Liquid Staking: What It Is and How It Works

With liquid staking, you deposit your tokens with a provider who spreads them across proof-of-stake validators. In exchange, you get liquid staking tokens (LSTs) that show your share of the pooled stake. These tokens earn staking rewards and can also be used in other DeFi activities.

• To get your original assets back, you return your LSTs to the provider, who then releases your share of the stake.

• Each platform has its own redemption rules, and some may require you to wait a set period before you can access your funds.

A standard staking definition involves locking tokens to secure the chain. Liquid staking adds an extra mechanism: you still delegate your coins, but the system mints a receipt token in return. This second token is yours to trade, lend, or deposit in liquidity pools.

As a result, you don’t have to abandon yield from staking or relinquish the chance to use your funds across various DeFi applications.

• Some people like this approach because it preserves the chain’s security while avoiding the inconvenience of long unbonding periods.

• The minted token typically mirrors the growth of the underlying stake, though it can deviate based on market trends.

The comparison table below lays out the differences.

• Yes. You can still collect staking payouts from the underlying PoS network, and you might generate further returns by lending out or using your liquid staking tokens (LSTs).

• That said, your outcome depends on broader market movements and the reliability of whichever protocol you choose. Any gains could be undermined if a derivative token’s price declines or a validator faces slashing.

• The potential for multi-layered yields attracts many crypto enthusiasts, but it demands careful planning and awareness of each platform’s details.

• Maintain liquidity: Liquid staking gives you an LST that can often be transferred or used elsewhere while your underlying crypto remains staked.

• Earn staking rewards: Your underlying assets can continue generating proof-of-stake rewards while you hold the corresponding LST.

• Use assets in DeFi: Depending on the token and protocol, you may be able to lend, trade, or provide liquidity with your LST.

• Lower barriers to entry: Liquid staking services allow users to participate without running their own validator or meeting a network’s solo-validator minimum.

• Improve capital efficiency: An LST can earn additional DeFi returns while the underlying position continues to generate staking rewards.

• Smart contract risk: A bug or exploit in the liquid staking protocol could put deposited assets at risk.

• LST price risk: A liquid staking token can trade above or below the value of the underlying asset, particularly during periods of market stress or low liquidity.

• Slashing risk: Depending on the network and protocol, validator penalties can reduce the value of the underlying staked position.

• Liquidity risk:

  You may not always be able to sell or redeem an LST quickly at the price you expect.

• Protocol and platform risk: Users depend on the staking provider’s infrastructure, security, governance, and redemption process.

• Added DeFi risk: Lending, trading, or depositing an LST into another protocol introduces additional smart-contract and counterparty exposure.

• Tax complexity: Receiving rewards and later trading, redeeming, or otherwise disposing of an LST can create additional recordkeeping and tax questions.

When you stake coins through these platforms, you receive tokens that track your deposit. Examples include stETH from Lido or rETH from Rocket Pool. Each derivative is, in principle, pegged to the underlying currency, but daily market factors can push its trading price up or down.

People often treat these tokens much like other DeFi assets. They might trade them, lend them out, or combine them with further yield strategies. Some tokens pay out in a rebase-like format, while others rely on an exchange rate. Make sure you check how your chosen token handles reward distribution.

Various providers cater to different blockchains:

• Lido: Ethereum-focused liquid staking protocol that issues stETH and wstETH. Its wrapped token can also be used across a number of supported networks and DeFi applications.

• Rocket Pool: Ethereum liquid staking protocol that lets users stake ETH and receive rETH, which represents their staked position and accrued rewards.

• Coinbase: Offers cbETH, a liquid token representing ETH staked through Coinbase. cbETH can be transferred or traded, while redemption to ETH may require processing time.

• Binance: Offers WBETH, a liquid staking token representing staked ETH plus accumulated staking rewards. WBETH can be transferred and used in supported DeFi applications.

Compare fees, reward rates, redemption rules, supported networks, liquidity, and smart contract risk before choosing a liquid staking provider.

Yes. Liquid staking can create taxable events for US taxpayers. Staking rewards are generally ordinary income when you gain dominion and control over them, based on their fair market value at that time. Selling, swapping, or spending those rewards can later create a capital gain or loss.

Liquid staking tokens add another layer. Exchanging crypto for an LST, trading the LST, or redeeming it can create additional tax questions depending on how the transaction is structured. Keep records of the original deposit, LST received, rewards, redemptions, and any later disposals.

Pro tip
Prepare to report liquid staking for tax season and create a strategy for all your staking activity using our expert guide to crypto staking taxes.