can be traded on decentralized exchanges, and they may also be used to earn an additional staking rewards in DeFi protocols.

Liquid staking derivatives give you a number of advantages over the traditional staking. Firstly, they allow the users to access their staked assets without having to wait for the unbonding period to expire. Secondly, they can be used to earn additional staking rewards in DeFi protocols. Thirdly, LSDs are more liquid than traditional staking because LSDs don't have a locking period, making them easier to trade.

Liquid staking derivatives are relatively new in the DeFi space, but they have the power to revolutionize traditional staking. By allowing the users to use their staked assets and earn an additional staking rewards, LSDs are making staking more accessible and attractive to a broader range of users.

Overall, liquid staking derivatives have a number of advantages to offer over traditional staking. They are more liquid, they can help to earn additional staking rewards, they can help to reduce risk and others that we’ll discuss further in this blog.

History of Liquid staking derivatives

Liquid staking derivatives is relatively new in the DeFi world, but it has seen a rapid growth in recent years. The first liquid staking protocol was launched in 2020. The growth of liquid staking derivatives is a sign of the growth in popularity of staking. Staking is a way through which users can earn rewards for securing a blockchain network. Even though there is a long way for liquid staking derivatives to go, the future of liquid staking derivatives is bright. As staking becomes more popular, liquid staking derivatives will become an increasingly important part of the DeFi ecosystem.

Benefits of Liquid Staking Derivatives

Here are some of the benefits of using liquid staking derivatives:

Increased staking rewards: LSDs are used to earn additional staking rewards in DeFi protocols. LSDs are essentially the tokens that represent staked assets, and they can be used for participating in the DeFi protocols that offer the staking rewards.
Increased liquidity: LSDs allow users to access their staked assets without the need to wait for the lockup period to expire which makes them more liquid than the traditional staking, which can be beneficial for users who need to access their funds quickly.
Reduced risk: LSDs can be helpful in reducing the risks associated with staking because the LSDs typically increases diversification, choosing a varied set of validators and therefore spreading the risk across many actors in the ecosystem. Apart from this, LSD are issued by reputable liquid staking protocols, which are typically backed by insurance or other forms of a collateral.
Simplicity: LSDs are relatively easier to use. Users can easily stake their assets with a liquid staking protocol and then use their LSDs to participate in the DeFi protocols or trade them on DEXs.

Liquid staking derivatives have a number of advantages over traditional staking. They are more liquid, they can help to earn additional staking rewards, and they can be helpful in reducing risk. If you are considering staking your assets, liquid staking derivatives can be a good option to consider.

Risks of Liquid Staking Derivatives

Liquid staking derivatives (LSDs) are a relatively new type of financial investment in the crypto market, and as such, they’ll have a number of risks. Some of the key risks with LSDs that you should be aware of include:

Smart contract risk: Liquid staking derivatives are typically issued on a blockchain, and as such, they are subject to the same risks as any other smart contract including the risk of bugs, hacks, and other security vulnerabilities.
Protocol risk: LSDs are issued by liquid staking protocols, and can be subject to the same risks as any other DeFi protocol. This includes the risk of rug pulls, hacks, and other scams.
Market risk: The value of LSDs is typically related to the value of the underlying staked asset. However, there is always the risk that the value of the LSD could disassociate from the value of the underlying asset. This could be due to a number of factors, including the liquidity issues, market volatility, or other market conditions.
Liquidity risk: LSDs are typically less liquid than the underlying staked asset which means that it may be more difficult to buy or sell LSDs, and that the price of LSDs may be more volatile.
Regulatory risk: The regulatory landscape for LSDs is still evolving. It is possible that the LSDs could be subject to new regulations in the future which could impact the ability of users to buy, sell, and use the LSDs.

Liquid staking derivatives do have a number of potential benefits, but they also have a number of risks associated. It is important to carefully consider these risks before deciding whether or not to use LSDs. It is important to carefully understand the risks and benefits of using liquid staking derivatives before deciding whether or not to use them.

How to we use Liquid staking derivatives?

Following are the steps on how to put liquid staking derivatives (LSDs) to work:

Choose a liquid staking protocol: There are a number of liquid staking protocols available, so it is important to choose one that is reputable and has a good track record like for instance, Stader Labs.
Stake your assets with the liquid staking protocol: For this, you’ll have to create an account with the liquid staking protocol and deposit your assets.
Receive LSDs in return for your staked assets: The liquid staking protocol will issue you LSDs in return for your staked assets. The number of LSDs you receive equals the number of assets you staked.
Use your LSDs to earn additional staking rewards: You can use your LSDs to earn additional staking rewards in a number of ways. You can participate in DeFi protocols that offer staking rewards, or you can trade your LSDs on decentralized exchanges.

5. Unstake your assets when you are ready: Whenever you unstake your assets, you can simply return your LSDs to the liquid staking protocol. The liquid staking protocol will then return your staked assets back to you.

How can LSDs affect the DeFi Activities ?

Liquid staking derivatives (LSDs) and DeFi activity are related in a number of ways. Firstly, LSDs allow the users to earn staking rewards without having to lock up their assets making it possible for users to participate in the DeFi protocols and earn additional staking rewards. Secondly, LSDs may be used as a collateral in DeFi protocols which can help the users to access liquidity without having to sell their assets. Thirdly, LSDs can also be used to mint the synthetic assets in DeFi protocols. This will help users to get the exposure to assets that they wouldn’t otherwise be able to access.

Overall, LSDs help in increasing DeFi activity by making it easier for users to participate in DeFi protocols and earn additional staking rewards through them. They can help in reducing the risk associated with DeFi by providing users the access to liquidity and collateral.

Here are some of the specific ways that LSDs can stimulate DeFi activity:

Increased participation: LSDs make it easier for users to participate in DeFi protocols. This is because they allow users to earn staking rewards without having to lock up their assets. This can lead to increased demand for DeFi protocols and services.
Increased staking rewards: LSDs can be used to earn additional staking rewards in DeFi protocols. This is because they can be used in earning staking rewards and engaging in other DeFi activities. This can lead to increased profits for DeFi users.
Reduced risk: LSDs can help to reduce the risk associated with DeFi. This is because they can be used to collateralize loans and mint synthetic assets. This can help users to protect their assets and avoid losses.

Overall, LSDs can help to stimulate DeFi activity by making it easier, more profitable, and less risky for users to participate in DeFi protocols.

How Does the Ethereum Shanghai Upgrade Help Liquidity Staking Derivatives?

The Ethereum Shanghai Upgrade, which was implemented in March 2023, has introduced a number of changes that makes Liquid staking derivatives more attractive and accessible to users.

One of the most important changes is that the Shanghai Upgrade allows the users to withdraw their staked ETH without having to wait for the lockin period to expire which makes it possible for users to use their staked ETH in other DeFi protocols, while still earning staking rewards.

The Shanghai Upgrade is a significant development for liquid staking derivatives which makes it easier for users to use their staked ETH and earn additional staking rewards. This could potentially lead to increased adoption of liquid staking derivatives and a more liquid Ethereum staking market.

Some of the specific ways that the Shanghai Upgrade helps the liquid staking derivatives are:

Increased liquidity: The ability to withdraw staked ETH without having to wait for the unbonding period to expire makes liquid staking derivatives more liquid. This makes them more attractive to users who want to use their staked token in other DeFi protocols.
Increased staking rewards: The ability to mint LSDs that represent staked tokens makes it easier for users to participate in DeFi protocols and earn additional staking rewards which leads to an increased demand for LSDs and higher prices.
Reduced risk: With the Shanghai Upgrade, a number of security features that helps to reduce the risk associated with liquid staking derivatives. This makes them more attractive to users who are more concerned about security.

Overall, the Ethereum Shanghai Upgrade has a positive development for liquid staking derivatives. It will make them more liquid, more staking rewards-generating, and less risky for the users which could lead to increased adoption of liquid staking derivatives and a more liquid Ethereum staking market.

Frequently Asked Questions (FAQ’s)

Q) What are the benefits of liquid staking derivatives?

Ans) Some of the benefits of using liquid staking derivatives are as follow:

Increased staking rewards
Increase in liquidity
Reduced risk

Q) Which cryptocurrency is commonly used for liquid staking derivatives?

Ans) One cryptocurrency which is commonly used for liquid staking derivatives is Ethereum 2.0 (ETH). Ethereum 2.0 is an upgrade to the Ethereum network that introduces a new consensus mechanism called Proof of Stake (PoS) instead of the current Proof of Work (PoW) mechanism.

Q) What is the future of liquid staking derivatives?

Ans) The future of liquid staking derivatives holds potential for further growth and innovation in the cryptocurrency ecosystem. Here are a few aspects that could shape their development:

1. Increased adoption: With more blockchain networks transitioning to proof-of-stake (PoS) consensus mechanisms, liquid staking derivatives are likely to gain prominence. Ethereum 2.0 is a good example for it, and as other PoS-based networks emerge, the demand for liquid staking derivatives may also expand.

2. Enhanced accessibility: Liquid staking derivatives can make staked assets more accessible and tradable. This accessibility will attract a broader range of users, including the one who want to benefit from staking rewards without the technical requirements or time commitments of running a validator node.

3. DeFi integration: Liquid staking derivatives can be integrated with decentralized finance (DeFi) applications, allowing users to utilize staked assets as collateral for borrowing or participating in various staking rewards-generating strategies. This integration can create new opportunities for financial innovation and increase the utility of staked assets.

Therefore, while the potential for liquid staking derivatives is promising, their long-term trajectory will depend on these factors and how the ecosystem evolves over time.