A consensus mechanism is a system used to secure and regulate a blockchain network, including the verification and recording of transactions. Bitcoin and Ethereum use a Proof-of-Work (PoW) mechanism, where miners verify transactions through solving mathematical algorithms. However, PoW has been facing its fair share of criticisms due to its high energy consumption.
Many networks including Ethereum, are migrating to Proof-of-Stake (PoS), an alternative consensus mechanism to help minimize PoW’s excessive energy outputs and target higher scalability. Stakers, or the PoS equivalent of miners, lock up their assets in a smart contract to have a chance at validating the legitimacy of transactions and earn rewards in return.
Aside from being more environmentally friendly, staking also opens doors for passive income – rather than just holding digital assets, institutional investors can now stake and earn rewards in return for delegating their assets to a network. Unlike some high-risk yield options commonly provided by DeFi, staking provides relatively stable yield with lower risk, making it a suitable alternative for financial institutions seeking ways to participate in the digital asset economy. This resulted in a rising innovative trend, and an increasingly growing number of staking options within the digital asset space.
Despite being a solution to PoW’s drawbacks, staking also has its own challenges. First, there are concerns around the lack of transparency and decentralization, as staking relies on validators – meaning the amount deposited for staking is proportional to validating power. Additionally, staking often requires minimum deposit amounts – for example, ETH 2.0 and its networks require a minimum of 32ETH to become a validator.
The biggest criticism around staking however, is on the illiquidity of assets. Staked assets become locked in blockchains – both during the staking and unstaking process – making them unavailable to the investor. They cannot trade or move the funds across chains without penalties. Considering the volatile nature of digital asset markets, this doesn’t always meet the criteria of relatively risk averse investors.
That changed with one of the most disruptive technologies in the DeFi space of 2022 – liquid staking. Offering the best of both worlds, liquid staking carries all the benefits of staking such as a relatively stable yield, while eliminating the problem of having the assets locked up. This is possible through the use of derivatives which mirror the asset – when delegating assets to an underlying network (e.g. ETH), tokenized versions of the underlying staked asset are distributed (e.g. stETH). These tokenized assets can themselves be traded on open markets, act as collateral, and be utilized across the DeFi ecosystem. Liquid staking also minimizes risk of slashing through diversifying the stake across various validators.
With this new wave of liquid staking applications, an increasing number of platforms are being launched with most projects hosted on Ethereum and Solana. However, platforms are also being built on other networks such as Cosmos and Avalanche, giving institutional investors a wide range of choices across multiple layer 1 and layer 2 blockchains.
Nevertheless, the growing variety of staking protocols and their respective requirements can be overwhelming. There are a few projects addressing this exact challenge including Trusted Node, one of our ecosystem partners, which provides access to multi-chain staking and governance. Trusted Node is a non-custodial staking platform and validator network focused on building a range of capital incentives and user-friendly experiences – enabling participation in validating networks without the need for an organization to run the nodes themselves. Additionally, Trusted Node users can access PoS rewards, DeFi yield, and multi-chain governance through one single interface, increasing capital flow and security. As the trusted infrastructure provider underpinning institutional access to DeFi ecosystems, Hex Trust is excited to venture into this partnership with an innovation leader in the DeFi space.