‘Liquid staking’ is one pocket of crypto seeing big growth this year. Here’s what investors need to know

Published Sun, Sep 10 20237:10 AM EDT

It's been a tough summer for cryptocurrency as prices trade in a narrow range and trading volumes slump , but one corner of the market is growing: liquid staking protocols. Liquid staking protocols give investors access to liquidity while staking their funds. Generally, staking gives investors a way to earn yield on their crypto by locking up tokens on a network for a period of time. The total value of crypto assets locked, or TVL, in liquid staking protocols, such as Lido and Rocket Pool, has grown 131.6% from the beginning of this year to about $20 billion, according to data provider DefiLlama. The momentum started to ramp up after March 13, following a dip across across DeFi, or decentralized finance. That decline coincided with a drop in prices around the fall of Silvergate Bank, whose SEN network provided much of the liquidity in the crypto market. In April, the total value locked in liquid staking protocols began outpacing the total value locked in lending protocols and decentralized exchanges, according to DefiLlama. The action came after Ethereum's Shanghai upgrade , which gave investors the ability to unstake their locked-up crypto. Early crypto investors say liquid staking only has further to grow in popularity as people become more familiar with the different protocols, traders get more regulatory clarity and as the macro environment starts to shift down the road. "When [traditional finance] rates and bond rates start falling and interest rate cuts happen, if or when they do, we'll be comparing maybe a 2% or 3% bond yield to a 4% or 5% staked Ethereum yield," said Conor Ryder, head of research at Ethena Labs, a decentralized stablecoin protocol built on Ethereum. "Right now you've got traditional bonds yielding 5% and staked Ethereum yielding something similar and really it's a no-brainer for people to choose U.S. bonds as a collateral asset." Here's what investors need to know about liquid staking compared to regular staking. It's more liquid Staking is a way for investors to earn passive yield on their cryptocurrency holdings by locking tokens up on a proof-of-stake network — like Ethereum, Solana, Polkadot or Cardano — for a period of time. When you stake your crypto, you contribute to the system that keeps decentralized networks like Ethereum running and secure. You become a "validator" on the blockchain, meaning you verify and process the transactions as they come through. Rewards vary by network, but generally the more you stake, the more you earn. The "Merge" event last September turned Ethereum into a proof-of-stake network that allowed staking. Then, this year's Shanghai upgrade made it possible for stakers to withdraw those staked assets. The problem is that staking itself is a pretty illiquid activity, according to Riad Wahby, CEO of Cubist, a company that builds infrastructure to make liquid staking easier. Liquid staking, however, is effectively a derivative financial product. It overlays the network where people can exchange their funds for the promise of the ability to retrieve their staked funds later. With liquid staking, you can continue to earn yield on locked-up tokens while still accessing liquidity. "By design, the process of staking new Ethereum is actually kind of slow, and the reason for that is you don't want people to be popping in and out of the consensus protocol – you want a stable set of people who are watching the chain and watching to make sure things are going well," Wahby said. "Later if I decide I want to take my validator offline and claim my staked money back, then there's a long wait to remove that money from the protocol." It's less risky Like anything in crypto, liquid staking isn't without its risks – primarily technological and regulatory. However, the fact that it's more liquid than regular staking means it's comparatively less risky. "Staking as an activity has become too risky and it's a no-brainer for many people who are considering vanilla staking versus liquid staking," said Christine Kim, vice president of research at Galaxy. "Liquid staking offers you that additional benefit of having an asset that you can freely move around without having to worry about your lock-up period." Ethena Labs' Ryder said you can think of it as a risk-free yield in the crypto market, which has been trending toward stablecoins and other crypto assets designed to take on yield-bearing "real-world" assets like U.S. Treasurys. Since last year, crypto has struggled to have its own yield-bearing instruments, which has led to some centralization. "We know the dependency on centralized stablecoins like USDC and USDT – basically, DeFi and crypto run on those stablecoins and they essentially internalize all the yields on U.S. Treasurys," he said. "What liquid staking tokens are doing is providing crypto with its own native yield" as well as an opportunity "to build crypto native products that aren't so dependent on the outside, traditional financial system," Ryder added.