When you have a fundamental belief system that identifies the inherent trade-offs that exists across most things, you tend to question any and all things.
Of course, this direction isn't from a place of resistance or opposition of anything, but simply an effort towards full understanding of costs, risks, rewards and benefits.
Understanding trade-offs helps determine what direction one should favor.
When it comes to LSTs, I've highlighted associated risks on multiple occasions and also benefits, my most recent article explored how this very solution could help crypto platforms maintain a grip on the "safe yield" seeking market.
So once again, let's talk about liquid staking tokens (LSTs).
For those unaware, liquid staking tokens are essentially tokens that represent staked positions of another token.
For instance, a project could launch a liquid staking solution where ETH staked with them will result in the minting of ETH Liquid (ETHL), pegged 1:1 with ETH. While the original ETH is staked and generating yield, the users can use the LST across other DeFi protocols or even sell them.
On paper, this is a dream come true for investors, using the same capital twice, but what's the quantifiable cost of this flexibility?
In Proof-of-Stake blockchains, staking is the foundational security mechanism where validators lock up tokens as economic collateral, making attacks prohibitively expensive. Traditionally, this created the stark trade-off in which capital committed to network security became economically dormant.
In addition to this, said capital helps maintain the pledge of integrity of validators as the inherent risk is losing it if wrong doings are detected.
LSTs threatens this social and governance contract because Validator get to have some control over the staked value, while still maintaining governance influence.
Well, to get honest, that last line isn't entirely true.
Liquid staking solutions generally gets investors or users to give up their governance roles for access to liquidity, while maintaining access to yield — although reduced.
So here's what it actually looks like.
Investors stake with a LST provider.
Get up to 90% of generated yield in most cases (10% fee on on-chain yield effectively).
Gives up governance control in the process as tokens are staked in contracts of a third-party.
Gets access to liquid tokens representing their staked positions with said project.
So if their staked value is $1,000 and on-chain yield is approximately 5% APR.
They get $45 in yield yearly, which is 90% of $50, the real on-chain yield generated. The project keeps $5.
Additional, they still have $1,000 in liquid staking tokens of their position and can move it out and use however they like.
The LST provider doesn't get most of the yield or the liquid capital, just the governance role and a small percentage yield, the users get the aforementioned.
Judging by this, is the cost quantifiable?
Make no mistake, in extreme conditions, all liquid staking solutions are high risk factors to the ecosystem; the projects offering them, the users and the networks themselves are all exposed.
But most things are high risks in extreme conditions right?
So let's look at the immediate costs.
We can say that there isn't any yield-side costs that threatens the ecosystem because the users lose yield in the process, not gain more. All they get is liquid staking tokens and if that is sold, until bought back, they can't redeem their position, they can only keep earning the yield and at 5%, it would take 23 years to double their money and enjoy purely profits from there on.
The reason it isn't an immediate cost is because if those tokens are sold into the market, the value technically remained through fresh demand. So provided there's sufficient demand, it's all good. Plus, the upside is that if prices of these assets go up, the users who sold their LSTs incur higher costs to redeem their positions.
The market settles it all.
This leaves one thing as the real risk or cost of letting locked capital assume active economic roles.
And comical enough, it has nothing to do with their active roles, it is even economically sound to have capital run more actively.
The true cost is concentration of power.
If tokens are moved into LSTs providers, as we've seen in the case of Lido of Ethereum, power gets centralized to a few people.
This effectively, I'd add, suggests that liquid staking tokens come with the most risks when they are representing governance tokens. If tokens hold no roles in the sovereignty of a protocol or blockchain, then the largest risk factor goes out the window.
Everything else becomes a market-side problem, a more manageable scenario in comparison.