Superfluid staking is a concept created by Osmosis that allows OSMO tokens contributed to the DEX liquidity pools to be reused to continue making profits through staking.
In other words, instead of letting the funds remain locked up, superfluid staking unlocks the utility of OSMO in different pools in order to leverage them and generate additional return to the LPs (liquidity providers).
Omosis, a revolutionary DEX
In a DEX, you must choose a pair of two assets and specify the amount you are willing to block in a 50-50 ratio. You can either choose a pair from an existing pool or create a new pool. Thus you will be providing liquidity, which means that you are helping to ensure that transactions have minimal impact on the price of the pairs. Users who do this are known as Liquidity Providers (LP), and in exchange for locking these assets, they are automatically incentivised.
Not so long ago, token holders could only earn returns by staking or contributing them as liquidity. There was no other way to make money except from the blockchain itself. As a result, two great solutions to this problem emerged: liquid staking and superfluid staking.
Liquid staking is a mechanism whereby synthetic tokens are received and can be reused in different liquidity pools with the intention of increasing returns to LPs. However, this solution encourages liquidity fragmentation, which makes it difficult to trade these assets.
Also, Osmosis created the superfluid staking, an innovative solution that was initially released for the liquidity providers of pool #1 ATOM/OSMO, and is now open to more pools, such as OSMO/CMDX or OSMO/AKT, and will soon be applied to more pools in the ecosystem.
How superfluid staking works in Osmosis
Let's see how to do this using pool #1 as an example. To participate in the superfluid staking, you will need to add liquidity to the DEX by going to "Add / Remove Liquidity". You will have to add the same amount of ATOM and OSMO in the pool #1 ATOM/OSMO of the Osmosis DEX.
Note that the amount allocated to superfluid staking is 50% of the OSMO tokens you have contributed to the pool. For example, if you contribute $100 in total, split into $50 OSMO and $50 ATOM, half of your OSMO tokens would be dedicated to superfluid staking. For example, $25 would be delegated to a validator to generate additional rewards.
Once you have provided liquidity to the ATOM/OSMO pool, you will need to click on "Start earning" and choose the 14 day bonding period to be able to access superfluid staking. It was set to 14 days to coincide with the bonding period applied in OSMO staking. On the other hand, since the second main function of superfluid staking after providing liquidity is to provide network security through staking, you will need to choose a trusted validator to delegate your OSMOs to.
If you have participated in this pool before, you will have to withdraw the liquidity and add it again by selecting the 14-day bonding period with the superfluid staking option enabled.
Where will I receive the rewards from superfluid staking?
If you have finally linked your tokens to superfluid staking, you will receive the rewards directly in your wallet, thus avoiding having to claim them as with traditional staking.
Benefits of superfluid staking
Superfluid staking brings major benefits to the ecosystem:
Through superfluid staking, users support the PoS mechanism of the Osmosis blockchain while adding liquidity to their DEX.
Liquidity providers get higher returns. The 50% of the OSMO tokens added to the ATOM/OSMO pair are reused for staking. This way, they get two types of rewards simultaneously.
As it is a strong incentive for LPs, it helps to increase the LTV of the Osmosis DEX.
Risks of Superfluid Staking
Not only do we run the risk of slashing with superfluid staking, but we also run the risk of the Impermanent Loss.
Slashing can be prevented by delegating to a trusted validator. In the event that a validator is affected by slashing, the assets are allocated to the community Osmosis fund.
Impermanent loss, on the other hand, is a term you may be familiar with if you come from DeFi. When you deposit a pair of assets into the liquidity pool at a certain price, over time this price may depreciate and become worth less in dollar terms. This is known as an "impermanent" loss because you are not considered to have lost until you finally withdraw the assets by agreeing to take them out at their current value.
In short, superfluid staking represents a paradigm shift in the way staking has been applied up to now, by allowing part of the liquidity provided to AMMs to be used for staking and produce higher returns.