The many layers of crypto staking in the DeFi ecosystem

Staking has been used fluently to describe several actions within the world of crypto, from locking your tokens on a decentralized finance (DeFi) application or centralized exchange (CEX) to using tokens to run a validator node infrastructure on a proof-of-stake (PoS) network.

PoS is one of the most popular mechanisms that allows blockchains to validate transactions and it has become a credible consensus mechanism alternative to the original proof-of-work (PoW) used by Bitcoin.

Miners require a lot of computational power to carry out the energy-intensive PoW, while PoS requires staking coins as collateral to validate blocks and verify transactions, which is significantly more energy-efficient and presents less centralization risk. These are some of the reasons why companies like Mozilla changed their donation policies to only accept PoS crypto donations in line with its “climate commitments.”

The Ethereum protocol is expected to undergo a transition to a PoS consensus mechanism before the end of the year. On the roadmap to scale the network, the merge feels right around the corner. Ethereum miners will have to mine a different cryptocurrency or pivot to staking if they wish to continue securing the network.

Dogecoin also has plans to perform this transition in the future.

Staking rewards are incentives provided to blockchain participants for validating new blocks. There are several ways in which one can participate in staking within the crypto ecosystem:

Run your own validator node

Proof-of-stake allows for anyone with a computer to run a node and validate transactions by participating in the consensus of the selected blockchain. Validators are assigned at random to verify a block.

Validators have to build their own staking infrastructure to run a node. Depending on the network, being a validator can demand high entry costs as a set amount of tokens needs to be staked before going live.

As long as the validator node is live, the tokens being staked are both locked up and earning a yield. Running your own node can be complicated and technical for beginners and if done incorrectly, can incur financial losses of the tokens at stake.

Delegate to a validator

Tokens of PoS networks can be assigned to a third party so they can run their own node and validate transactions. This is a less complicated method than running your own node but involves delegators joining a staking pool and trusting the selected validator with their tokens.

Projects like Stake.fish offer “Staking as a Service” to ensure the legitimacy of these validators. The founder of Stake.fish’s validating services also co-founded f2pool, one of the largest Bitcoin and Ethereum mining pools.

Similarly to running a mining pool, a staking pool requires a robust team of engineers. The main difference comes down to the target audience. While mining pools are focused on miners, staking pools cater to anyone who holds PoS tokens. Dasom Song, head of marketing for Stake.fish, told Cointelegraph:

“Managing and building our own infrastructure is our way of contributing to the crypto ecosystem.We talk with projects, research ecosystems as well as listen to our community to make a decision on new chains to support.”

Both running your own node and delegating to a validator are some of the safest ways to earn an active return on your tokens but come at the cost of making your assets illiquid for a set period.

Liquid staking

In recent years, several projects have sprouted that offer token holders an alternative to staking pools and solve the illiquidity of staking while still contributing to validating the network.

Lido (LDO), the highest-ranked protocol by total value locked (TVL), supports several blockchains with their yield-bearing tokens like Ether (ETH), Cosmos (ATOM), Solana (SOL), Polkadot (DOT), Cardano (ADA) and more. It is a non-custodial protocol but it is not permissionless as the Lido DAO selects validators through governance voting. Stake.fish is one of those trusted validators voted by the Lido community to support the protocol.

Other projects like Rocketpool (RPL) have decided to focus on just supporting liquid staking for ETH at the moment. Rocketpool is a permissionless protocol so anyone can become a node operator.

Although similar in principle, LDO tokens are different from RPL tokens.

Those tokens staked with Lido are pegged to the original token. Meaning that 1 ETH is equivalent to 1 Lido stETH (STETH). This method is similar to yield farming in DeFi and incurs a gas cost to harvest with every transaction.

Rocketpool’s tokens will remain as a fixed amount of Rocket Pool ETH (RETH) but the value of these tokens increases over time as the decentralized network of nodes earns rewards, making it more cost-effective as it does not requires the harvesting of tokens.

Liquid staking was created with DeFi applications as the prime users of these tokens. Staked tokens have value and can be used as collateral for many decentralized applications to earn a yield on top of the staking rewards.

The first and main use in DeFi at the moment is providing exit liquidity to those liquid staking protocols via liquidity pools. Curve Finance liquidity pool of ETH + STETH tokens allows for STETH to be swapped for ETH until the merge is complete. RETH also has a liquidity pool in Curve Finance.

There is even a liquidity pool that facilitates swaps between STETH and RETH with more than $100 million in assets locked on Convex Finance.

Locking tokens in a DeFi protocol

Protocols in DeFi can incentivize participants to lock their tokens in exchange for rewards in the form of yield. This can be done for lending and borrowing protocols like Aave (AAVE), to provide liquidity on a decentralized exchange (DEX) like Uniswap (UNI) or SushiSwap (SUSHI), and to support governance-related operations of decentralized autonomous organizations (DAOs).

Governance has seen the most innovation with regard to staking as the vested escrow (VE) model was used by many DeFi applications to align community interests and incentivize long-term awareness of the protocol.

Curve Finance has received major attention with the use of this mechanism as Curve’s native token (CRV) is deposited into the voting escrow contract for a period of one week to four years; the longer the contract, the bigger the voting power the VE token will hold.

Two things make the DeFi world go round:

• Liquidity
• Incentives

Protocols want liquidity, and we want incentives. We say we’re in it for the tech, but we’re also greedy.

Protocols understand this. They fight for our liquidity, incentivizing us with creative rewards.

— Ross Booth (@rossboothr) March 9, 2022

Colloquially denominated “Curve wars” in DeFi, protocols like Convex Finance have built a structure around this mechanism to influence Curve Finance token reward allocation and position themselves as the top liquidity providers for CRV governance tokens, making it the sixth biggest DeFi application with $12.26 billion TVL, per DeFi Llama’s data at the time of writing.

Staking through a CEX

Centralized exchanges provide several of the staking options mentioned above in a traditional custodial and permissioned manner. The exchange will stake the tokens on the users’ behalf and ask for a commission in exchange for the staking services.

Binance, the biggest crypto exchange, allows users to stake their tokens for a locked period or in a liquid way, depending on their preference and yield appetite. For those users who stake ETH, the platform provides exit liquidity in the form of a Binance ETH (BETH) token until after the merge takes place. Binance recently launched a new TerraUSD (UST) staking program for more than 30 million users.

Kraken, another leading exchange, provides staking services but doesn’t offer an exit liquidity option. Those users that stake ETH will have to wait until after the merge to obtain a liquid asset. It also recently announced the acquisition of the non-custodial staking platform, Staked for an undisclosed amount, which was described as “one of the largest crypto industry acquisitions to date.”

Locked tokens that earn a yield

Staking comes from PoS but has taken a meaning of its own in DeFi and crypto as a whole. As of the time of writing, any token that is locked either to support a network via a validator or used in a decentralized application is considered to be staked.

The above-mentioned examples showcase the different ways to stake tokens and they all come with different implications and characteristics. Staking tokens provides a strong foundation for earning yields while contributing to a network’s overall ecosystem.

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