June 3, 2024
(Updated:
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On February 10th 2021, Solana’s validators voted to enable staking rewards and inflation of the SOL token. This move enabled regular SOL token holders to stake their SOL with their chosen validators to verify transactions on the chain and in return, users would earn a yield on their staked tokens in exchange for securing the Solana blockchain.
This yield is based on a variety of factors which include the current Solana inflation rate, the total amount of SOL staked across all validators as well as the specific validator’s performance and commission during the period. Solana started off with an initial annual inflation rate of 8%, with the rate decreasing by 15% year on year to achieve a long-term 1.5% annual inflation rate.
There are currently around 1,750 active validators on the network, and more than 65% of the total SOL supply staked.
By default, staking SOL tokens with validators keeps tokens locked up with the validator, preventing the user from using their tokens to, for example, pledge as collateral. Unstaking also subjects the user to an unstaking period, as the user will only receive their SOL tokens back at the end of the epoch. This unstaking period can be as long as 48 hours.
Enter liquid staking.
Liquid staking protocols return users a receipt token in exchange for staked SOL. This token represents the user’s staked SOL and is used to redeem it (along with rewards earned).
Taking SolBlaze as an example, users who deposit with SolBlaze receive bSOL in return, which represents their staked SOL with the protocol. Rewards accrue automatically to the bSOL token, resulting in bSOL increasing in value against SOL’s value over time.
These staking rewards are distributed by all staking protocols. Liquid staking enables in addition the use of receipt tokens in DeFi applications, which enables stakers to further leverage their staked SOL. These strategies are not without risks however, which we’ll look at more closely at the end of this article.
Liquid staking enables stakers to use the liquid staking tokens in DeFi protocols for further yield, such as by providing liquidity on decentralized exchanges (DEXs) and lending on money market protocols.
In traditional staking, most users delegate their SOL tokens to a single validator and generally only with leading validators, which are already holding most staked SOL. This arguably creates a centralization risk for Solana as staked SOL is concentrated amongst a small fraction of the total active validators. The top 21 validators on Solana hold more than 33% of the total stake. If these 21 validators colluded to act maliciously, they might be able to censor transactions or otherwise corrupt the blockchain.
Liquid staking protocols seek to reduce this concentration risk. When users deposit their SOL tokens into these protocols, these tokens are distributed across hundreds of validators to increase the decentralization of the network. This further increases the security of Solana and its resistance to malicious attackers.
Each liquid staking protocol has its own selection of validators curated to strike a balance between high rewards, high quality and size to improve decentralization in the network without compromising on staking rewards for their users.
Liquid staking protocols often provide native token incentives as well. Protocols such as Marinade and SolBlaze reward their users with their native tokens, MNDE and BLZE respectively. Jito Network, another popular provider, rewarded users with an airdrop of the JTO token, based on the amount and duration of SOL staked with them prior to the airdrop.
The liquid staking sector has grown tremendously on Solana since its inception in March 2021. Today, liquid staking protocols make up more than 80% of TVL on Solana at $3 billion.
While there are almost 30 different SOL liquid staking tokens and providers on Solana, the majority of Solana’s liquid staked SOL is held in the top three providers: Marinade Finance, Jito and SolBlaze.
Marinade Finance was the first liquid staking protocol on Solana, launching in March 2021. They currently offer both liquid staking and native staking.
Native staking, also known as Marinade Native, lets depositors stake with a selection of validators, without passing through smart contracts, while maintaining custody of their tokens. Marinade Native is targeted at institutional investors who seek to stake their SOL holdings for yield but may not wish to take the smart contract risk associated with liquid staking or the concentration risk associated with directly staking with a single validator.
Jito launched in November 2022, in the wake of the FTX collapse. Jito quickly gained popularity in the second half of 2023 with their points program and subsequently, their airdrop in December.
One aspect of Jito’s product relates to Maximal Extractable Value (MEV), which is profit generated from the way validators arrange, include or exclude transactions in a specific block. MEV traders, sometimes called searchers, can pay validators to arrange transactions in specific ways to seek a profit from these transactions. Jito’s validator client, which is run on all validators which Jito delegates to, previously included MEV functionality. Jito advertised its liquid staking pool as one which granted users MEV rewards on top of their staking yield.
However, in March 2024, Jito turned off the MEV functionality on their validator client, citing the negative impact it had on Solana users as a result of the ‘sandwich attacks’ which it enabled.
SolBlaze was the last of the three to launch, only arriving on the scene in 2023. It currently has the largest selection of validators at 305, compared to Jito’s 148 and Marinade Finance’s 292.
SolBlaze was also the first to launch custom liquid staking, which enables liquid stakers to stake with specific validators or groups of validators of their choice.
One of the main strengths of liquid staking tokens is composability. This means that these tokens can be easily utilized within DeFi applications.
Users can deposit their liquid staking tokens into liquidity pools on DEXs to facilitate swaps between the liquid staking token and other tokens on Solana. In return, users earn fees from swaps made in their liquidity pool as well as any other token incentives provided by the specific protocol. A common strategy for traders seeking to avoid impermanent loss (a common problem for DEX liquidity providers) is providing liquidity against other liquid staking tokens or wrapped SOL itself to reduce fluctuations in value. While yields from this approach are often lower due to the large number of liquidity providers, it is considered by many to be less risky and tends to be favored by those newer to DeFi.
Another oft-used strategy involves lending liquid staking tokens on money market platforms or perpetual DEXs. Users aim to earn from interest payments made by borrowers on the respective platform. Several platforms like Kamino Finance and MarginFi support the main liquid staking tokens such as JitoSOL, mSOL and bSOL.
A factor for lenders might also be the ability to take a loan out on their deposited liquid staking tokens. Currently, Kamino Finance enables loans on liquid staking tokens of up to 45% loan-to-value ratio. In simple terms, this would mean that with a deposit of $1,000 worth of mSOL, a user would be able to take a loan of up to $450 at a specified interest rate.
This refers to the situation in which users use leverage to stake significantly more SOL than they currently own by borrowing SOL through money market platforms. For example, Kamino Finance supports this strategy in their “Multiply” product, letting users leverage their staking by up to 5x.
When users deposit their liquid staking tokens, Kamino uses a flash loan to borrow SOL using their deposit, which is immediately swapped for the target liquid staking token (in this case, bSOL). This batch of liquid staking tokens are deposited into Kamino’s Lend product, whereby SOL is borrowed against them to repay the initial flash loan.
This strategy, like most leveraged strategies, is not without significant and consequential risks. Taking on higher leverage can lead to liquidations in high volatility events. Additionally, socialized losses on lending platforms are often distributed across all users, which can also push a highly leveraged position close to or even into liquidation.
A non-exhaustive overview of risks associated with liquid staking:
A notable risk that liquid staking tokens are subject to is smart contract risk. Since the minting of new tokens and withdrawal of SOL deposits are governed by the smart contract, vulnerabilities in liquid staking smart contracts could be exploited resulting in loss of funds for depositors.
Some potential exploit vectors include infinite minting of the liquid staking token or unauthorized withdrawal of SOL deposits, both of which can result in total loss of user deposits.
One of the key reasons people prefer liquid staking over traditional staking is the ability to swap between the liquid staking token and the base asset without having to wait for the unstaking period.
Under normal circumstances, liquid staking tokens trade in tandem with their underlying asset. Using the example of Marinade’s mSOL, 1 mSOL is currently equivalent in value to around 1.1886 SOL at the point of writing. This ratio is not 1:1 and will continue to rise over time as it includes accrued rewards from liquid staking.
During periods of high market volatility, a liquid staking token may diverge from its expected price. This is known as depegging. Depegging makes it hard for holders to swap out to the underlying asset without taking a significant loss. For liquid staking tokens with low liquidity supplied, this risk is significantly higher. If your liquid staking token is used as collateral for a loan during a depegging event, this could also result in liquidation if your collateral value falls under the required threshold.
In December 2023, mSOL suffered a significant depeg, where mSOL/SOL fell from 1.14 to a low of 1.01 before recovering within the day. The depeg event was a result of a large sale of mSOL for SOL into insufficient liquidity. Arbitrageurs identified an opportunity and quickly bought up mSOL tokens, returning the token to its expected price.
On Proof-of-Stake blockchains, validators are responsible for securing the network. Slashing is a punitive mechanism where a portion of a validator’s stake is confiscated in the event that they do not adhere to the rules of the blockchain. These violations can include double-signing, prolonged downtime or direct manipulation of the network.
In most liquid staking solutions, users do not choose their validators but instead delegate to a selection of validators based on the liquid staking protocol’s delegation strategy. This could result in losses to user deposits if validators within the selection are subject to slashing.
Since liquid staking is a concept that only exists within the crypto space, regulations around these tokens are still unclear. Future regulatory action could impact the availability of such services and tokens.
Liquid staking is one of the fastest growing parts of the Solana DeFi ecosystem. As part of this growth further developments and expansions of the liquid staking concept are underway, including restaking protocols such as Mantis Games, a vault solution launched by Picasso Network, seeking to bring the restaking primitive to Solana. However, these strategies are not without serious and consequential risks.