Staking is possible thanks to the POS (Proof-of-Stake) algorithm, according to which the share of ownership determines the right to mine the next block. The essence of staking is that users voluntarily block their assets and vouch for the validator, due to which they get the right to a share of the mined cryptocurrency. The size of the share received by the user depends on the share of the cryptocurrency allocated and blocked for staking.
However, staking faces one big problem – asset freezes. If you use a currency for staking, then for a certain period of time it is not available to you, which means that you yourself limit your ability to manage it. The solution to this problem is liquid staking.
With liquid staking, you also freeze your tokens, but in return you are given other - derivative tokens (derivatives). You can draw an analogy with a depository receipt in the stock market. This is a simple piece of paper, on which it is written that the owner of the depositary receipt owns a share of some enterprise, and is stored in such and such a depository. The receipt itself is not a share, but the owner of the receipt is in fact the owner of the share. The same scheme works in liquid staking. You are given a new token, which confirms the right to the token used as part of staking. The advantage of this scheme is that such a derivative can be traded on the market and used by the owner to make a profit.
In PoS mining, miners who have locked more mining funds in their wallets have an advantage. The more the miner blocks the funds, the more profit he gets from mining. PoS mining works well only if the price of the coin is either stable or rising. If the price of a coin falls, then the meaning of blocking disappears, since the income from mining will not be able to cover the losses from the loss of the value of the coin as a result of the fall in the rate.
In liquid staking, you do not just lock a coin, but instead of a locked coin, you get its derivative asset, which is backed by the main coin. This derivative asset can be used in a DeFi project, earning money from profitable farming as a liquidity provider, or issue a loan secured by another asset.
Thus, engaging in liquid staking, the user receives profit directly for staking the underlying asset and for farming its derivative.
Liquidity pools and mechanisms based on them play an important role in the DeFi ecosystem, as they provide the necessary liquidity to traders, thanks to which they can quickly convert one asset to another without losing value.
The main risks are associated with the volatility of cryptocurrencies and the possibility of hacking the protocol to which the smart contract belongs. First of all, it is important to remember that investments are associated with the risk of losing funds: due to the fall in the rate of cryptocurrencies, the value of your assets in the pool may decrease.
Another risk arises from impermanent loss. Such losses occur when the price of one of the assets in the pool moves strongly after large purchases or sales of the asset. Until the holder withdraws the assets, these losses are considered unrealized and can be reversed at any time, therefore they are called impermanent. This means that these losses cannot be called actual, that is, until the coins or tokens are blocked in the pool. But in the event of their withdrawal, the losses will become permanent, that is, realized.
The third risk is that hackers can find a vulnerability in the protocol and withdraw all funds from the contract and even compromise the wallets of users who are connected to the platform. Unfortunately, such cases happen often, but, basically, they affect medium-sized protocols.
Liquidity pools allow you to receive passive income on staking and additionally farm cryptocurrency. For users who do not invest in cryptocurrencies, this method can be very risky, but for holders who have coins lying idle in their crypto wallet, it provides an opportunity to generate additional income and allows you to increase the profit from investments in digital assets.
