Liquid Staking and Security of PoS-Networks
In simple words about Difficult things
I’ve been following the development of PoS for over two years now, and I’m a validator for 12 PoS-Networks.
During this time, I have accumulated a fairly large amount of information that I would like to share.
The most important thing is to understand what PoS is!
It is easy to find information on the Internet that PoS is short for Proof-of-Stake.
But what is this Stake, and what does it prove?
In simple words, Stake is your part of blockchain ownership!
This is how much the Blockchain belongs to you.
Wait, can anyone own the Blockchain?
Of course! Any PoS-Blockchain belongs to all those who own the coins of this Blockchain. And not only own coins, but also delegates these coins, or in other words, sends this coins to the Stake.
That is, all people can be divided into two categories:
- People who don’t have coins of PoS-Blockchain — these people cannot influence the Blockchain in any way:
- They cannot sell their coins to reduce the price of the coin.
- They cannot keep their coins, than reduce the supply of coins in the market, and accordingly increase the price of coins.
- They cannot participate in the governance of the Blockchain, since in order to participate in the governance of the blockchain, they need to own the coins of the blockchain.
- The only thing they can do is purchase coins of PoS-Blockchain. Then they will not only affect the increase of the coin price, but also it will transfer them to another category of people.
- People who have coins of PoS-Blockchain— these people can influence the Blockchain:
- They can sell their coins, which will reduce the coin price.
- They can hold their coins, which will reduce the supply of coins in the market, and increase the coin price accordingly.
- They can delegate their coins (or in other words send coins to the Steak), which will not only reduce the supply of coins on the market, but also increase the security of the Blockchain!
And for providing the security to the Blockchain, those people who delegate (stake) their coins will receive a reward from the Blockchain (part of the emission of new coins).
Also, they will get the right to participate in the governance of the Blockchain. And the Voting Power of delegators (or stakers) is directly proportional to the number of coins they delegate (stake).
So, people who delegate (stake) their coins are the owners of the PoS-Blockchain. And each of them owns the Blockchain for exactly as much as its share of the number of all staked coins.
As an example:
PoS-Blockchain issued 200 coins.
100 coins are in circulation — these coins are bought and sold.
And another 100 coins are staked. These coins are neither bought nor sold. They cannot be bought or sold. These coins are kind of “frozen”.
These 100 coins belong to 5 people:
- Alice staked 35 coins
- Bob staked 25 coins
- Carol staked 20 coins
- Diana staked 15 coins
- Evan staked 5 coins
This Blockchain belongs to 5 people. These people can vote and accept any changes to the PoS-Blockchain. And these changes will affect not only those who stake coins, but also those who trade coins in the market!
Since there are 100 coins in total, then:
- Alice owns 35% of the Blockchain
- Bob owns 35% of the Blockchain
- Carol owns 20% of the Blockchain
- Diana owns 15% of the Blockchain
- Evan owns 5% of the Blockchain
How is Staking related to Security?
Firstly, the one who stakes (or delegates) coins, tells: “I deprive myself of the opportunity to sell the coins of the project. Even if the price of the coin is very high, I will not be able to take advantage of this and sell my coins, as they are frozen. That is, I cannot speculate on the price of coins. By this I want to show that for me the Blockchain is much more important than personal economic interests! “
And because the interests of blockchain is more important for staker than personal economic interest — the staker gets the Right to Vote, i.e. can governance the Blockchain by creating Proposals and voting for Proposals.
And the Security of the Blockchain directly depends on those Proposals that the stakers will accept or reject.
Secondly, the staker not only hold coins, but it also doesn’t sell coins in the market!
Anyone who holds coins, but didn’t stake them, can send their coins to the market at any time, unlike a staker!
That is, the staker doesn’t allow attackers to buy coins, which gives the Blockchain additional Security.
Imagine that someone wanted to destroy the Blockchain. How can this attacker do this?
Obviously, an attacker has no way to hack or destroy all the nodes of the Blockchain. Blockchain nodes are distributed all over the planet, and are located on different continents. And even if an attacker manages to destroy or gain control over a part of the nodes, then people who are interested in the Blockchain will immediately launch new nodes on other continents.
Then the attacker has another potential opportunity: to buy up all the coins that are on the market, stake them, and start creating and accepting Proposals that will harm the Blockchain.
To understand this better, let’s go back to our example:
Let’s imagine that there is an attacker Fry, who decided to destroy the PoS-Blockchain. He started buying coins that are on the market. Since Fry decided to buy 100 coins out of 200 of all existing coins, the price of coins began to rise, and therefore Fry managed to buy only 80 coins. Greg bought another 20 coins when he saw that the price of the coin began to rise sharply.
Both Fry and Greg stake their coins, since staking is rewarded from the Blockchain, and taking into account the fact that there are no more free coins on the market (that is, the supply is equal to zero), the price of these coins tends to infinity. Whoever comes to the market to buy coins — the answer will be the same: “There are no coins in free circulation. Everything is in stake. “
Now the PoS-Blockchain has 7 owners:
- Alice staked 35 coins (17.5% Voting Power)
- Bob staked 25 coins (12.5% Voting Power)
- Carol staked 20 coins (10% Voting Power)
- Diana staked 15 coins (7.5% Voting Power)
- Evan staked 5 coins ( 2.5% Voting Power)
- Fry staked 80 coins (40% Voting Power)
- Greg staked 20 coins (10% Voting Power)
If Fry creates a Proposal for the implementation of a new program code into the Blockchain with a hidden ability to steal user funds, and for accepting this Proposal if more than 50% of the stakers vote, then the Proposal will be accepted, the code will be implemented, and users’ funds will be stolen.
It is good that Fry has only 40% of the Voting Power, which means that the rest of the stakers can vote against the proposal with a total Voting Power of 60%. The offer will be rejected, user funds will not be lost, and the Blockchain will continue to exist.
But just imagine what would happen if the attacker had 60% of the Voting Power? Such an attacker would be able to propose and make any decisions in own interests, and to the detriment of the interests of other participants of the Blockchain. In other words, the attacker centralized the Blockchain.
That is why the Security of the PoS-Blockchain directly depends on the number of coins in stake. And the larger the percentage of coins out of the existing number of coins is in the stake, the higher is the PoS-Blockchain Security.
In other words, the Staker is the provider of Security, and the Blockchain pays the Staker a reward for this (the new emission of coins is distributed among the Stakers in direct proportion to the number of staked coins).
If you use the StakingRewards resource and select the display of blockchains by the Total Staked parameter, you will see which blockchains are the safest:
Well, if with Stake and Security are clear now, what does this stake prove?
When we say PoS-Blockchain, we mean Blockchain in which PoS-consensus operates.
Consensus is a way of making decisions in which all participants agree on a decision. Roughly speaking, this is 100% agreement.
That is, in PoS-Blockchains, all participants agree that the new emission of coins will be distributed among those who stake their coins, as well as that those who stake their coins have the right to governance the Blockchain.
What if I disagree?
If you disagree, then you are not participating in the PoS-Blockchain.
That is, the fact that you bought coins and sent them to the stake indicates that you agree with what is happening in the Blockchain. If you disagree, then don’t buy Blockchain coins and don’t stake them.
Okay! Agree! What do we prove with a stake?
Proof-of-Stake is proof that you are interested in the Blockchain and agree with what is happening in the Blockchain and by what rules it happens.
That is, if you sent coins to a stake, you prove with this stake that you agree with how decisions are made, as well as how the new emission of coins is distributed.
For simplicity of explanation, we can say that PoS-Blockchain is a company that issued its shares. And all coins are 100% of the company’s shares. Only those coins that are traded are shares for profit, and those coins that are staked are shares for both profit and voting shares.
And any staker is a member of the board of directors of this company. It’s just that the company is not in an office building, but on the Internet. And its activities are conducted not on paper, but in the blockchain.
Consensus is the charter of the company under which it operates.
And the safety of the company, like its success, depends on the actions of the board of directors.
Well, if everything has become more or less clear with staking, now you can move on to Liquid Staking!
Coins of the PoS-Blockchain are an asset.
If you are holding coins, or trading coins, then this is your current asset.
But if you stake your coins, then they turn from a “current asset” into a “fixed asset”.
Staked coins gain in value (in value , but not in price) as they begin to bring you profit.
Moreover, there are times when the profit from the staked coins is tens and hundreds of times higher than the value of the staked coins. This is made possible by various airdrops and stakedrops, which you can learn more about in this video.
Each coin has two sides. And the staked coin also has two sides: on the one hand, staked coins are more valuable and bring you profit, and also bring security to the Blockchain.
On the other hand, the staked coins are “frozen”. You cannot send them anywhere, or somehow use them — this is what brings additional security to the PoS-Blockchain.
In order to “unfreeze” (unbond) coins, you will need to wait a long time, which is different for each blockchain. And the longer you have to wait for the unbonding of staked funds, the higher the security of the blockchain.
The unbonding period for coins from a stake can be from 3 to 28 days.
After this time period, you can freely withdrawn funds — transfer them to another address or sell them on the stock exchange.
In the POS-Blockchains, where you can unbond your coins instantly, staking of coins doesn’t bring additional security to the Blockchain.
Coins that are not in the stake (your “current asset”) can be used as collateral to obtain a loan. Or you can lend it out at interest. Or you can provide the liquidity and receive a percentage of exchange.
How great it would be if the staked coins could be used as well! And in order to still receive a reward for providing security to the Blockchain! And also, not to lose the opportunity to governance the Blockchain yet!
Do you want a lot?
Not a lot! Liquid Staking is exactly the solution that allows you to combine the positive aspects of a current and fixed assets, and at the same time eliminate the negative aspects.
There are several solutions for implementing Liquid Staking:
- You can stake your funds not directly, but through a third party, for example, a centralized exchange. The turnover of centralized exchanges is quite large, and many people constantly keep their funds on centralized exchanges. The amount of funds that enter or leave centralized exchanges is much less than the amount of funds that are inside the exchange. Thus, a centralized exchange can calculate how much funds remain immovable and send these funds to the stake.
The exchange may offer you to stake your funds, you will receive a reward for this, and at the same time the exchange will give you some amount to participate in trading, which is equivalent to your staked funds.
This seemingly simple solution has three drawbacks:
1. You will not be able to take part in the governance of the Blockchain. Now the centralized exchange provides security to the Blockchain, not you. This means that the centralized exchange receives the staking reward. And only the exchange decides which part of this reward to keep for itself, and which one you will receive.
2. You will be able to use the funds received from the exchange only within this exchange.
3. Your funds on a centralized exchange are not your funds, they are funds on a centralized exchange. At any time, a centralized exchange is able to deprive you of access to your funds under any pretext, or it can declare that “the exchange has been hacked, the funds may come back someday, when it is not known, wait, we don’t promise anything … ”
- You can receive the equivalent of the staked funds directly from the Validator.
The Validator is a blockchain participant just like you. The validator keeps the infrastructure (node) that stores information about all transactions that take place on the Blockchain. When you stake your coins, you delegate them to the Validator. This doesn’t mean that you are sending your funds to the Validator. This means that your funds are frozen at your address, and a record appears on the blockchain “these funds are frozen and assigned to the stake of this Validator”. But the Validator doesn’t have access to your funds.
The Validator is also a staker, it is just that the Validator delegates coins to itself (or to other Validators, which happens, but less often).
It’s possible to create a multi-signature blockchain address. That is, to withdraw coins from the address, you need the sign of both the staker and the validator. Neither the Validator nor the Staker will be able to withdraw funds from the address without mutual consent.
When creating such an address, the Validator can safely issue the equivalent of the staked funds to the Delegator (Staker) so that the Delegator can use the equivalent of these funds as a “current asset”.
The only drawback of this solution is that it is not clear where the validator should take the equivalent of the staked funds, and in what units this equivalent should be issued.
- You can stake your funds through a third party, which is not a centralized exchange (or a large investment fund), but which is a sovereign decentralized blockchain.
First, such a blockchain may have its own coins, which will be issued to stakers as the equivalent of staked funds.
Secondly, your funds on the blockchain are your funds. And no one is able to deprive you of your funds, provided that you keep the mnemonic (password from your address) in a secret.
Thirdly, you will receive the equivalent of staked funds in blockchain coins, which means you can both trade these coins and lend them, as well as provide liquidity to liquidity pools. And if the blockchain has bridges with other blockchains, then you will be able to transfer funds from one blockchain to another.
And the most important thing is that you never stop being the security provider for the Blockchain, whose coins you sent to the stake. Quite the opposite! You give the Blockchain even greater security, since now, in order to withdraw coins from the steak, you need not only to withdraw funds, but first return the equivalent coins, and only after that start the unbonding procedure.
And participation in the governance of the Blockchain can be solved using an additional smart-contract, which, in addition to equivalent coins, issues non-tradable Voting Power tokens, which can be used exclusively to instruct the validator how to vote with your stake when voting for the Proposal.
- There are also solutions related to the implementation of the Liquid Staking functionality in the PoS-Blockchain. And the description of this solution is beyond the scope of this article.
- There are also solutions related to the creation of NFTs, which should also be issued as the equivalent of staked funds (this solution also needs a blockchain as a third party, or this functionality must be implemented in the PoS-Blockchain code). The description of this solution is also beyond the scope of this article, and requires a separate article, which I will publish later.
Perhaps there are solutions that don’t fit into any of these categories, but at the moment I don’t know anything about them, although it is absolutely certain that they will appear soon.
But this is all in general terms! Are there any specific examples, or is this all your fantasy?
Of course we have! But so far there are not many such examples. Liquid Staking is a very young direction that could not have appeared earlier.
Why couldn’t it?
Liquid Staking is the answer to the problems we faced only after unlocking the real potential of PoS and DeFi. To put it bluntly, Liquid Staking is a child of PoS and DeFi.
First, PoS and DeFi had to grow, then they had to meet, love each other, and only after that “give birth” to Liquid Staking.
Staking came to us from PoS, and Liquidity came to us from DeFi.
If we have already dealt with Staking, let’s deal with Liquidity.
DeFi (Decentralized Finance) is a logical extension of FinTech, which is a direct answer to the questions that traditional financial institutions have asked us.
For finance to work, they need a space in which to unfold. We need something like an “economic field” in which “economic interaction” could take place. And this “economic field” appears when capital begins to “flow”, or, as they say, the movement of capital is necessary.
And the more capital “moves”, the stronger the “economic field”.
The stronger the “economic field”, the greater the potential for “economic interactions” that take place in this “economic field”.
Forgive me this analogy with electro-magnetic interaction , further I will explain everything in simple words.
The movement of capital is carried out in the process of some values for others. If there is no exchange, then there is no movement of capital.
The more often the exchange takes place, the faster the capital flows.
The more people participate in the exchange, the more often the exchange takes place.
The more different values are provided, the more people take part in the exchange.
Therefor, capital flows faster when there are many different values that can be exchanged with each other.
All DeFi is built around providing Liquidity. That is, on the supply of as many of the most varied values as possible to the market.
Alice brought Apple to the market.
Bob brought Book to the market.
Carol brought a Case to the market.
Diana came to the market for Apple, and brought Doll for exchange.
Evan came to the market for a Book, and brought Egg for exchange.
Fry came to the market for a Case, and brought Flag for exchange.
Alice needs Flag, Bob needs Case, Carol needs Doll …
All market participants are trying to find the shortest way to exchange one for the other.
Diana wants to trade with Alice: Doll for Apple.
But Alice doesn’t need Doll! Alice needs Flag!
Fry offers Carol to exchange Flag for Case, but Carol wants to exchange Case for Doll….
How nice it would be if someone came to the market and brought everything and a lot at once … So that you can immediately get what you want, for what you have!
Previously, banks and intermediaries were the main providers of liquidity. They were few, but they had many. And thanks to their privileged position, banks and intermediaries could charge pre-inflated interest rates for extending liquidity.
Now, ordinary people are becoming the general providers of liquidity. Each of them has few, but there are a lot of these people!
And the Liquidity that the common people supply is so diverse that it attracts more and more people who bring with them an increasingly diverse Liquidity.
The number of ordinary people is so large and the exchange takes place so often that the interest for providing Liquidity is much lower than the interest charged by banks and intermediaries.
Those who paid a large percentage to banks and intermediaries no longer want to use the services of banks and intermediaries. They start taking advantage of better deals …
What is missing in the DeFi market?
Just two things:
1) Traditional Financial Institutions — and this is not their fault, but the fault of the regulators. But this topic is for another article.
2) Staked Assets.
Before the appearance of Liquid Staking, the only thing that could not be replenished in the Liquidity Pool was the Staked Assets.
And roughly speaking, each market participant had to choose:
- Either send funds to the Liquidity Pool in order to receive a percentage for providing Liquidity;
- Either send funds to a stake to receive a reward for providing Security;
But you and I know that there is a solution (and more than one!) That allows you to enjoy both the percentage for providing Liquidity and the reward for providing Security!
Can you be more specific? Which projects provide the opportunity to receive Staking Rewards and Liquidity Interest at the same time?
There is also the Lido project , but it is engaged in Liquid Staking between Ethereum and Ethereum2.0, while Ethereum2.0 still exists only in our expectations.
The pSTAKE platform creates liquid tokens in one-to-one proportions for the funds that are in the stake. These tokens can then be used in various DeFi projects for additional profit.
How does this happen?
Very simple! Ingenious and simple!
You are sending $ATOM or $XPRT to the pSTAKE platform.
The pSTAKE platform associates your cosmos- and persistence- addresses with an ethereum- address.
$ATOM or $XPRT are sent to smart-contract addresses, and in return, exactly the same number of ERC-20 tokens are created on your ethereum-address: pATOM or pXPRT.
To return your $ATOM or $XPRT from the smart-contract address to your addresses, you need to burn pATOM or pXPRT on your ethereum-address in 1:1 proportions.
But if you want to enjoy the Liquidity Staking, you can stake your pATOM or pXPRT!
Another open source smart-contract burns your pATOM or pXPRT, sends $ATOM or $XPRT to the stake to proven Cosmos Network and Persistence validators, and exactly the same number of ERC-20 tokens is created on your ethereum-address: stkATOM or stkXPRT.
It is at this moment that your $ATOM or $XPRT is in the stake, and brings you a reward for providing security to the Cosmos Network or Persistence blockchains, and this reward goes to your ethereum-address in the form of pATOM or pXPRT, which you can either exchange in a ratio of 1:1 for a reward in $ATOM or $XPRT, or send to a stake, which will burn your pATOM or pXPRT, and create the same number of stkATOM or stkXPRT.
And one more bonus! You can still get a part of the retroactive rewards from pSTAKE for the liquidity providers of stkATOM and stkXPRT on SushiSwap .
Read more about this in this article .
If you want to better understand how the pSTAKE platform works, read this article.
Here you will find tutorial on how to use the pSTAKE platform.
And please yourself with a video about tokens for tokens)
Thanks for reading to the end!
Vladimir Understanding wrote this article for you.
Write to me in Telegram about all errors or typos.
My Starname profile: https://app.starname.me/profile/*posthuman
My validator on the Persistence network is called POSTHUMAN (commission is only 3% until the end of 2021!)
Everything that I have written is my personal experience.
I don’t advertise anyone, and I don’t get any money for what I do.
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