Intro

Blockchains first emerged with a Proof of Work engine attached. Soon after, people realized this engine was too wasteful and a new solution was developed by the Ethereum team, called Proof of Stake, which was released in 2021 under the name Beaconchain. It’s a new consensus mechanism replacing miners with validators, where instead of computer power validators deposit ETH to secure the chain.

Within the last couple of years, an entire ecosystem was built around staking, with new problems and solutions constantly filling the media space, with the crypto community following up closely. For the occasional blockchain user, staking is a new way to generate passive income on stagnant funds, even more so with the advent of liquid staking.

Staking is necessary to keep the blockchain running. Users who stake through liquid staking platforms are rewarded with a steady income, while retaining the ability to use their coins in other blockchain protocols and stack rewards.

But what exactly is staking? Why does it give rewards and why does it look so appealing? Are there any disadvantages? Let’s dive in.

Proof of Stake is a consensus mechanism

A blockchain is a registry managed by a network of equal participants. People are willing to pay to write in this registry because it’s incredibly difficult to alter the data it contains, whilst also being difficult to take it down.

The strength of this registry relies on the fact that it is widely replicated all over the globe, and taking it down would require a large amount of said copies to be destroyed. In spite of its wide distribution, participants can still agree on its content, just like if it was a single notebook archived somewhere in a safe bank.

This notorious fact is achieved by a consensus mechanism. There is no good-will in keeping the registry secure. Participants are economically rational and they don’t tamper with the registry because it’s more profitable to keep it pristine than to change the records in one’s favor. Proof of Stake consensus relies on both sides of a major economic principle: incentives (and disincentives).

Staking is participating in the consensus

We’ll get to incentives later. As for discouraging bad behavior, this is achieved by effectively betting money on the process. A participant needs to be able (and willing) to lose coins if he behaves against the rules of the majority. In other words, you participate in consensus by putting something at stake. In the LUKSO blockchain, the stake are LYX coins.

You might wonder how one could behave against the rules. Or even participate in the consensus mechanism that secures the LUKSO blockchain.

You need a 24/7 computer or coins (or both):

• Participants who have both are called solo stakers.
• Participants who only have computers running are called node operators.
• Participants who only have coins are called stake delegators because they “delegate” their stake to node operators.

Liquid staking

When you deposit coins in liquid staking protocols like LEEQUID, you are effectively authorizing the protocol’s infrastructure to participate in consensus using your coins as stake. An operator registered with LEEQUID runs the computer program that participates in the network. As long as he follows the rules, your stake generates participation rewards, and in return, the operator gets a small fee for his services.

The idea behind staking is simple: consensus participants put down coins as collateral in order to ensure they are acting in the interests of the whole network.

However, while these coins are at stake, they are locked inside a vault in the blockchain called The Deposit contract. If you wish to use them for something else, it will take a while until you can get the coins back (unstake). This means that when you stake, your LYX loses liquidity. In other words, it loses the capacity to be instantly exchanged with other assets.

Liquid staking solutions solve this problem by giving you a token (receipt) that represents coins you have staked. This receipt token works as proof that you have coins in the vault, so other people and protocols accept it as currency just as if it was native LYX.

And why would they?

Because there is a guarantee that the liquid token you have, called a Liquid Staking Derivative, or LSD, can be redeemed by LYX. This LYX is stored in the Deposit Contract and can be withdrawn by the code in the liquid staking protocol.

For example, imagine you liquid stake 100 LYX; you get 100 staked LYX tokens (sLYX) back. Now you’re not only accruing rewards from the 100 LYX you staked, but you have 100 sLYX in your wallet which are totally liquid and can be transferred to anywhere you want.

Solo Staking vs Liquid Staking

Staking, at its core, requires a computer machine connected to the network 24/7, making attestations and proposing blocks in the blockchain with your stake. This machine is called a node. One of the biggest differences between solo staking and staking pools (either centralized or decentralized) is in who takes care of operating the nodes, ensuring they run smoothly and behave as expected.

Solo stakers deal with the whole staking process, from depositing their coins to connecting their node to the network. On the other hand, participants of staking pools pay a fee and leave the operational tasks to the pool’s staking provider.

Staking through centralized exchanges (like Binance) is only available for major blockchains like Ethereum and is a similar experience to staking through decentralized staking pools. Below is a table highlighting the biggest differences between the two major types of staking, solo and liquid staking:

Liquid staking — where from & where to

Let’s run through the history of staking on Ethereum, in order to get the necessary knowledge to understand emerging liquid staking paradigms. We’ll study one of the latest approaches to liquid staking, which we’ve called Liquid Staking 2.0, comparing it with what was previously implemented. What changed from Lido V1 to V2, from Stakewise’s V2 to V3? Why are these big players moving in the same direction and what do they want to accomplish? Read on!

Understanding pre-withdrawals

The history of Proof of Stake is very recent. Ethereum was the first to transition to this consensus mechanism, in December 1st 2020, with the official launch of the Beacon Chain. For almost 2 years, the Beacon Chain was working in parallel with its Proof of Work (PoW) counterpart, void of actual data, but producing block after block, perfecting the network.

Many people participated in this process by depositing their ETH in the deposit contract, accepting that it would remain locked until the takeover from Proof of Stake, to which withdrawals would follow.

In December 1st 2020, no one really knew when the merge with the PoW chain would happen, or even if it would happen. However, that was no deterrent for the hundreds of node operators who configured their machines and locked their ETH in the protocol, attracted by the prospect of withdrawing it in the future, plus a hefty premium of rewards accrued over the years.

Soon after the release of the Beacon Chain, some node operators realised they could invite others to stake ETH within their nodes, promising to give back that same ETH plus the rewards, once Proof of Stake became permanently established. That promise of payback became known as a Liquid Staking Derivative, and this type of delegated staking became the liquid staking as we know it. The promise of payback (sETH, stETH etc) started being accepted everywhere.

This booming market was sustained by the single assumption that Ethereum would eventually fully transition to Proof of Stake and the full withdrawal of staked ether (along with the exit of validators) would finally be permitted.

The Ethereum team reputation was so strong that millions of dollars flowed into liquid staking protocols, as people trusted the foundation’s plans and believed in their success. Liquid staking was a huge improvement over solo or simple pooled staking, because it presented an alternative to locking your ether away for months, maybe even years.

Liquid staking nowadays

Nowadays, we have the post Merge era of EVM blockchains, all running on established Proof of Stake consensus. One of those blockchains is LUKSO, with its LYX coin. Just like with Ethereum, on LUKSO it’s possible for a node operator to exit a validator and get the LYX back in a matter of days, which makes staking a relatively liquid endeavour. Certainly not as illiquid as before.

Staking through liquid staking pools has become all about the advantages outlined in the table above, with people realizing liquidity was just another one of those advantages. Consequently, the amount of ether staked in pools hasn’t stopped increasing since then.

Naturally, the tendency to concentrate large amounts of ether in a single staking provider leads to an undesirable degree of centralization. Some flags have been raised, warning against the current staking infrastructure, which placed too much responsibility on staking providers managing thousands of validators under their wing. These circumstances eventually led to the emergence of a new liquid staking paradigm, which decouples node operators from the staking providers, creating an open market for validator solutions, all connected to the staking pool through a mechanism called the “staking router”.

The shift in paradigm for liquid staking solutions aims to bridge the gap between stakers and the node operators to whom they delegate their ETH. The liquid staking pool becomes an aggregator that connects stakers to node operators and provides the infrastructure for those agreements to happen, including cash flows and reward payouts.

Decoupling node operators from staking pools is good for everyone:

• The responsibility is taken out of the shoulders of the staking provider and delegated to independent node operators. If slashing occurs, the staking provider is no longer liable, but instead, the node operator is.
• A more diversified roster of node operators means different options to choose from. Some operators will offer better performance, others better fees. Some can offer discounts according to the volume staked, others can offer insurance or additional security measures like distributed validator technology (DVT), different geographic locations, etc. Certainly, this healthy competition will lead to an improvement in the validator services offered.
• More censorship resistance as there is no longer a single operator managing millions of ether in stake. Different node operators will be under different jurisdictions, and adopt different policies which can conform, or not, to censorship pressure.
• More decentralization as one single entity no longer has the power to control the blocks produced by thousands of validators. This goes in line with censorship resistance, which is one of the benefits of decentralisation.

Below is a diagram that highlights the main differences in liquid staking going forwards:

There are, however, a few uncertainties on how the market will shape up to this paradigm. It is possible that a single node operator stands out from the others and takes over the market for liquid staking providers, creating an even worse situation for decentralization. On the other hand, a new burden has been placed in the hands of users: to choose the node operator they want to delegate their stake with. Previously, they’d chose the liquid staking providers. Currently, they have to choose both the staking provider and the node operator. This naturally means the user will have to better understand the Proof of Stake protocol, or else fall prey to marketing and communication fallacies.

Another issue that arises is the certification of node operators: who is going to ensure that node operators are keeping their promises? That they indeed have the insurance they claim to have, or employ the security measures they advertise in their technical sheets.

Ethereum Restaking

Most (recent) news within the Liquid Staking industry point towards the advent of restaking, a new protocol recently proposed by the EigenLayer team, allowing LSTs from Ethereum to be used in validators from other networks. This will allow other protocols to leverage Ethereum’s network of node operators to secure their data. For the user, this means their staked coins can be leveraged beyond what’s currently possible within DeFi protocols.

We’ll be keeping a close eye on restaking developments and researching the optimal integrations that make sense for LUKSO.

Proof of Stake in the LUKSO blockchain

The fundamental act of running a validator node, and staking LYX in it, is what keeps the blockchain running and secure. LUKSO launched a campaign, upon the inauguration of mainnet on May 23rd 2023, to onboard validators from block zero. These validators, known as genesis validators, held the consensus fabric of the network together while other players, like smaller solo stakers and staking pools, were getting ready to enter the scene.

In this phase, tapping the fountain of staking rewards was only reachable by a knowledgeable few, while other stakeholders were left gazing at a giant wall of technical hurdles, waiting for a simpler way to stake their LYX.

LEEQUID is the first staking-as-a-service platform on LUKSO, paving the way for the future emergence of DeFi protocols and other integrations with the liquid staking derivative sLYX. Upcoming months will certainly bring new players into the staking market, such as node operators, validator hardware/software sellers (Dappnode being the first one) and probably other staking providers.

In its first iteration, LEEQUID places itself somewhere in between Traditional Liquid Staking and Liquid Staking 2.0. The new approach to liquid staking requires a mature market of node operators, which may promote a real and healthy competition and provide users with an actual choice. On a recently launched blockchain like LUKSO, this market will take a while to establish and so we understand that the 2.0 infrastructure adds unnecessary complexity to onboarding users.

With this said, at LEEQUID we’re riding the wave of change, paying close attention to all developments in the LST market. Our main priority is creating a competitive (yet accessible) product, that every user can understand and profit from in the most seamless way.

Liked the article? Make sure to follow us and reshare on X/Twitter for more content, and drop by our community channels (Telegram & Discord) for any questions/doubts or just to hang out!

An introductory journey through Liquid Staking was originally published in LEEQUID on Medium, where people are continuing the conversation by highlighting and responding to this story.

The LEEQUID protocol has seen a massive surge in staking value over a matter of a few days post-launch. Naturally, this led to a considerable activation queue on the LUKSO blockchain, since there’s a protocol-level limit of roughly 40 validators per hour. How does this impact LEEQUID users? It’s time to understand reward dilution.

Intro

Let’s dive right into the numbers and what these mean. There are, at the time of writing, 17,377 validators in the activation queue of the LUKSO blockchain. At the rate of 900 per day, it will take a bit over 19 days for these validators to start accruing rewards.

The activation time affects staking pools

This queue affects the APR of the LEEQUID staking pool. Why? Pending validators do not yield rewards. When presented with this scenario, the protocol can behave in two ways:

Option 1: Discriminate users who just entered the protocol by noting the position of their stake in the activation queue. Once their stake becomes active, the protocol would start distributing rewards proportionally.

Option 2: Socialize rewards and immediately distribute rewards to all users that enter the pool, temporarily reducing its global APR. The established stakers take a small hit for the newcomers, and the cycle moves on, with the newcomers becoming the established stakers of tomorrow.

The diagram above shows the consequences for each of the aforementioned options. The dashed line, in blue, shows us that the APR granted to each staker by a social staking pool increases as less and less stake is pending. Naturally, in the days that followed the launch of LEEQUID, the opposite occurred, where the pending stake in the protocol surged as more and more users staked their LYX while the activation queue caused it not to generate increasing rewards.

At LEEQUID, we decided to go with option 2 (dilution of rewards) to create a smoother and more balanced experience for our first stakers. However, the fact that the amount of rewards received in the initial days did not match the expected APR generated some confusion amongst our users.

Let’s clarify:

Users staking with LEEQUID are in the red line of the graph. Their APR is reduced temporarily when there’s s a massive surge in pending stake. However, they start accruing rewards from day 0, regardless of the size of the activation queue! The alternative is the yellow line of the graph. Instead of earning reduced rewards for a short while, users would earn zero rewards until their respective validators finally became active.

The lower APR during activation congestion is compensated by the fact that you start accruing rewards from the very beginning, instead of having to wait until the end of the queue. It’s equally important to note that in a socialized staking pool, everyone gets the same APR. You get the same yield percentage over your stake, regardless of when you staked or how big your share of the pool is.

The pool APR will match the expected APR

The diagram above shows the current state of validators in the LEEQUID pool. 17290 are waiting activation and 12539 are already active and providing rewards. This means that the ratio of activated to pending stake in LEEQUID is currently around 2/5, and consequently, the current APR is reduced to 2/5th.

In the column chart above, only the green section is generating rewards, but it does so for the total LYX staked, equivalent to the green and blue sections. The blue part will be generating rewards soon enough, but for now, it’s the part responsible for reward dilution. As the blue portion reduces, expect the APR to increase proportionally.

Final notes

Precise calculations show us that early stakers tend to carry a larger share of the weight pertaining to reward dilution. However, the effect this has on the annual rate is so low that it is negligible, due to the fact dilution is a phenomenon lasting only a few days (until the queue clears). Furthermore, we should take into consideration that earlier stakers were, at some point, onboarding stakers, and they, as well, benefited from the socialization of rewards.

Like the article? Please share it on social media or send it to a friend who might be having the same doubts as you did!

Until next time, stay staked!

Launch overview and reward dilution explainer was originally published in LEEQUID on Medium, where people are continuing the conversation by highlighting and responding to this story.