After Ethereum switched to proof of stake, ETH holders could stake their coins to help the network produce blocks and earn rewards. The problem is that staked ETH is locked up in a validator, so you can't access it when you need it. Liquid staking emerged to solve this dilemma.
$LDO is the governance token of the liquid staking protocol Lido. Current price: 0.4118 (24h +5.37%).
Why does staking lock up funds:
Running a validator independently on Ethereum requires staking at least 32 ETH and keeping the node reliably online. While staked, this ETH cannot be transferred at will; before the Shanghai upgrade (Shapella) in April 2023, staked ETH could not be withdrawn at all.
After the upgrade, you can apply to exit and withdraw, but you have to queue according to the protocol rules. When many validators are waiting to exit, the wait can be longer. For people who need to move their funds at any time, this is still rather inconvenient.
How do LSTs solve this problem?
Liquid staking protocols pool ETH from many users and delegate it to node operators for staking. In return, they issue users tokens representing their staked shares, known as liquid staking tokens (LSTs), such as Lido’s stETH and Binance’s WBETH.
These tokens can be transferred and traded, and can also be used as collateral in DeFi protocols. Holders can earn staking rewards while still using the asset—that’s what “liquidity” means here.
How are rewards reflected?
LSTs commonly use one of two accounting methods. Lido’s stETH uses a rebase mechanism: the amount you hold is automatically adjusted each day based on staking rewards, so the rewards show up as an increase in your balance.
The other method keeps the token amount unchanged while its exchange rate rises. wstETH and Binance’s WBETH both work this way: the rewards are reflected in each token representing an increasing amount of ETH. Some DeFi protocols aren’t compatible with tokens whose balances change automatically, so this wrapped form is more commonly used in DeFi.
What are the risks?
Liquid staking comes with layers of risk: the protocol’s smart contracts may have vulnerabilities, node operator errors can lead to penalties (slashing), and an LST’s price on the secondary market may fall below the value of the ETH it represents. During the sharp market downturn in 2022, stETH traded at a notable discount on the secondary market.
If you also use your LST as collateral to borrow and keep leveraging, a discount could trigger liquidation. It may seem like you’re simply giving staked ETH another use, but in reality, you’re taking on several additional layers of risk.
My take:
Liquid staking makes staked ETH liquid again, at the cost of adding another protocol layer and a market price that may diverge from ETH’s. Before using it, make sure you understand the accounting method and redemption process. When I was new to crypto, I thought knowing how to read candlestick charts was enough. Later, I realized that the fundamentals come first. Learn the rules before you act—don’t make decisions based on gut feeling.
Have you ever misunderstood this too?