The Impact of Liquid Staked Derivatives on Token Price and Liquidity

In decentralized finance (DeFi), liquid staked derivatives (LSDs) have become a key innovation, enabling users to unlock liquidity from staked assets while still participating in staking rewards. LSDs allow holders of staked tokens to trade or use derivatives of their staked assets, making these otherwise locked tokens available in the market. While this boosts liquidity, the introduction of LSDs often causes a decline in the price of the underlying token—a phenomenon that can persist in the long term if demand fails to keep pace with the increasing supply. This dynamic can be explained through logical and mathematical reasoning, centering on the interaction between supply, demand, and liquidity. Increased Liquidity The primary benefit of introducing a liquid staked derivative is the increased liquidity of the underlying token. Liquidity, in this context, refers to the ability to easily buy or sell an asset without significantly affecting its price. LSDs facilitate liquidity by transforming staked tokens, which are typically locked and illiquid, into tradable derivatives that represent these staked positions. For instance, in the Cosmos Hub ecosystem, ATOM holders who stake…

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While it’s true that the introduction of Liquid Staked Derivatives (LSDs) can boost liquidity, the assumption that this automatically leads to a long-term decline in the price of the underlying token lacks substantiation. We believe the misconception may stem from not accounting for how inflation adjusts based on the ratio of staked tokens. When the share of liquid staked tokens increases, the economic impact depends on where the funds for liquid staking come from. If users are staking funds that are already part of existing staked tokens, then your assumption holds some merit—liquidity would indeed increase. However, it’s important to note that this view is fundamentally flawed. Real liquidity is only achieved when an LST is sold to obtain liquid ATOM, which, by definition, requires locking liquid ATOM in a liquidity pool. This process ultimately reduces the circulating supply. The more significant misconception likely arises from the fact that many liquid staking transactions are funded by liquid ATOM (this is something we’d appreciate seeing in an on-chain analysis from a protocol like @Stride ). In such cases, liquidity remains relatively unchanged, as the liquid supply is…

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Thank you for your thoughtful response. I appreciate the insights and would like to clarify and expand upon a few points, particularly regarding inflation, liquidity, and the effects of Liquid Staked Derivatives (LSDs). On Inflation and the Bonding Goal: You rightly mention that inflation adjusts based on the staking ratio, but I’d like to delve deeper into this. If the liquid tokens being staked via LSDs exceed the amount of staked tokens entering liquidity via the Liquid Staked Module (LSM), then inflation will reduce as we approach Cosmos’ bonding goal of 67%. However, this reduction will halt once we reach that goal, as the inflation rate bottoms out at the current minimum of 7%. For a continuous effect on inflation reduction, one would need to adjust the minimum commission rate . Without this, the inflation percentage won’t change once the 67% bonding target is met. So while LSDs can positively impact inflation until the staking ratio goal is met, the parameters in place currently suggest that the impact on inflation will stagnate after this threshold. On Liquidity and Locked Liquidity: I do agree with your point about liquidity dynamics, but I’d like to…

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waqarmmirza: This nuance is important because it highlights that LSDs can increase liquidity without necessarily “locking away” tokens in the same way traditional staking does. This is precisely where your perspective should be reconsidered. An LST only becomes liquid if a counterparty is available to provide liquid ATOM. Without this, the LST functions similarly to a staked token. “Liquid” staking occurs only when someone on the opposite side of the transaction provides the ATOM that the user purchases in exchange for the LST they wish to liquidate. In most cases, a market maker serves as the counterparty, applying a spread and charging a fee for the trade. Typically, the market maker will redeem the LST they acquired for the ATOM they sold to the user and then wait for the 21-day unbonding period before replenishing the DEX pool. Throughout this process, they earn a profit. Understanding this mechanism highlights that the liquidity of LSTs is directly tied to the market depth of available ATOM in the pool. While concentrated liquidity can reduce the spread, it doesn’t fundamentally increase the pool’s depth. This is why your argument is only partially correct and…

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Govmos:

Therefore, liquid staking could be a highly effective strategy to reduce token inflation by shifting a large portion of the liquid supply into liquid staked form.

waqarmmirza:

while LSDs benefit market liquidity, token holders and investors should be mindful of the potential long-term price effects stemming from the introduction of these derivatives.

In addition to price, it is imperative to note that liquid staking providers gain that much more leverage in governance, via voting power, in the respective token. This could inherently lead to a steady governance takeover, which honestly seems to be happening already, in the case of ATOM.

Though LST’s can meaningfully serve as being part of the inflation solution, if the software of a specific protocol experiences bugs, the native asset is bound to unnecessary risk via the respective LST provider. Therefore, limiting liquid staking on the Hub is crucial.

I don’t mean to stray too far from the initial discussion at hand, but fully in favor of lowering the mimimum bound of 7%.

I agree with this post. All else being the same, introduction of liquid staking would reduce the price of a token just based on the increase in the supply of available tokens for sale. That’s why I was warning people that the introduction of Drop was not bullish for ATOM. Not every product that comes on market that is associated with ATOM is bullish. When you increase the supply of tokens, that is not bullish. Hydro - which will make more of the ATOM locked in the community treasury available for trading on exchanges - is also bearish for the ATOM price, all else being the same. To have higher $$ prices for ATOM, you need more $$ to enter the space and acquire ATOM, not make available more ATOM for the same $$. The only reason for the higher prices of Cosmos assets in the 2020-2021 period was the presence of UST (Terra USD) which was giving higher prices because it was a fake USD. One other, very underappreciated aspect of liquid staking, was that - for retail investors, it makes holding ATOM insecure. Whereas previously you could be sure your ATOM is locked for 21 days, now anyone can come in and steal your ATOM by liquid staking it and then dumping it on the market. Before…

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LSM vs. Stride and Liquidity I still hold that the Liquid Staked Module (LSM) has made more ATOM liquid than Stride has locked into liquid staked ATOM (stATOM). This is a key part of my hypothesis, which fundamentally differs from the assumption that liquid staking has been the dominant factor in reducing circulating supply. To truly assess whether LSM or Stride is making a larger impact, we need to look directly at chain data and compare the amounts of ATOM that have become liquid through LSM versus those staked via Stride. I suggest that rather than introducing more complexity into the discussion, we first simplify the hypothesis and validate it using on-chain data . By examining the movement of tokens between liquid and staked forms over time, we can better understand whether the LSM has, in fact, released more liquid ATOM into circulation than has been locked into staking. This would give us a clearer picture before adding more variables or assumptions. Liquidity of stATOM: Is a Counterparty Truly Needed? You’ve raised an interesting point that stATOM (liquid staked ATOM) is only liquid when there is a counterparty with ATOM available for trade. While this might be…

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I support setting the minimum inflation to 0%, as it would simplify our approach. I also acknowledge Stride’s governance bond and recognize that while Stride doesn’t vote directly, it indeed has an influence on the validators it stakes with. It would be beneficial if Stride could enable governance rights to be passed to stATOM holders, promoting a more decentralized governance model.

waqarmmirza: By examining the movement of tokens between liquid and staked forms over time, we can better understand whether the LSM has, in fact, released more liquid ATOM into circulation than has been locked into staking. Although I haven’t analysed how much (in terms of ATOM value) has been extracted using the LSM, I have found a snapshot of Cosmos Hub 2 months ago (19 July), and I could extract the below information, hoping it can help for a start. What I take from it is that there has been around 2 million more liquid staked ATOM during this period, with 600k leaving Stride, and Drop being the winner (+2.6 million). Also, a bit part of the unstaking was due to the large wallets who unstaked ~1 month ago (around 12 million ATOM if I recall correctly). So except for these wallets, in general, there has been more staking (liquid and solid). Based on the above information, how many ATOM do you think the LSM would have needed to release into circulation during these 2 months, for your hypothesis to be valid? If there is a request to investigate deeper, I am happy to look at extracting the number of staked ATOMs that had been liquefied using the LSM over this…

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waqarmmirza:

As we move forward, I think it’s critical to first test the hypothesis with a simplified approach, using chain data to determine whether LSM has indeed made more ATOM liquid than Stride has staked via LSD

We are 100% aligned with that proposition. However we suggest waiting until the combined LSTs market share represents a bare minimum 5% of the overall staking before collecting and analyzing the datasets.

Although this data is concerning itself that the bonded % is in a downtrend. But for the above hypothesis to check we need LSM from point A to B that we already have in this data, then we need Liquid Atom that got staked via Liquid stake providers that we don’t have in this image. (dAtom is a outlier) Excluding the dAtom (which won’t be appropriate) the hypothesis is true that we have 11.7K Atom got liquid using the LSM but instead of increasing the liquid staked by at least 11.7K ATOM we can see further unbonding.

Sorry, maybe I was not clear on one point of the data I submitted:
The 11.7k delta in the LSM row is not 11.7k ATOM that has been liquefied through the LSM, it is only the number of times that the LSM “liquefy feature” has been used.
I do not have data (at this time) of how many ATOMs were liquefied through the period.

Regards,
arlai

Thank you for the clarification. Can you help find out the required data?