Delve Into the Sophisticated Realm of Liquid Staking Derivatives

In simple words, Liquid Staking Derivatives (LSD) are assets that represent staked cryptos. While bringing liquidity, they also promote participation in various DeFi activities. Since they depend on other underlying assets, they are considered derivatives. Like any financial instrument, LSD has its benefits and risks. 

Particularly, the liquid staking derivatives have something called smart contract vulnerabilities. Thus, crypto users need to analyze LSDs very closely before investing in them. Some popular examples of LSDs are RoketPool’s rETH and Lido’s stETH. In a way, they revolutionize blockchain networks.

To understand all of it, one must dig deeper into the concept of liquid staking derivatives.

Liquid Staking Derivative: The Gist of It

So far, LSD is compatible with proof-of-stake networks only. They have been largely associated with Ethereum as well as Solana. The distinct asset class has been used to liquidity challenges in the staking environment. It locks away the tokens and enables the stakers to earn rewards with them. 

However, it follows the other guidelines of a staking network and makes the staked tokens inaccessible. But it certainly does more than ordinary staked networks and offers additional solutions. Using LSDs, token holders can access several DeFi activities. While maintaining liquidity and offering services, it also maintains asset productivity.

As mentioned above, LSDs expose users to risks as well. To begin with, these derivatives follow liquid staking protocols that are known to be vulnerable. Users dealing with this instrument must make their evaluations on benefits and drawbacks. Still, it’s important to know that LSDs are growing in terms of dominance and market capitalization.

So let’s analyze what the crypto investors get with LSDs. 

Advantages of Liquid Staking Derivatives

Increased Liquidity– LSDs enhance liquidity in blockchain networks with staked assets. It converts those accumulated tokens into tokenized items. Hence, whenever users want to trade, they can use those altered staked assets. 

Passive Income– Like a standard staking system, LSD also gives chances to make potential income to the users.

DeFi Involvement– As mentioned above, LSDs make DeFi services more accessible. They enable the users to tap into services like collateral for loans or investment strategies. Platforms like Aave make these solutions very easy with their own LSD, wstETH.

Easy Access– Usually, the staking platforms set the bar high for joining this service. However, LSDs make it very easy for the users to start staking.

Risk Management– LSDs help investors lower the risks usually involved with investments. On the contrary, they enable the traders to make extra money.

Reduced Cost– LSDs curtail the risk factor by making staked assets usable within the DeFi ecosystem.  

While offering these advantages, LSDs expose its users to some risk factors as well. Besides the smart contract vulnerability, they become susceptible to market fluctuations. Some other factors might also make crypto users doubtful about using LSDs. It is a must for them to know all of the potential downsides before investing in them.

Drawback of LSDs

Depegging– This means that the market price of LSDs may underperform their staked cryptos. In fact, there’s no surety that LSDs will always stick to the price they originally gained.

Withdrawal Delays– The withdrawal time of LSDs could disappoint many users. On platforms like Rocket Pool and Lido, it could take 1 to 4 days to redeem the tokens. 

Fees– When users redeem with LSDs, they have to pay the gas fee for it. Depending on the protocol, they may end up using 2% to 5% of staking rewards.

Smart Contract Risks– Liquid staking platforms use smart contracts to execute their operations. Unfortunately, smart contracts haven’t been able to remain invulnerable to hackers. They can be easily compromised and stolen by bad actors.

Centralization Risks– Staking protocols have a major concern of being handled by large stakeholders. The system defies the very purpose of decentralized systems and cedes control to certain individuals.

Network Perils– Every blockchain has certain inherent factors like gas fee spikes and transaction congestion. Such issues can impact the performance of the structure and slow it down.

With all the pros and cons, LSDs are getting more dominant in the blockchain space. Some leading platforms have adopted this solution and have achieved notable outcomes. They haven’t just adopted it but have also promoted its usage in the crypto sphere. Here are some protocols that have benefited from liquid staking derivatives.

Lido Finance 

Rocket Pool

Binance Staked ETH

Frax Ether

Coinbase Wrapped Ether

Bottom Line

Experts suggest that in the future, the risks associated with LSDs may be mitigated. However, no one can be certain about how this will pan out. It may continue to soar high with its vulnerabilities too. The crypto users will have to wait and see what happens with liquid staking derivatives. 

Adarsh Singh is a true connoisseur of Defi and Blockchain technologies, who left his job at a “Big 4” multinational finance firm to pursue crypto and NFT trading full-time. He has a strong background in finance, with MBA from a prestigious B-school. He delves deep into these innovative fields, unraveling their intricacies. Uncovering hidden gems, be it coins, tokens or NFTs, is his expertise. NFTs drive deep interest for him, and his creative analysis of NFTs opens up engaging narratives. He strives to bring decentralized digital assets accessible to the masses.