Creating Utility for Tokenized Derivatives of Proof-of-Stake (PoS) Assets Is Critical for DeFi’s Growth

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Two sig­nif­i­cant events define the growth of cryp­to and the broad­er blockchain-pow­ered indus­tries. The first is the emer­gence of decen­tral­ized finance (DeFi), under­pinned by blockchain-based dig­i­tal assets.

DeFi quick­ly became an alter­nate finan­cial sys­tem that facil­i­tates glob­al acces­si­bil­i­ty and supe­ri­or finan­cial infra­struc­ture. And today, this new finan­cial sys­tem has over four mil­lion unique users and is worth over $200 bil­lion.

The sec­ond defin­ing event is the tran­si­tion from proof-of-work (PoW) to proof-of-stake (PoS) blockchains. PoS as a con­sen­sus pro­vides an ener­gy-effi­cient and prac­ti­cal way of secur­ing the blockchain. It is also more scal­able when com­pared to PoW.

But a more sig­nif­i­cant rea­son for its pop­u­lar­i­ty is that it pro­vides a way for users to put their dig­i­tal assets to use. By sim­ply lock­ing up their dig­i­tal assets in PoS pro­to­cols, users earn a guar­an­teed yield, which is gen­er­al­ly sig­nif­i­cant­ly high­er than yields in tra­di­tion­al finan­cial systems.

How­ev­er, with DeFi grow­ing both in val­ue and num­ber of users by the day, the long stak­ing peri­od for assets on PoS pro­to­cols leads to pools of idle liq­uid­i­ty that are now crip­pling the domain’s growth.

DeFi’s idle liq­uid­i­ty problem

The total mar­ket cap of PoS assets hit an all-time high of $594 bil­lion in 2021. The pro­ject­ed rewards earned by stak­ing these assets are also set to hit $18 bil­lion soon. Addi­tion­al­ly, the total vol­ume of assets locked in DeFi pro­to­cols is $214 bil­lion cur­rent­ly. While all these num­bers seem impres­sive on the sur­face, they actu­al­ly hide more than they reveal.

Most of this liq­uid­i­ty is frag­ment­ed, under­uti­lized and inac­ces­si­ble. This is because assets locked in PoS pro­to­cols lose their usabil­i­ty for a long peri­od of time and are siloed away in their indi­vid­ual networks.

Although these staked assets acquire inter­est over time, their usabil­i­ty in the larg­er DeFi frame­work becomes lim­it­ed. More­over, this con­tributes to the inde­com­pos­able nature of DeFi, mak­ing it hard for net­works to exchange val­ue efficiently.

Thus, to ful­ly access DeFi’s liq­uid­i­ty, pro­to­cols in the indus­try are now cre­at­ing tok­enized deriv­a­tives of PoS assets through a process called liq­uid stak­ing. But for DeFi to achieve true com­pos­abil­i­ty, the indus­try also needs to focus on cre­at­ing real util­i­ty for these tok­enized derivatives.

Cre­at­ing util­i­ty for under­used liquidity

For the unini­ti­at­ed, liq­uid stak­ing is a process of issu­ing to users deriv­a­tives of PoS assets. This means that the liq­uid­i­ty of the under­ly­ing asset is unlocked with­out unlock­ing the asset itself. So, users  while reap­ing the stak­ing rewards for the locked asset – can still put the asset to use on var­i­ous oth­er pro­to­cols in the ecosystem.

For instance, a user stak­ing asset X on a PoS pro­to­col will earn a yield of about sev­en per­cent annu­al­ly and will also receive a tok­enized deriv­a­tive of the asset – say, tX. Then, if the user pro­vides liq­uid­i­ty to a tX-ETH pair on a pro­to­col that earns an annu­al yield of about nine per­cent, at the end of the year the user earns a total yield of 16% on a sin­gle asset.

This way, PoS assets, while being used for the con­sen­sus to secure blockchain net­works, can still be used across oth­er pro­to­cols, facil­i­tat­ing full access to DeFi’s liquidity.

How­ev­er, while liq­uid stak­ing pro­to­cols are grow­ing in num­ber, the indus­try still lags behind on cre­at­ing prop­er util­i­ty for these new­ly mint­ed deriv­a­tives of PoS assets. With­out real­is­tic use cas­es, the indus­try is once again left with liq­uid­i­ty that is underutilized.

So, the need of the hour in DeFi is to cre­ate pro­to­cols that make use of this new­ly unlocked liq­uid­i­ty in the right way. There are a few net­works that are already tak­ing strides in this direction.

Such inno­va­tions will final­ly allow DeFi’s liq­uid­i­ty to be accessed ful­ly and also facil­i­tate the exchange of val­ue between pro­to­cols and net­works to make the indus­try composable.

Mak­ing DeFi capital-efficient

The first iter­a­tion of DeFi, with its inno­v­a­tive nature and glob­al acces­si­bil­i­ty, brought a sig­nif­i­cant inflow of cap­i­tal and liq­uid­i­ty into the indus­try. How­ev­er, with the tran­si­tion toward DeFi 2.0 tak­ing shape, the indus­try is now focused on cre­at­ing finan­cial prod­ucts and pro­to­cols that allow for this liq­uid­i­ty to be prop­er­ly accessed and used.

In this regard, liq­uid stak­ing brings a world of new oppor­tu­ni­ties into DeFi. Com­bined with prop­er util­i­ty for staked deriv­a­tives, this can cat­a­pult DeFi’s suc­cess and make it a cap­i­tal-effi­cient indus­try in the near future.


Tushar Aggar­w­al is a Forbes 30U30 recip­i­ent and the founder and CEO of Per­sis­tence.

 

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Disclaimer: Opinions expressed at The Daily Hodl are not investment advice. Investors should do their due diligence before making any high-risk investments in Bitcoin, cryptocurrency or digital assets. Please be advised that your transfers and trades are at your own risk, and any loses you may incur are your responsibility. The Daily Hodl does not recommend the buying or selling of any cryptocurrencies or digital assets, nor is The Daily Hodl an investment advisor. Please note that The Daily Hodl participates in affiliate marketing.

Fea­tured Image: Shutterstock/Philipp Tur/Vladimir Sazonov



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