Last summer, Polkadot made its own little piece of history after confirming the first five projects to occupy parachain slots on its Kusama Canary network. Disparate blockchains that connect to the main Polkadot relay chain for security purposes but are otherwise independent, parachains represent a new way of doing business on the blockchain, a maximalist vision aimed at improving the scalability and governance while allowing for forkless upgrades. The five projects were Karura, Moonriver, Shiden, Khala, and Bifrost.
Fast-forward to today, and the first batch of parachains is about to expire, releasing over 1 million Kusama (KSM) tokens locked into the market. Given that the current supply of KSM is 9 million, basic economics dictates that the price will suffer as previously inaccessible tokens suddenly come back into circulation. Price fluctuations of course affect staking and liquid staking, although the latest innovation allows users to use their tokens even when locked.
Related: How Much Intrigue Is Behind Kusama’s Parachute Auctions?
Have your cake and eat it
We are all familiar with staking: it is the process of “locking” tokens into a system as collateral in order to secure a network. In exchange for one’s participation in such an effort, rewards accrue.
Within Polkadot’s complex nominated proof-of-stake (NPoS) ecosystem, participants can be nominators (whose role is to nominate validators they trust) or validators, but the same economic incentive applies in both cases. The problem, as described above, is what happens at the end of a participation period. It’s all very well receiving generous rewards for securing the relay chain (not to mention multiple parallel chains), but if the price of the native token plummets, it could become a mockery of the entire company.
While liquid staking does not protect the underlying price of the assets staked, it apparently allows users to safely unlock on-chain liquidity and take advantage of the profitability opportunities offered by numerous decentralized applications. This is made possible by issuing a separate token that represents the value of one’s stake. With this liquid derivative essentially acting as the native token in the market, the risk of sudden price volatility after the end of an unpeg period is addressed.
This model allows users to maintain their liquidity and use the underlying token, either by transferring, spending or trading as they see fit. In fact, stakeholders can even use their derivatives as collateral to borrow or lend in different ecosystems to participate in other decentralized finance (DeFi) opportunities. And the best part is that staking rewards continue to accrue to the original assets locked in the staking contract.
Related: How Liquid Staking Disrupts Polkadot Parachain Auctions
But I hear you asking what happens when the entry period ends. Well, the derivatives are simply exchanged for the native currencies to maintain a constant circulating supply.
Simply put, it’s about having your cake and eating it.
The future of proof of stake?
The proof-of-stake consensus mechanism has come under an increasingly bright spotlight, particularly as we get closer to the release of PoS for Ethereum 2.0. Blockchain’s long-discussed transition to proof-of-stake is expected to reduce its power consumption by more than 99%, leaving environmental critics to target Bitcoin and its controversial proof-of-work model with their censure.
There is no doubt that PoS is the environmentally sound option, even if some criticisms of PoW are exaggerated due to an improved energy mix favored by miners. However, despite the many improvements the consensus mechanism has made over its predecessor, there is still work to be done. Far from being an established science, proof of stake is an innovation that can and should be refined. And we can start by increasing the number and capabilities of PoS validators.
This was the idea behind Polkadot’s NPoS model, which sought to combine the security of PoS with the added benefits of stakeholder voting. In my opinion, liquid staking builds on those advantages by solving a long-standing dilemma users face: whether to lock up their tokens or use them in DeFi decentralized applications (DApps).
Related: The Many Layers of Crypto Staking in the DeFi Ecosystem
This dilemma does not only affect users, of course; it hurts the big picture of DeFi. For some cryptocurrencies, the percentage of circulating supply locked into the stake can exceed 70%. At the time of this writing, for example, nearly three-quarters of Solana’s SOL tokens are staked, and more than 80% of BNB, according to Statista. It doesn’t take a rocket scientist to figure out that having just 30% of a token supply available for use in DApps is a bad thing for the industry as a whole.
While proof-of-stake systems need an active participation community to ensure security, DApp developers want to make transactions easy, and transactions need tokens. Therefore, both parties have welcomed the emergence of liquid staking, and in particular DApp creators, who have been forced to offer higher and higher APYs to convince users that their assets are better implemented in DApps. lucrative than in staking contracts.
By maintaining a constant circulating supply, addressing worrying price fluctuations, and helping users generate higher rewards (staking payouts plus DApp performance), liquid staking is one of the brightest innovations in DeFi’s short history. Hopefully more interested will take notice of that.
This article does not contain investment advice or recommendations. Every investment and trading move involves risk, and readers should do their own research when making a decision.
The views, thoughts, and opinions expressed here are those of the author alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.
Lurpis Wang is a co-founder of Bifrost and an entrepreneur involved in the field of Web3. She was one of the first full-stack developers for Sina Weibo. After Lurpis co-founded Bifrost in 2019, the platform became the first batch of teams to use Substrate, received a Web3 Foundation grant, and won the first Substrate hackathon award.
This post Staking or DApp? With liquid staking, you don’t have to choose
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