Much has been made about the potential risks of liquid staking.
The work iqlusion has done in the staking module over the last year has been specifically designed to mitigate these risks. This work is covered under ADR-61
During the Three Arrows capital liquidation event, there was a substantial divergence between the price Lido’s staking derivative STETH. Many liquid staking protocols require substantial waits to process withdrawals and final settlement of the underlying stake token collateral. This enables a purely financial event like deleveraging to undermine the strategy tokens and subject liquidity providers to substantial loss.
ADR 061 on the cosmos sdk creates a share token system. Any staked ATOMs can instantly converted into TokenizedShares, the TokenizedsShares can be transferred to counter parties and redeemed into staked ATOM. The intended design of the system is that any liquid staking system that is under economic duress can provide a reasonable path to final settlement. This should cap the downside risks of liquid staking protocol depeg events.
There might be other source of depeg risk from large scale slashing incidents. Those are outside of the scope of the design mitigate and it’s up to liquid staking providers to devise how the manage this risk.
There are liquid staking protocols that could result in validators cartels that could take over governance with little at stake themselves. We are seeing a lot of innovation in how liquid stakers can participate in governance from protocols like Govmos. There is a strong chance that governance will become more active and informed and less power will sit with centralized exchanges as a result of liquid staking. But we do see risk and we designed the exempt delegation system and the exemption factor to mitigate this risk.
Each delegator has the option of exempting their delegation from the share tokenization system. This means that tokens are not part of the liquid staking system at all. These exempt shares behave like delegations before the liquid staking systems. The system keeps track of the total amount of exempt delegation to each validator.
The exemption factor is a chain wide parameter that sets the relationship between outstanding liquid staking shares and the total amount of exempt delegation for each validator. By setting the exemption factor to be a small value between 0.1 and 3.0, the chain creates an incentive for validators who want to participate heavily in liquid staking to increase their exempt delegations by owning more ATOMs for example.
This means that validators need more skin in the game themselves and closely aligned ATOM holders.