What are Liquid Staking Tokens (LSTs)? – Everything You Need to Know

LSTs (Liquid Staking Tokens) have recently become a popular feature in the DeFi (Decentralized Finance) market. These digital assets continue to draw new users to their networks for various reasons. What are Liquid Staking Tokens, and what makes them such a draw for DeFi users? Here’s everything you need to know about the rise of LSTs.

What is Staking?

To understand Liquid Staking, you must first grasp the concept of staking. Proof-of-Stake (PoS) networks don’t rely on miners to remain secure. Instead, they have users lock their tokens into network smart contracts to participate in the validation process. This action is known as staking. Notably, this style of consensus reduces costs, enables more participation, and improves scalability.

Staking protocols require you to keep your assets locked in a smart contract for a predetermined time. In exchange for these actions, you receive network rewards in the form of tokens. This approach helped reduce the pain points of Proof-of-Work (PoW) networks like Bitcoin but still left much to be desired.

Enter LSTs (Liquid Staking Tokens)

Liquid staking tokens are blockchain assets that get issued to stakers when they participate in a liquidity pool. Notably, these tokens have a direct value correlation with the tokens you stake. As such, they serve multiple roles such as representing the staker’s ownership in the assets and rewards earned from the stake pool.

It’s common to see these assets referred to as liquid staking derivatives as well. Much like other derivatives, they enable users to access market opportunities without holding the direct assets. In the case of LSTs, your original asset remains staked while you hold a tokenized version. The main thing to understand is that the value of your LSTs directly correlates to the value of your staked tokens.

What Problems Do LSTs (Liquid Staking Tokens) Attempt to Fix?

There are many issues that LSTs help to resolve for traders and platforms. For one, LST helps to free liquidity that was once unavailable. In the past, you didn’t have access to your assets when they were staked. This lack of liquidity could result in missed opportunities for users and even larger operating issues for platforms.

Liquid staking tokens ensure you don’t miss your next great opportunity. They enable stakers to secure rewards using the pool and additional features at the same time. For example, a user can stake their tokens and then yield farm their LSTs. This option opens the door for higher ROIs and more network growth. It also enables you to react to market conditions and offset any losses incurred due to the value of your staked asset dropping during volatile market conditions.

Benefits of LSTs (Liquid Staking Tokens)

There are so many reasons why LSTs have become a common sight in the DeFi market. For one, these tokens are flexible. They can be traded for other assets or even used as collateral to access additional funding. LSTs trade on most DEXs (Decentralized Exchanges) and can be staked in other pools. This flexibility means that you can always get the most out of your market movements.

Proof of Staked Assets

Liquid Staking Tokens serve another vital role in the economy. They act as blockchain-backed proof of ownership of the staked assets. This ownership can be confirmed in seconds using a blockchain explorer. As such,  LSTs can improve your access to passive income significantly.

Diversify Holdings

Another huge benefit of LSTs is their cross-chain capabilities. As fourth-generation digital assets, these tokens can be used across multiple networks. Users can stake in one asset and then leverage lending, staking, or yield farming options on a different network. This capability empowers users to integrate certain networks based on their offerings to improve their DeFi strategy.

Capital Efficiency

Those who want to enhance their capital efficiency will find that LSTs are a good option to consider. These digital assets enable users to extract additional utility and rewards from staked assets without breaking their commitment.  As such, your capital becomes far more useful than traditional staking options that leave your tokens inaccessible.

Collateral

The rise of P2P lending services has opened the door for more people to access capital when needed. Liquid staking tokens may be a smart option to use as collateral in these instances. Most P2P lending platforms require you to overcollateralize your loan to receive approval. As such, LSTs can be a great way to meet those requirements while leveraging future staking rewards as they emerge.

Transfer Staked Assets

Another huge benefit of LSTs is their ability to transfer ownership of staked assets without breaking any of the commitments. Staked tokens are inaccessible. In most instances, if you try to access the funds, you are either prevented or fined for not meeting your commitment.

Liquid staking tokens enable you to trade your token without breaking the staking period requirements. This structure means that you’re never stuck in a non-responsive scenario where your tokens are inaccessible during server market volatility. LST holders can always trade their LSTs if the market conditions dictate that’s the best option.

How Do LSTs (Liquid Staking Tokens) Work?

Liquid Staking tokens are currently available on multiple Proof-of-Stake (PoS) blockchains. The process of creating an LST begins when a user decides to join a liquid staking pool. The user will select the amount and time for their staked assets before approving the process.

Once they deposit their tokens, the network automatically wraps the token. The term wrap refers to the process of issuing another token on the blockchain that represents the original asset. This new tokenized asset will always represent the value of your staked assets. If the value of your staked assets declines or rises, your LST will immediately adjust to meet the new market value.

When a user’s staking period ends, they can deposit their LST to unlock their original staked assets and rewards. The LST is sent to a burn address, where it is permanently removed from circulation, and the original asset is released. Notably, the person who holds the LST is the only person who can unlock and access the staked assets and rewards.

Voting Rights

Liquid staking tokens are also used within DAOs (Decentralized Autonomous Organizations). Users stake their LSTs like governance tokens to gain access to voting rights and the ability to implement changes and upgrades. In most instances, these systems operate on a scaled structure. Consequently, those who stake more tokens gain more say.

Risks of LSTs

Liquid staking tokens have proven to be an effective way to improve liquidity and usability in the DeFi market. However, they are not perfect and there are some concerns that you should be aware of before participating in a liquid staking pool.

Lost Value

The first thing you need to understand is that you must have a reliable network connection and good intentions to use LSTs successfully. Any network downtime can result in penalties. These slashing fines are most commonly due to inconsistent network connectivity or outright malicious behavior. The penalties will cause your LST’s value to get slashed whenever this scenario appears.

Technical Risks

Another risk that you need to consider revolves around technical issues. LSTs are still fairly new to the market, and their platform’s interoperability can be seen as a blessing or a curse. Whenever you introduce cross-network bridges or have your assets operating across multiple blockchains, the added complexity can result in added security risks.

LSTs are on the Rise

When you look at the data, it’s easy to see that LSTs are more than just a fad. The LST market has +$26B in TVL (Total Value Locked), which is climbing fast. The ease of use and overall flexibility make these digital assets a wise decision for anyone trying to improve capital efficiency in their strategy.

Much of the LST activity is on Ethereum and Solana blockchains. Notably, Ethereum completed a major upgrade last year, converting the ecosystem from a PoW blockchain to a PoS platform. This maneuver took the world’s largest DeFi ecosystem and opened it to stakers. Today, Ethereum is still a top staking option.

Choosing an LST Network

Many networks support LSTs at this time. The main things you need to be concerned about are whether the network is compatible with your assets and how complicated it is to use and understand. The best option will offer a streamlined interface to improve results. Some networks like Lido offer a toolkit that helps you optimize your LST experience further.

LSTs – Increase Liquidity and Drive Adoption

Anyone who desires to get the most out of their staked assets should seriously consider leveraging LSTs. These digital assets continue to drive returns and improve liquidity for the entire market. Consequently, you can expect many more LSTs to enter service in the coming months.

You can learn more about exciting blockchain projects here.

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