What is the role of liquid staking? Can it save Cosmos?

Written by: KODI

Compiled by: Deep Tide TechFlow

THORchain (RUNE) is a lending protocol that allows users to swap assets across blockchain networks. It has just launched a new lending primitive. Here is THORChain's description of it:

New loans create a deflationary effect on the $RUNE asset, while closing loans creates an inflationary effect on $RUNE.

If the value of $RUNE relative to $BTC remains unchanged at the time of loan opening and closing, then $RUNE has no net inflationary effect (the amount of burning and minting is equal, minus swap fees). However, if the collateral asset increases in value relative to $RUNE between the opening and closing of the loan, it will lead to net inflation of the $RUNE supply.

Thus, THORChain's new mechanism simply algorithmically increases and decreases the supply of $RUNE tokens. Remember what happened the last time we had such a mechanism? That's right, our old friend LUNA!

For those who are unaware, Terra is a blockchain project aimed at creating a stablecoin called UST. Through an algorithmic system involving LUNA (Terra's native token), this stablecoin was meant to maintain a 1:1 peg with the US dollar.

It was very successful at first.

After the circulating supply of UST reached $18 billion, it quickly lost its peg, leading to the collapse of the entire Terra ecosystem, which at one point dragged down the broader cryptocurrency market.

The market cap of LUNA plummeted from $40 billion to nearly zero, with Bitcoin and Ethereum prices dropping over 30% each. As for UST, its current trading price is $0.0128.

However, when telling the story of LUNA, one chapter is often overlooked.

LUNA was built on Cosmos, which is an ecosystem composed of different blockchains, all connected to the main Cosmos (ATOM) chain. It was built using the Cosmos SDK and utilized Tendermint as the consensus algorithm, making the entire process very complete. It was also one of the most successful Cosmos chains, far surpassing others.

So it’s no surprise that today the cumulative Total Value Locked (TVL) in the Cosmos ecosystem is as follows:

Guess when the collapse of LUNA happened.

Cosmos projects that relied on or were being built on LUNA fell apart, and many Cosmos projects also depended on UST as their primary stablecoin.

Liquidity in the ecosystem plummeted. Osmosis (OSMO) is one of the leading decentralized exchange projects in Cosmos, and before the collapse of LUNA, its total locked value (TVL) peaked at $1.7 billion in April 2022, but by June 2022, the locked value was only $150 million, a drop of 91%.

In contrast, during the same period, the TVL of Uniswap and Curve only dropped by 30% and 55%, respectively.

So yes, the disaster of LUNA was bad for everyone in the cryptocurrency industry, but it was especially terrible for Cosmos. And it has yet to recover.

In the words of a prominent figure in the Cosmos ecosystem, Zaki Manian:

Cosmos may take up to a year to find a way to create something unique and distinct that differentiates it from Ethereum or other blockchain spaces, making it a coherent independent entity.

So, what can pull Cosmos back from the brink of death?

What Does Liquid Staking Mean for Us?

Here is a chart of the total locked value (TVL) in Ethereum over the past two years, measured in ETH.

If we subtract liquid staking derivatives (LSDs), this is the total locked value (TVL) of Ethereum over the past few years.

There is indeed a significant difference.

Note that the last chart includes LSDfi projects, where you can deposit liquid staking tokens like Lido's stETH. If we exclude these projects, we see a lower total locked value of only 12.5 million ETH.

Thus, it is expected that the total locked value of Ethereum in USD terms declined during the bear market of 2022. However, without the help of liquid staking, Ethereum's total locked value measured in ETH would have also seen a sharp decline in 2023.

Of the total 26 million ETH, liquid staking protocols hold 11 million ETH. This accounts for nearly 42% of the total locked ETH and 10% of the total supply. This is a good performance for an industry that was still in its infancy less than six months ago.

Moreover, liquid staking has brought much-needed vitality and innovation to DeFi.

Currently, about $1 billion is stored in up to 25 LSDfi protocols, which did not exist at the beginning of this year. And more protocols will be launched in the coming months.

If Cosmos wants to survive, this is the liquidity it desperately needs.

A New Hope for Cosmos

The goal of the Cosmos network is to realize the vision of application chains (App Chains): each application is its own PoS blockchain, and they are interconnected.

But the problem is that this means almost all value is locked on-chain to stake its native tokens to secure the network.

In contrast, Ethereum only has ETH staked. This allows a large number of tokens, from DeFi tokens to stablecoins to NFTs, to be freely used within the Ethereum ecosystem.

LSD can unlock this dormant value on Cosmos. By allowing stakers to mint derivative tokens representing their staked assets, liquidity can flow freely again.

And since staking is very core to Cosmos, the adoption of LSD platforms could be very rapid and widespread.

Staking is relatively new for Ethereum; it didn't even enable withdrawal functionality until the Shapella upgrade in April of this year.

In contrast, all Cosmos chains have been PoS from the start.

This leads to a much higher staking ratio on Cosmos chains.

But remember, the liquid staking path on Ethereum is a two-step process: first, ETH is staked, and then a portion of it flows into LSDs.

Cosmos can bypass this initial phase because a large number of tokens have already been staked. The demand for staking is already built-in.

LSDs may even incentivize more users to stake because their tokens no longer need to be locked up. If you can continue to use your tokens throughout the ecosystem, why not earn extra yield?

And these yields are quite substantial. The annualized staking yield for ATOM and OSMO is 19% and 11%, respectively. Ethereum's annualized yield is about 4%, and it is rapidly declining as the number of validators increases.

This massive influx of liquidity can greatly expand the DeFi potential on Cosmos chains. Decentralized exchange projects like Osmosis could see exponential growth in total locked value (TVL) and trading volume. Other areas like lending or stablecoins will also benefit immensely from higher liquidity.

Additionally, Cosmos's cross-chain features are very suitable for LSD products. The Inter-Blockchain Communication (IBC) protocol connecting Cosmos chains can enable new LSD products that allow seamless interaction across multiple networks.

For example, LSD vaults could optimize liquidity mining across networks using IBC. Or through IBC transfers, liquid staking assets could power lending markets and margin trading across the entire ecosystem.

With the existence of IBC, the composability of LSDs on Cosmos chains could quickly surpass the innovations on Ethereum. This could be the secret sauce to unlocking the truly disruptive potential of staking in Cosmos.

I know what you're thinking.

If liquid staking is such a huge opportunity for the Cosmos ecosystem, why hasn't it taken off yet? The main reason is that there hasn't been an efficient and proven liquid staking solution in the ecosystem. But that situation may be changing.

It's not that liquid staking has never been attempted in Cosmos.

The native LSD solution pStake Finance from the Cosmos chain Persistence has been running since February 2022. Quicksilver launched in May 2023. However, their total locked values are approximately $3 million and $2 million, respectively, failing to make a splash.

Now, Stride (STRD) has entered the scene.

Stride is another Cosmos chain that offers liquid staking. But unlike previous projects, it is gaining attention.

Since its launch at the end of 2022, Stride's total locked value (TVL) has rapidly grown to over $30 million, peaking at $30 million in June 2023, after which the adoption rate slowed and the prices of many tokens on Cosmos began to decline. However, its price in native tokens has not decreased.

Its LSD tokens (stATOM and stOSMO) have also gained attention in the DeFi space of Cosmos, with two pools (ATOM/stATOM and OSMO/stOSMO) ranking second and sixth, respectively, in Osmosis's TVL leaderboard.

Indeed, Stride's stATOM/ATOM pool has accumulated a total locked value (TVL) of $16 million, while Quicksilver's qATOM/ATOM pool is only $1 million, and pStake's TVL is even lower at just $500,000.

When comparing the stOSMO and qOSMO pools, the difference is even more pronounced. Stride's stOSMO/OSMO pool has a TVL of $3 million, while Quicksilver's qOSMO/OSMO pool has less than $100,000, which is less than 3% of its Stride counterpart. pStake doesn't even have an OSMO pool, as the only liquid staking token it offers in Cosmos is ATOM.

We are not here to criticize Quicksilver or pStake. But it is clear that with its innovation, Stride has finally shown the potential of LSDs on Cosmos.

Part of the reason is that it is very easy to use. Staking only requires a few clicks, and Stride's interface is very clean and straightforward.

In the crypto space, we often overlook good user experience.

Stride even selects validators for you when staking, so you don't have to go through a cumbersome selection process.

Additionally, Stride recently joined Cosmos's Inter-Chain Security (ICS) to further protect its network. ICS allows validators from provider chains like Cosmos Hub to secure consumer chains like Stride by using ATOM.

Thus, Stride is now using validators from Cosmos Hub instead of its own validators.

The main benefit is a significant increase in the value supporting Stride's security, from approximately $25 million in staked STRD tokens to $1.8 billion protected by ATOM stakers. This makes it much harder for individuals or groups to attack the network. Enabling ICS also further aligns Stride with Cosmos.

The Next Frontier for LSD

I bet that liquid staking, even if it cannot change Cosmos, can at least reignite the flame in users' hearts. This will bring much-needed attention and liquidity to the ecosystem.

The growth of LSDs on Ethereum this year has been astonishing. But due to the way the network is set up, this may only represent a small fraction of the opportunities that LSDs provide. IBC may enable Cosmos to unlock the disruptive potential of LSDs beyond other ecosystems.

We also believe that Stride will become the dominant LSD solution in Cosmos, given its impressive growth and significant use of inter-chain security.

Given the damage caused by the collapse of LUNA, the road ahead remains challenging. But if anyone can help Cosmos achieve a phoenix-like rebirth, it is the Cosmonauts (referring to the users of Cosmos).