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What Are the Top 3 Things People Get Wrong About Liquid Staking?
Liquid staking is one of the hottest concepts in crypto right now but what is it? And what are the common misconceptions about it?
Well, to understand liquid staking you first have to understand the idea behind regular staking. Staking is a built-in characteristic of any proof-of-stake cryptocurrency where you “stake” your crypto to help support the network.
It can either be self-directed (you run your own validator node), or delegated, which is when you devote your funds to a third-party that runs their own validator node. Liquid staking is a modification to conventional staking.
It gives you more flexibility to stake and unstake your coins at any given time, and earn some passive rewards in the process. Who wouldn’t like a little more freedom of movement on their coins? Let’s see what the top three things are that people get wrong about liquid staking.
Misconception #1: Liquid Staking and Staking Are the Same
Essentially, liquid staking is the devotion or “staking” of your coins to generate a passive yield (APR/APY) while maintaining access to your coins. This can be a great way to add to your passive income strategy. Typically, when you stake your coins, they are locked up for a specified amount of time during which you cannot sell or transfer your coins. With liquid staking, the funds are in escrow, and remain accessible.
Staking represents a novel means to earn an extra income. How is liquid staking any different? With liquid staking, you have access to, and can transfer your funds at any time. This is particularly ideal when you want to take advantage of time-sensitive opportunities elsewhere in the market, or you just want to lock-in your gains.
You may be wondering, which one should I go for? The best response to this question depends on a variety of factors that are best determined by you. Some questions that you could ask yourself to help make a decision include the following:
- What yield do I expect from staking my coins?
- Can I afford to lose these coins, and will I need access to them?
- How well do I know the project and the validator node operator?
These questions are not conclusive, but can form a good starting point to help you determine which direction you want to take with staking.
Misconception #2: Liquid Staking is the Best Way to Earn Passive Income
If the world of cryptocurrencies has taught us anything in the last few years, it is that there are a plethora of ways to put your hard earned coins to work. Liquid staking is just one of them. Most recently, there is yield farming as well as liquidity mining, which are viable ways of passive investment, and each have their own unique set of pros and cons.
The benefit of liquid staking comes at a cost in comparison to illiquid staking. Generally speaking, you will likely get a lower APR/APY for the freedom of movement of your coins. This is so, because regular staking makes it more predictable to see how many coins will be available to support the network at any given time. For some, this trade-off is negligible. However, it is important to consider when you are setting your staking expectations.
Staking comes with some risks that other methods of passive investment may not. These risks may include validator risk, volatility risk, loss or theft of funds, and liquidity risks. Some of these risks are more pertinent than others, but nonetheless, they all have an effect on the security and potential return on your staking investment. This is why it is important to do your research to stake with a project you trust, relatively speaking, and not stake funds that you may need.
Misconception #3: Liquid Staking is Guaranteed Passive Income
Nothing is guaranteed at this stage of crypto’s development, or in the world in general, except for death and taxes.
Given that your gains are paid out in the crypto you are staking, your earnings are subject to fluctuations in that crypto’s price. While it is true that you will earn the specified APR/APY regardless of price action of the coin, a drop in price has the potential to wipe your overall gains, despite your staking earnings.
In other words you can earn 10% APY on a certain coin but if that coin keeps dropping 20% in value every year then you’re not making any progress. In fact, you are losing money.
As mentioned above, liquid staking is not risk free. While not very common, you can lose some of your staked assets through a process called slashing. This is meant to discourage bad validator behavior such as system downtime or double signing of a transaction. Given that you will likely not be a validator yourself, the best way to mitigate against slashing is to only trust your funds with a validator who has a good reputation. Ultimately, due diligence is always necessary to minimize the inherent risks of staking, and maximize the probability of steady rewards.
Conclusion: Liquid Staking is Just One Way to Generate Yield
Liquid staking can be a great way to earn a passive return, however, it is not free from risk. It is solely the responsibility of the investor to do their research on the crypto in question, what is a reasonable amount to invest, and which validator to trust.
Whether liquid or not, understand the requirements, and the potential risk you are exposing yourself to.
