ELI5:50 – Web3 liquid staking versus traditional bank savings explained

As the decentralization of finance continues to steer the course of modern financial systems, the interplay between traditional bank savings and web-based liquid staking is something most may not fully comprehend.

Let’s break the topic down using the ‘Explain Like I’m 5’ (ELI5) concept.

ELI5: Liquid Staking in Web3

Imagine you’re at an arcade. You play several games, win tickets, and instead of immediately cashing them in for a prize, you lend them to the arcade owner. The owner gives you virtual tokens, which you can use at any time for a prize, while the owner uses the actual tickets to attract more players. This is how liquid staking works in the web3 world. You lend your cryptocurrency tokens to a network, and in return, you get “staked tokens” you can trade or use anytime.

ELI50: Liquid Staking in Web3

Liquid staking in web3 is a process that allows cryptocurrency holders to participate in network security and decision-making while maintaining the liquidity of their assets. Users delegate their tokens to a network’s validator node, receiving newly minted staking tokens representing the original stake and claimable rewards. These derivative tokens can be freely traded, providing liquidity to the staker.

ELI5: Traditional Bank Savings

Think of traditional bank savings like a piggy bank, but instead of home, you keep it at a trusted friend’s house (the bank). The friend makes your money work by lending it to others and pays you a small part of what he earns via interest.

ELI50: Traditional Bank Savings

A traditional bank savings account is a deposit account held at a financial institution that provides principal security and a modest interest rate. Banks use the funds from these accounts to lend to borrowers and charge a higher interest rate, the difference of which becomes their revenue. Account holders receive a portion of this interest while enjoying the safety of their deposit.

Comparison Between Liquid Staking and Traditional Bank Savings

Both liquid staking and traditional bank savings share the core principle of generating income from idle funds. However, the differences between these two methods become evident when we delve deeper into their functional dynamics, potential returns, and inherent risks.

Liquid staking, a byproduct of blockchain technology, provides an appealing level of transparency and potential for high yields fueled by the often volatile yet rewarding cryptocurrency markets. Meanwhile, traditional savings accounts offer relatively lower but more predictable returns, safeguarded by insurance up to certain limits.

Banks are intermediaries in the traditional banking ecosystem, utilizing deposits from savings accounts to fund loans. The interest garnered from these loans exceeds what is paid on the savings, and this disparity, known as the net interest margin, forms a significant portion of a bank’s income.

In contrast, DeFi protocols incentivize stakers through unique reward mechanisms. Part of the transaction fees and rewards from freshly minted tokens are distributed among stakers, creating an environment ripe for high-yield potential. However, this lucrative opportunity is balanced by high risk, primarily from market volatility and possible vulnerabilities within smart contracts.

Liquid staking, especially in the evolving web3 domain, and traditional bank savings each provide platforms for passive income generation. However, they cater to different risk profiles and yield expectations.

Fee Generation in Web3 and Traditional Finance

In the banking sector, fees are often associated with account maintenance and transaction costs. These fees can eat into the overall returns from a savings account. On the other hand, in the realm of staking, fees usually arise from transaction costs on the blockchain, and sometimes, a percentage is taken by the staking pool operator as a commission for services rendered.

As decentralization continues redefining the financial landscape, an in-depth understanding and adoption of these novel financial concepts and models, including staking, becomes invaluable. Therefore, it’s imperative for potential investors to meticulously analyze their risk appetite, desired returns, and the dynamics of each method before deciding where to park their idle funds.