What Problems Does Liquidity Staking Has And How to Solve Them?

Stacking changed the way blockchains function. It provides better energy efficiency, more flexibility in the hardware needed, and faster transaction speed. But despite its benefits, one of its biggest problems — and what keeps many from staking — is the unbonding period. Liquid staking became a solution to this particular problem but also brought about additional issues into the light.

Centralization

The basic principle of cryptocurrency is decentralization and freedom from censorship. Staking centralization occurs when multiple protocols or exchanges stake their assets through the same validators, or when one protocol has a controlling stake in the PoS network distributed across a limited number of validators.

This problem especially arises now that centralized platforms managed to get much more users than their decentralized counterparts. This happened largely thanks to a simpler user interface and because they were the first in the field.

We even do not have to wait to see this problem in real life. Analytics company Santiment reported that shortly after the completion of The Merge update and the transition of the Ethereum network to Proof-of-Stake (PoS), 45.15% of the nodes were running from two addresses. This confirmed that Etherium’s move to PoS may not be without fundamental problems and has raised new concerns in the crypto community about the centralization of the network.

Now, what a potential solution might be? Decentralized liquid staking protocols, like ClayStack, try to distribute their stakes through different validators so that no single validator becomes the dominant player in the PoS network (at least not through the protocol itself). This diversification is usually monitored by the protocol’s DAO, which sets different parameters for selecting new validators, which have a much-reduced chance of suffering downtime or being cut out.

First-Person Advantage

The so-called first-person advantage is one of the biggest problems for any decentralized ecosystem, as a dominant player can become a critical impediment to the entire network.

If the main share of the particular network is dependent on a single protocol or centralized exchange, the whole ecosystem suffers from it. As the ecosystem matures and the share of the protocol/exchange increases, it is likely to improve the overall user experience so that users stay with them. While this is a good thing for any pioneering business in any market, in the case of liquid staking, it can be a deterrent. The protocol can become too big to limit its own stakes, thereby becoming a huge point of failure in the network.

However, liquid staking is a perfect example of an ecosystem where multiple protocols can coexist, competing with each other to offer the best user experience to their users, while providing staking diversification through decentralized management.

Other Risks

More obvious risks and problems are also the since liquid staking cannot be called completely safe. There are at least a few risks that can be highlighted:

· Vulnerability of the protocol’s smart contract is a traditional risk for DeFi. Poor-quality contract code can contain vulnerabilities that can be exploited by attackers. When getting into a new protocol, every user should keep it in mind.

· Market risks. Liquid stacking is a way of issuing derivatives tokens. The price of this asset is highly volatile. If a derivative token is used to support an open position, a drop in the price of the “base” coin can lead to a chain reaction of liquidations and an increased level of losses.

· Systemic risks. Because of the close interconnection of DeFi-protocols, including through liquid stacking, problems in collateral in one protocol can lead to problems in several projects at once.

Everything described in this article is something the industry as a whole should deal with sooner or later.

About ClayStack

ClayStack is a decentralized liquid-stacking protocol that issues derivative tokens when you stake on Proof-of-Stake (PoS) networks through the protocol.

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