Crypto ventures @NGC/ ex-Goldman research/ tech VC/ Berkeley Haas MBA 2022 candidate
To investors looking for staking rewards, blockchain adopting the Proof-of-Stake consensus mechanism and decentralized finance (DeFi) projects with liquid staking components are great options to participate in.
In this article, we summarized some DeFi projects with liquid staking that are gaining traction in the market.
The problem that Proof-of-stake left is the opportunity for Liquid Staking in DeFi
Proof-of-Stake is a type of consensus mechanism of blockchain, which rewards users for collateralizing, or pooling, native cryptocurrency, and “locking” it in order to form a weighted consensus on a blockchain. Compared with Proof-of-Work algorithms, PoS is more energy-saving and rewarding more fairly to long-term holders.
PoS also offers a governance structure around staking. Token holders are able to vote in decisions such as network upgrades, emissions adjustments, and other changes that previously were the decree of a closed development team.
However, the majority of blockchain 2.0 projects failed to provide convincing models for the serious adoption of PoS schemes
This is mainly due to their vulnerability to socially-engineered exploits. For instance, EOS came under fire in 2019 after it was discovered that a significant number of their 21 block producers (large POS wallets) were actually a major cryptocurrency exchange utilizing user-deposited EOS tokens in order to manipulate the governance process with “mutual voting”. Likewise, there have been several other projects that incentivized 51% attacks.
For casual users, staking can present its own set of headaches. For example, Cosmos stakers are subject to a 21-day un-bonding period, much like a “token purgatory”: ATOM tokens are unusable and locked. However, there are a number of ways in which decentralized liquidity providers can alleviate the opportunity cost of time-locked capital and guarantee liquidity for assets trapped in escrow.
One important takeaway is that staking environments often end up quite different from how they were intended to and need additional solutions to alleviate the burdens of escrow, the un-bonding period, and un-bonding premium.
According to the Chorus Liquid Staking report published in June 2020,
“rigorous economic and game-theoretic thinking about the interplay of the incentives of token holders, validators and other key players has not been at the forefront of Proof-of-Stake design”.
What makes these new DeFi projects attractive are their three-fold improvements in regards to understanding financial game theory, liquid staking, and evolutionary governance models.
The next generation of PoS chains seeks to remedy many of the critical flaws from earlier iterations. Among the dozens of examples of successful PoS networks employing better-designed governance features and security, methods are Tezos, Cosmos, Algorand, Stellar, Hedera Hashgraph, and others.
Keen investors are also watching the development of new networks and protocols such as Polkadot Network, Compound, Ramp DeFi, StaFi, and now KIRA Network.
In traditional PoS designs, users are locked into contracts for a predetermined period of time. In many schemes, there is an early withdrawal penalty, along with a waiting period before assets are returned to user wallets.
Even though some of the most popular programs allow instant withdrawals, such as XTZs “baking scheme”, it has become apparent that over-collateralized staking agreements need to be circumvented with new solutions.
Liquid staking solves three layers of opportunity costs in conventional staking programs: escrow, un-bonding period, and the un-bonding premium.
Liquid staking allows users to access their locked capital while continuing to earn staking rewards and maintaining ownership of governance rights.
In some cases staking wallets only need to give up temporary governance rights in order to gain custody of a derivative liquidity token. Alleviating the burden of the un-bonding period and premium -- which can reach nearly 2% over three periods -- is one of the main objectives of liquid staking.
User funds will still remain in escrow but the opportunity cost is greatly reduced. This is a contrast to the traditional models which present acute portfolio vulnerabilities. Simply put, the number might go down over the “unlock” period mandated by many staking programs!
The new school of DeFi attempts to solve this in a few ways.
Compound Finance functions as a suite of smart contracts on the Ethereum blockchain and enables developers to interface with ERC-20 liquidity pools and generate interest on tokens such as 0x, BAT, Ether, and even stablecoins.
Anybody with access to the public Ethereum network may use the Compound’s protocol to earn interest on a growing number of crypto assets. The multi-collateral nature of Compound is an improvement on earlier asset pools such as MakerDAO, which was only funded through Ethereum tokens. In addition to this safer, distributed, and more risk-averse model of liquidity pooling, non-custodial user-facing platforms can be built on Compound protocol.
Opyn, for instance, is a decentralized margin trading platform that allows users to go long and short on their preferred ERC-20 tokens.
As of June the project claims to be fully decentralized with the implementation of an on-chain system that continuously will distribute COMP ERC-20 tokens to active participants.
Without any centralized management of the protocol, token holders may vote on community initiatives and continue the spirit of a fully open-source toolkit designed to be used, modified, and redistributed free of charge. One of the biggest drawbacks of Compound Finance is that it is native only to the Ethereum blockchain and cannot provide collateral against non-ERC-20 tokens.
Ramp DeFi intends to solve this problem by sweeping non-ERC-20 staking funds into rUSD -- a stablecoin derivative -- on the Polkadot Network. This can be traded or redeemed for USDT, DAI, or a number of other currencies.
By allowing cross-chain lending to occur against otherwise locked crypto assets, Ramp DeFi is creating a seamless on/off ramp for users “baking” Tezos or staking ATOM or locking other digital currencies. Protecting staking rewards, stacking yield, and enabling a cross-chain liquidity bridge are some notable achievements on this new and improved PoS design.
Simply put, Ramp focuses on moving a stable value, rather than the assets themselves, and granting more freedom in how users leverage their staking yield. If a user has USDT, for example, the rUSD value is a simple 1:1 swap.
Ramp is limited in its ability to collateralize and loan out against ERC-20 tokens.
Stafi (short for Staking Finance) is another DeFi Protocol hoping to unlock the liquidity of staked assets. Using staking contracts to make assets liquid and transferrable, Stafi plans to use their token rToken to hedge against market volatility while still earning rewards. The FIS token is a complimentary token to help with system abuse and also as a transaction fee for using the service.
Using STAFI can minimize opportunity cost but also assumes market liquidity. For example, wrapping an EOS token to PolkaDot as wEOS may sound good, but it may be hard to find people to accept wEOS. If the liquidity is thin, the value of the derivative may fluctuate greatly and present an unattractive experience for investors.
Moving assets can be useful, but only when someone is willing to off-take it and accept the wrapped native token’s value. Stafi hopes to use Frontier, a DeFi aggregator solution that can integrate with multiple forms of wallets, to increase adoption of the Stafi’s liquid staking approach.
The Acala Network aims to bring liquidity to staked assets and make them available for immediate use much like Compound, Ramp, and Stafi. What makes Acala unique is that people can secure their staked assets/rewards while accessing liquidity for lending, margin trading, and other DeFi services.
Acala stable coin (aUSD) is a multi-collateral cryptocurrency with a 1:1 rate to US dollar. aUSD is generated by collaterals such as tokens belonging to the Polkadot, Bitcoin, or Ethereum networks. Acala is native to Polkadot and is compatible with any project on the Polkadot network.
Acala’s partnership with Laminar is instrumental to the potential success of their liquid staking protocol. Laminar is a VC-backed DeFi protocol company which is building an open finance platform with better access to trading instruments, and tools for developers to build custom DeFi solutions.
Laminar’s flow exchange comes with a user interface that makes it easier to trade and take loans in comparison to other liquid staking protocols. Additional features include margin trading, trading synthetic assets, and multiple liquidity pools as trading counterparties for different levels of risk management.
KIRA Network DeFi
KIRA Network is a new and exciting model in the DeFi race for utilizing staked capital and enabling its access to the market. Its core blockchain application is a scalable, trustless, and permissionless interchain exchange protocol built with the goals of ensuring liquidity within cross-chain ecosystems such as Cosmos and Polkadot.
Kira’s use of Interchain Exchange Protocol (IXP) is next-generation technology engineered for staking any digital asset type while earning revenue yet maintaining liquidity and ability to trade all those assets at stake. Kira employs a new scheme called Multi Bonded Proof-of-Stake (MBPoS).
By interconnecting multiple networks with existing native tokens, Kira invites token holders to stake their digital assets including derivative products and NFT’s directly on the KIRA Network to create a next-level DeFi experience. The issue of the stake illiquidity is avoided because, with Kira, users receive 1:1 derivatives representing assets they staked, which enables them to claim revenue and trade those assets directly on the KIRA Network.
Staked assets can not only be traded for un-staked assets but also traded directly for other types of staked tokens, this means that there is no need to un-stake tokens which otherwise decreases the security of the typical PoS networks during market volatility peaks.
Backed by several interchain protocols such as Cosmos IBC and Polkadot XCMP, Kira positions itself between two of the most prominent cross-chain ecosystems to enable the peer-to-peer market access for any digital asset.
What sets Kira apart from other projects is their approach to utilizing capital at stake for the purpose of creating a viral DeFi environment, without sacrificing security and creating honeypots like typical PoS to which assets from foreign blockchains can be deposited.
KIRA Network creates a positive feedback loop mechanism incentivising token holders to stake any digital assets by sharing with them a portion of the block and fee rewards. This, in turn, increases the liquidity of the IX protocol and network activity, this creates more incentives from block and fee rewards which makes users stake even more and generates a new cycle of economic growth.
All those mechanisms proposed by Kira are taken even further with the concept of Initial Validator Offerings, where investors instead of spending their assets just stake them to “cross-chain mine” new tokens while maintaining liquidity and ability to trade their staked assets.
IVOs can be seen as a way to force new projects to perform and deliver otherwise investors can redelegate their assets to another validator. This prevents new projects from just running away with investor’s money like it often took place in the case of ICO’s. This is also an ideal solution for decentralized organizations that operate outside of traditional finance arrangements due to inadequate banking and loan resources in their jurisdiction or a desire to simply remain anonymous.
Their governance and consensus structure is a unique departure from previous models because it is based on utilitarian (“greater good”) rather than plutocratic (“greater wealth”) principles.
Kira uses a Network Actor Permissioning Model which consists of just two rules enabling bootstrap and self-evolving almost any imaginable governance model. The rules of the system state that only whitelisted actors can execute on-chain actions, and that they can only execute actions that they have permission to.
This seemingly simple permissioning system is what puts Kira ahead of most PoS networks in terms of security. In the case of Kira each network actor possesses equal voting power or chance to propose new blocks, this guarantees that it is not possible to exploit the governance system by stealing tokens, accumulating, or otherwise taking control over large amounts of assets.
Network Actor Permissioning ensures that the governance system can not only efficiently define roles and permissions of its own members but most importantly expand and self-evolve its own structure towards complex governance models such as multicameralism and checks and balances.
Kira leaves it to its own governance system to define its own structure, Code of Conduct and enables control over all economic aspects of the network such as interest rates for staking foreign tokens or inflation rate within certain safety thresholds rather than forcing and inventing specific rules that the community must obey.
Kira governance can also define its own on-chain and off-chain rules for onboarding new validators and governance members which means that wealth status is no longer the only aspect of judging candidacy and thus eliminates most vulnerabilities of plutocratic governance models known from other PoS networks.
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