Exploring Decentralized Finance Solutions to Proof of Stake Lock-Up Periods.

      Proof of Stake enables token holders to participate in network consensus and earn rewards for doing so. Staking users can avoid inflation and earn transaction fee returns.

      However, there are still some misalignments between the user needs and the protocol designs. 

      Protocols want to provide the highest security level possible. With that in mind, many Proof of Stake protocols are designed with mechanisms like:

      1. Lock-Up Periods: To make sure the network security is not threatened from immediate stake withdrawals in critical situations
      1. Slashing: To make sure the Validators behave in the interest of the network.

      Staking users, on the other hand, want to avoid both slashing penalties and locking up their tokens. Liquidity is a very important investment decision factor for many. Users want to be able to sell their stakes in critical situations.

      Exchanges provide the first logical, as well as a feasible solution. They can provide liquidity simply by managing their reserves. An exchange can allow its users to trade and withdraw their assets while still earning a close to maximum reward rate. This is an important development in the staking industry. But still, not everyone is comfortable to keep their assets on exchanges. And the best return rates are often provided by non-custodial staking products.

      We at Staking Rewards believe that sooner or later DeFi products on top of Proof of Stake networks will emerge to address these issues. There could be secondary markets, derivatives, and insurances to allow staking users to manage their risk and to improve the overall user experience.

      The team at Chorus One has conducted comprehensive research of liquid staking approaches. They explored possible solutions to tokenize staking positions in a decentralized fashion. The recently released research report gives a great overview of possible solutions and the implications of staking and decentralized finance. You can download the entire report here.

      To explore the background and motivation of the Liquid Staking Report we have talked to one of the main authors of the report. Felix Lutsch from Chorus One shared some exciting insights:

      What led you to start the Liquid Staking initiative?

      We noticed the impact of liquidity restrictions in Proof-of-Stake assets first hand since we are among the first validators on Cosmos. In June 2019, we won a Cosmos hackathon with Sikka with a design that tokenized stake, which would alleviate some of the most pressing issues for staking end users. The idea was quite controversial, as many feared the systemic risks this kind of financialization of Proof-of-Stake might introduce. At the same time, it was clear to us that if the staking ecosystem does not figure this out, custodial players like exchange will dominate the staking game. We kept thinking about product directions and saw that other people are working on similar concepts too, and finally we decided to work with the Interchain Foundation on a research project to take a look at this space in-depth.

      We formed the Liquid Staking Working Group and invited various parties in the field to present and discuss their work during our community calls, with the goal to examine benefits and risks, as well as to create a framework to evaluate these designs.

      In your opinion what are currently the most interesting liquid staking approaches?

      Currently, there are a few teams working on interesting DAO-style concepts which would allow users interested in staking to get liquidity on their staked assets. StakerDAO’s Blend token for example allows investors to get exposure to a basket of staked assets, but due to its custodial design there are a bunch of requirements that people interested in such a product need to fulfill.

      Stake DAO by Stake Capital is an interesting concept that tries to achieve liquid staking in a completely non-custodial manner for multiple protocols – a big vision, but that also means a lot of work needs to be done still. If they manage to turn this into a DAO with many different stakeholders it could become a great success. Other interesting designs are often focused specifically on one network, e.g. Rocket Pool on Ethereum or Acala for Polkadot. 

      These devised solutions are nice, but they introduce additional business models and other constraints, as well as sometimes conflicts of interest, which is why I personally am somewhat convinced that the best solution is to build liquid staking into the core protocol – something that as far as I’m aware only Matic, who took inspiration from our delegation voucher concept, are tackling. 

      What are the biggest challenges for liquid staking designs?

      To me the biggest challenges are to design these protocols in a way that they do not endanger the security of the network. It can be concerning for a network if most tokens are staked through a third party protocol or provider that might have interests that are not aligned with the network at large.

      On a more granular level, there are also challenges around achieving liquidity and legal clarity. A liquid staking protocol only makes sense if it is widely adopted. Furthermore, many designs are at risk to fall under some regulatory regime, especially in the US. Our report has an entire section that covers these questions (thanks to Gabriel Shapiro who contributed this analysis).

      Are decentralized liquid staking approaches a necessity for long-term healthiness in Proof of Stake networks?

      In my opinion yes, because otherwise power will consolidate with large custodial players that are able to provide better products to those interested in staking and we will end up with a comparable setup to what we have in Proof-of-Work mining pools already. I think it’s somewhat unreasonable to think that a large portion of stake will run their own nodes, the added costs, risks, and lack of support and integration into DeFi will likely simply be prohibitive to most. That is not to say that I don’t hope we will see this happen, I think there are some great efforts to make it as easy as possible to run your own node!

      Generally, advances in cryptography and interoperability protocols will likely make it impossible to “stop” liquid staking if there is user demand for it, thus it is important to figure out the correct way to deal with this trend now, which is why we wrote this report to hopefully start a larger discussion!

      Are Lock-Up Periods and Slashing Conditions for all staking participants a necessity in stable and secure networks? Or could Liquid Proof of Stake models where only a certain self-bond ratio is locked and slashable (e.g. Tezos or Wanchain) already solve a lot of these issues?

      It’s a good question. From the protocol perspective someone needs to be on the hook if something goes wrong, this is mostly why all these restrictions exist in the first place. Liquid staking only allows these risks to be shared in different ways among participants. In a way, protocols with self-bond do this by creating this tranched system in which validators absorb all the risk and receive higher rewards (commissions) in return (which is why some people are already referring to Tezos as Liquid Proof of Stake). Liquid staking only takes this design pattern to the next step and enables different mechanisms to emerge. It is important to notice that if these mechanisms become too complex or intransparent there might well exist scenarios in which risks amplify and may start to threaten a network. The staking community should stay vigilant and observe what is actually happening and where risks are moving in the (in my opinion) soon-to-be interwoven decentralized finance ecosystem. 

      How are you at Chorus One going to move forwards with the liquid staking initiative?

      At the moment we do not plan to get involved in building a liquid staking protocol ourselves. From the perspective of us as a staking provider, we are considering ways to get involved in what others are building to potentially become a part of their projects. Our current focus lies on operating nodes and cross-chain interoperability, which is a prerequisite for most interesting liquid staking protocols. 

      We will stay involved in the space and keep up the discussion through the Liquid Staking Working Group, as well as in the communities in which we are active, as we see this as a crucial topic in the evolution of Proof-of-Stake.

      How can Staking Rewards users get involved and contribute towards your efforts?

      The most valuable thing to do is probably to read our report and to share it if you found it valuable. The staking industry is a very nascent space and most people do not have a good understanding of the highly complex and interwoven nature of staking and decentralized finance.

      If you want to join the discussion or provide us with feedback, please join the Liquid Staking Working Group on Telegram. At Chorus One, we are also building a tool to help stakers manage their reward data and participation. Anthem is currently live on Cosmos with Celo, Oasis, and Terra to follow soon. Try it out by pasting in an address to get valuable insights into how your staking portfolio developed over time. You can also connect your Ledger and stake with Chorus One or other staking providers to help support their work.

      Thanks to Mirko from Staking Rewards for this interview and for creating the best data aggregation platform there is in the staking ecosystem!

      About The Author

      Staking Rewards Research

      is a team of analysts dedicated to analyzing the economics, profitability, risks, and yield potential of various cryptocurrencies.