NFT Staking and How the Concept of Shared Liquidity Pool Works
The potential for NFTs, or Non-Fungible tokens is immense. From regular digital collectible tokens to utility tokens with embedded value in under five years, the growth and potential for NFTs are immense. Already the blockchain industry is expanding its perception and use of NFTs in ways that are similar and yet different from cryptocurrencies.
One of the ways this is happening is through staking. Concepts like staking and liquidity pools which are already in use with digital assets are being expanded to accommodate NFTs. Although similar, they serve different purposes.
In this article, we’d be looking at these two concepts as they affect NFTs, how they work within the NFT space, and their similarities and differences.
What is NFT Staking?
Most of the definitions of NFT staking can be very confusing to people new to the blockchain industry, so the two definitions in this article are broken down for easy understanding.
The simplest explanation for NFT staking is that it is a method that NFT holders use to earn passive income on their NFTs. While this definition makes it easy to understand, it is too simplistic and excludes important nuances.
NFT staking is a process that involves NFT owners locking up their non-fungible assets on a platform for a period of time as a way to earn rewards. It is very similar to keeping money in a high-yield savings account. The bank uses your money to give loans to other people, and in return, they give you a cut of the interest.
When you stake your NFTs, the platforms use them to secure the network and, in return, offer you rewards. A common misconception of NFT staking is that when a person stakes their NFT, it no longer belongs to them. This is wrong. Staking isn’t the same as selling; it’s more similar to lending. So when you stake your NFT, it still belongs to you even though it won’t show on your wallet.
All in all, NFT staking is a neat way to make some money off your tokens that would otherwise sit unused in your wallet until sold. While it is a great idea, there are some downsides. The most significant is that you have no access to your NFT for its staked duration. If you see a great opportunity or need to use it, you can’t until the time duration elapses.
It is also important to note that not all NFTs can be staked, and the requirements for a stackable NFT depend on the platform in use. The top five NFT staking platforms are:
- Polychain Monsters
How does NFT Staking Work?
NFT staking refers to locking up non-fungible tokens on a platform or protocol in exchange for staking rewards and other benefits. Staking NFTs allows holders to earn an income from their collection while maintaining ownership.
NFT staking works on the same PoS consensus mechanism that digital asset and blockchain use to verify transactions. The nitty-gritty details are slightly different and depend mainly on the platform. Some platforms allow their NFT stakers to vote on proposals, while others simply pay stakers a reward for staking their NFTs and securing the platform.
The differences are typical considering the newness of NFT staking. In a few years, there should be more of a general structure in the way that digital asset staking has. In the meantime, check your platform to see its rules on how to stake your NFTs.
How much money can you earn from staking your NFT?
The rewards gotten from NFT staking vary by platform and by NFT. Although the rewards are different, the factors that affect them are the same regardless of the platform. Three factors affect passive earnings from NFT staking.
- The annual percentage yield (APY)
- The staking duration
- The number of NFTs staked
The annual percentage yield is the rate of ROI due to the NFT holder after staking. A general formula calculates this percentage yield, but there are various factors to consider. One of them is the value of the NFT, which is evaluated based on its rarity. Rarer NFTs have more value and would generate a higher APY. NFTs that already earn royalties are considered very valuable. More extended staking periods and more NFTs staked would also bump your earning potential.
The type of staking reward varies from platform to platform, but most rewards are usually tokens of the platform, which can be swapped for other tokens or sold for fiat currency. If you play your cards well, you can earn a high passive income from staking your NFTs.
Staking is a type of liquidity pool designed to lock tokens in to improve the value of the token and validate transactions.
What is Liquidity Pool?
A liquidity pool is a pool of tokens locked in a smart contract. People who contribute to the liquidity pool are known as liquidity providers, and they are required to add equal values of two tokens to balance the collection. In exchange for contributing to the liquidity of the pool, the transaction fees of the trades that occur in the pool are shared amongst the liquidity providers according to their contribution to the pool.
Without liquidity pools, financial activities like peer-to-peer lending and token trading would be challenging. It also protects against slippage and other downsides of an illiquid market.
An NFT liquidity pool follows the same blueprint explained above. The liquidity providers, LP, contribute two tokens to the pool.
NFT liquidity pools were only ideas a few years ago because of their highly illiquid status. Unlike other tokens, NFT tokens are not easily swapped or sold the way cryptocurrencies are, so they are called non-fungible tokens. Since a liquidity pool is designed to provide liquidity for the platform, NFTs have not previously played much of a role.
Now, an NFT liquidity pool is very close. Platforms like NFTX are working on creating an NFT liquidity pool where members can trade specific NFT types on Uniswap and Balancer.
How Does It Work?
The way liquidity pools work is more straightforward than staking. In a liquidity pool, the liquidity provider identifies a liquidity pool they want to be a part of and supplies the pool with equal value amounts of two tokens. In return for providing liquidity, the liquidity provider(LP) receives tokens in tune with the amount of liquidity they have provided.
Whenever a trade is made within the liquidity pool, the LP gets a percentage proportional to their provided liquidity. If LP 1 supplies $500 worth of ETH and $500 worth of USDC, and LP 2 provides $1000 worth of both tokens, LP 2 gets a higher fraction of the trading fees than LP 1.
The Difference Between NFT Staking and Shared Liquidity Pools
NFT staking and shared liquidity pools are similar in the sense that they both involve crowdsourced funding mechanisms by platform users, who then get rewarded for their participation. The main difference between them is their reward system.
The rewards for both follow different patterns. For NFT staking, rewards are calculated using the annual percentage yield and other factors based on the platform. The rewards could also be daily or weekly. On shared liquidity pools, the rewards are from the transaction fees in the pool, and they are distributed according to the LP’s contribution to the pool.
Other minor differences can be found in the way they work and the purpose of the tokens being crowdsourced. For NFT staking, the tokens are used to secure the platform by improving liquidity for the running of the platform. In liquidity, the tokens assembled are used to enhance peer-to-peer lending, borrowing, and trading.
To stabilize the pool, shared liquidity pools work with the automated market maker (AMM) and smart contracts while staking uses the proof-of-stake consensus mechanism.
Regardless of their differences and similarities, both NFT staking and shared liquidity pools are essential to the growth of the protocol. They facilitate activities within the protocol and help it stay liquid. Both are also very beneficial to the liquidity providers, allowing them to earn a passive income. For now, these two concepts are still infantile within the NFT industry but there are high hopes that they would be able to significantly impact decentralized finance.