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The more utilizable capital you receive from an investment, the higher it's capital efficiency. Think of it like this, if you deposit $1,000 in Fortune 500 stock, that money is capital inefficient because it’s locked up in the stock, and you can only utilize it in one way: selling it. Likewise, when you stake your assets on a PoS blockchain, those assets become locked up and capital inefficient in quite the same way. Moreover, staking Ethereum, in particular, is wildly capital inefficient because not only are your assets locked, they’re locked for an indefinite amount of time until the full proof of stake merge happens.
Liquid staking came along as a solution to this with the primary value proposition of enabling capital efficiency on staked assets. What this means is that you can stake a token like BNB, and receive a liquid staked token through protocols like Ankr Staking that equal the value of your original staked assets. So now you can utilize those staked assets in other DeFi strategies, making it capital efficient again. Then when you want to cash out, you initiate the unbonding period on Ankr Staking and wait to receive your original assets + staking rewards.
Why is Capital Efficiency Important?
The fact that you can have access to capital that was once locked creates new opportunities to deploy capital and boost yield.
Not only this, but now you can stake your assets without the hassle of configuring a node and without needing the total capital required to run a node. This levels the playing field of opportunities!
It also gives more freedom and flexibility to smartly allocate your capital, resulting in better decision-making for investors. On the majority of protocols, if you wish to unstake your tokens, you’ll need to wait a certain period of time before having access to your tokens. However, with liquid staking, you can just sell your liquid staked tokens on the market and have access to your funds at any time. In addition to this, you can allocate your staked tokens through other DeFi protocols and boost your yield, whether you are providing liquidity or lending your tokens to other people.
Liquid Staking also opens new technological opportunities for DeFi. From new listings in DEXs, new lending markets, or new arbitrage opportunities, it boosts the DeFi ecosystem as a whole, adding more liquidity to the ecosystem, bringing communities together, and making them more efficient.
The Capital Inefficiencies of Liquidity Pools
With that being said, we can see how the primary utility of liquid staking is the capital efficiency that is unlocked even while your assets are staked. The last thing we’d want is to lock the assets in search of more yield. And this is one of the main downsides of liquidity pools; the capital efficiency disappears. Above all, you can’t utilize it, your assets are locked once again.
With this, we can see that liquidity pools within DEXs possess more underlying risks than first meets the eye.
Depositing Liquid Staked Tokens in LPs Decreases Overall Rewards
Recall that the primary reason to yield farm within liquidity pools is to receive transaction fees from that pool. So the most ideal LP pair would be two assets that are pegged to each other, like USDC/DAI or wBTC/BTC. But let me remind you that liquid-staked tokens like aETHb are reward-earning and increase in value over time as a result of rewards.
The only thing is there are multiple downsides to having a liquidity pool with an asset and its liquid-staked derivative. Think about it this way, in order to supply funds into a liquidity pool, you need to deposit two assets of equal value. For example, you could supply aETHb & ETH. But the thing is, aETHb already earns rewards and ETH doesn’t, so you’d earn more yield by depositing all of your available assets into aETHb rather than dividing it equally into aETHB & ETH for the liquidity pool’s sake.
On top of that, the liquid staked derivative (ie, aETHb) accrues in value and is subject to Impermanent Loss as a result. In summation, the transaction fee rewards that you receive from the liquidity pool don’t make up for the opportunity cost of only staking half your assets and the impermanent loss from the reward-bearing nature of liquid-staked derivatives.
Conclusion
At the end of the day, liquidity pools are risky, and we wouldn’t recommend depositing liquid staked tokens into them because it decreases staking rewards due to impermanent loss, and it makes your newly capital-efficient assets inefficient again.
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