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The Complexity of Staking and How Liquid Staking Helps

July 22 2022
Nesting

Staking is considered one of the safest ways to generate yields. Why? Because the rewards that you get from staking your L1 assets come from network inflation and are not subject to the prevailing market conditions. At the same time, the complexity of staking can become too tedious for an average investor. These complexities include understanding how to set up a validator node or choosing a validator node if you want to become a delegator. Both require a certain level of technical expertise, and it can become too difficult for investors who have neither the expertise nor the time to acquire it. While staking pools help in this case, they have inherent problems such as the illiquidity of staked assets and/or pose stake centralization risks on the network.

In this article, we will explore how liquid staking manages to solve these problems by offering a much more viable solution. Let’s dive in.

Complexities of Staking

One of the biggest complexities when staking is setting up validator nodes. The technical know-how required to set up a node itself is too vast. Imagine scanning through hundreds of pages of technical documentation of PoS chains! When you set up a validator node, you participate in the consensus mechanism of the blockchain and help validate transactions. To set it up, you need to:

  • have the minimum amount required to validate on that chain,
  • participate in major governance activities,
  • maintain +99% uptime to get the most rewards
  • keep up with all the updates that are happening in the ecosystem to ensure your node is never outdated.

Imagine keeping up with the updates happening on Discord while ensuring that your node is maintaining +99% uptime whilst also ensuring that you are keeping up with other activities. It can be an extremely cumbersome and exhaustive task! And that is why most investors who want to earn sustainable staking rewards but do not want to set up their own validator node often end up delegating their stake to a validator. By delegating, you are effectively giving your money to a validator who, in turn, stakes it on the PoS network and gives you a share of the rewards that they make (after deducting the management fee). While delegating seems like a viable solution for most investors, it has problems of its own.

Is delegating your stake better?

To delegate your stake, you need to first understand which validator to delegate it to in the first place. Most PoS networks have a number of validators who help validate transactions. The delegators have to decide which validator to choose. The first thing any investor will want to look for in delegation is the commission that a validator charges. But that is just the tip of the iceberg.

An investor must understand the validators’ slashing history and uptime. While both are connected, the former is an indicator of whether validators’ funds have been slashed previously (i.e., taken away). This can happen due to multiple factors such as downtime, malicious behavior on the part of the validator, and so on. Uptime refers to how long the validator has been online in the past few days, weeks, and months. High uptime is required to get rewards for every block/epoch irrespective of whether they were proposing the block. If the validator is offline when it is their turn to propose/sign, they might lose some rewards depending on each protocol’s rules.

Additionally, investors must also understand the team behind the validator, how responsive they are to queries, how attentive they are to network-wide changes and how soon they can respond to upgrades. All of this could become too tedious if you were to research the top 10 validators on the top 5 PoS networks!

As a result of this, several investors either end up staking via a centralized exchange or going to the most popular validator on that network. Centralized exchanges offer a much better user experience for staking - in most cases, you can stake your assets in one click. The same goes for the most popular validators on the network. Since these larger entities have more money flowing through them, they can provide much better user experiences. However, there’s a problem.

And that is of stake centralization. A single exchange or staking pool (that pools users’ funds to stake) is a huge liability to the PoS network. Imagine if the exchange gets hacked or the staking pools’ keys get compromised. The users' funds can get lost, effectively damaging the entire PoS network. Moreover, in the case of a hack, the entire network becomes at risk as the largest validator (be it an exchange or a staking pool) can manipulate votes in its own favor. While some exchanges can offer better staking yields, you never know where the yield is coming from. You don’t even know if the exchange is utilizing those funds for staking or putting them elsewhere!

In this case, staking ends up becoming a winner-take-all game where these staking pools and/or validators control the majority stake - and hence have a hegemonic influence over the network. The largest validator on the network will get the most fund delegation, making it the most profitable validator, while the smaller ones will get quashed. This is where liquid staking breaks this centralization phenomenon. How? Let’s explore.

How liquid staking aims to decentralize PoS networks

Liquid staking solves the problem of stake centralization by spreading the stake across a number of different validators. It abstracts the complexities of staking by offering users the same smooth experience that centralized exchanges and large centralized staking pools offer - without compromising on decentralization. In a decentralized liquid staking protocol, the users who hold the governance tokens decide the parameters for choosing validators. (We know there are concerns around how the governance of liquid staking protocols can become a liability to PoS networks. We will explain our perspective on that in a separate article soon.)

On top of all this, users also get to utilize their staked capital (as they get liquid-staked tokens i.e., csTokens in return) across a multitude of different DeFi applications and compound their yield. Not only do liquid staking protocols help unlock the capital efficiency of staked assets, but they also help give true decentralized freedom to users. While the smart contract risk of the liquid staking protocol does exist, it is mostly minimized thanks to the team of researchers and security experts who keep hunting for attack vectors and solving them.

We believe decentralized liquid staking protocols are a much more viable alternative to staking pools and staking on exchanges because they help retain security without compromising decentralization.

ClayStack is a liquid staking protocol that offers tradeable value-accruing liquid-staked tokens for every token you deposit. To learn more about how ClayStack works and how the protocol is on a mission to help maximize capital efficiency for its users, check out claystack.com.

  • To start earning staking rewards on your tokens, head to app.claystack.com.
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