Nexo experiments with liquid staking of client assets in hunt for DeFi yield

Crypto lender Nexo is ramping up the level of client funds it allots to liquid staking DeFi protocols as it seeks to boost returns.

Nexo started employing liquid staking — which effectively leaves staked tokens free to use in other trades — about a year ago and has been steadily increasing its use since, DeFi strategist Kiril Nikolov said in an interview at the Avalanche Summit in Barcelona on Wednesday. 

Nexo is a centralized service that lets users lend out crypto and receive a return. It generates this yield in a few ways, including lending funds to institutions, trading tokens and staking tokens. Staking is a big part of its business and is used to generate the yield for most newer coins, such as solana, luna and avalanche. 

About a year ago, Nexo began experimenting with liquid staking as a way to not only generate more yield but to free up liquidity, particularly for ether. Since then, it has expanded its range of liquid staking platforms across different blockchains and increased the amount of capital allocated to such protocols. 

“It’s still a very low percentage” of Nexo’s business, Nikolov explained, although it “will increase as time goes by and ETH 2.0 comes closer.” 

What is liquid staking?

Liquid staking is a way of freeing up liquidity and generating extra yield on assets that are being staked. When you stake with a liquid staking provider, you receive a token that represents your staked assets. These tokens essentially have an equivalent value and you can use them in other DeFi protocols to generate further yield or for any purposes, such as trading. But you will need to return the tokens to unlock the original staked assets.

Nikolov explains the main problem lies with Ethereum. While Ethereum lets you stake tokens — and some $32 billion worth are being staked already — the network has not yet fully moved to proof of stake (POS) validation, meaning unstaking is impossible. Any funds staked on Ethereum are locked in until the POS switch – perhaps later this year.

Here’s an example of the dilemma. Say one of Nexo’s customers deposits ether (ETH) and Nexo stakes it on Ethereum to get the staking yield. If the customer wants to remove their funds from the platform, Nexo has to give them back their ether. Yet for Nexo, it’s still stuck on Ethereum.

“With Ethereum, you can never unstake until ETH 2.0 is ready. This is the obvious one where, if you need any kind of liquidity, then liquid staking is for you,” said Nikolov.

With liquid staking, you can sell the staked tokens on the open market at any time, rather than waiting to unlock them. Typically this will roughly reflect the underlying value of the staked assets, since anyone can arbitrage the difference. The biggest concern for Nexo is that sometimes there’s a premium for those looking to cash out immediately, something that would hurt its returns.

“So that’s again, a huge problem, right? When it comes to ETH, if you’re making 5% a year, a 1% discount is a very big concern,” he said.

A question of risk

Nexo primarily uses Lido Finance, the largest liquid staking provider on Ethereum (and other chains), which Nikolov described as battle tested. He added that Nexo tries out newer liquid staking protocols on other chains but starts with small sums and builds up over time as the protocol shows it’s safe.

Beyond liquid staking, Nexo has put its own funds to work in DeFi protocols but has largely avoided experimenting with client funds – simply due to the levels of risk involved.

In contrast, rival crypto lender Celsius has been more aggressive in the DeFi industry and has a dedicated DeFi team. Yet it lost around $50 million when DeFi protocol Badger DAO was exploited. At the time, Celsius declined to comment on what percentage of customer funds were held in DeFi protocols.

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