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 effectively transferred to staked tokens. This increases the bonding ratio, and if it surpasses the bonding ratio parameter (currently set at 67%), inflation decreases.
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. This creates a dual effect, as previously mentioned: not only does it increase the demand for liquidity in LST/ATOM pairs on decentralized exchanges (DEXs), but it also provides seamless on-and-off ramps for Liquid Staked Tokens (LSTs).
We are currently working on a structural reform of the inflation formula to account for the ratio of liquid staking tokens. We will soon present it to the community, right here in this forum.
If adopted this would further reduce inflation if the demand for liquid staking is raising.
While we wait to present this proposition, we hope this brief answer to your post helps you see the complex picture with a bit more clarity. There’s a lot more to discuss on the matter of inflation and liquid staking. We hope to see a general debate on the matter and your contribution with this post shows you have some valuable knowledge to bring to this table. We can’t wait to have you participate.
Thank you for reading,
Govmos.
