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Liquid staking reached prominence when Ethereum did not allow for the stakes to be withdrawn but even in the post-Merge world, it is still a hot topic. What started as a temporary solution became a versatile instrument in digital finance and a shining example of the potential of DeFi.
In this guide we will introduce you to this concept, explain its benefits and pitfalls, and list some popular examples of supported blockchains and DeFi products.
What is Liquid Staking?
Let’s break down the definition to get to the meaning at its core. In finance, ‘liquid’ as an adjective and ‘liquidity’ as a noun describing a quality refer to the ability to be obtained or filled (when talking about an order) without significant difficulties. In turn, staking in crypto is a process and result of committing a sum to the protocol to help secure and maintain it for staking rewards in return.
Therefore, liquid staking is the kind of staking that would let you keep using the staked funds while keeping the rewards. The ‘using’ part is what differentiates it from traditional staking, especially in protocols that lock up the user’s stake.
From a security standpoint, this limitation is necessary to maintain stability in the total value locked in a protocol. In other words, to prevent sudden and drastic changes in the network’s securing mechanism. Staking isn’t inherently financial and benefits from illiquidity. Some proof-of-stake networks are not so restrictive but still impose a delay on a stake withdrawal (unstaking).
However, from the user’s perspective, lock-ups and illiquidity can be a nuisance, to say the least. Financially-oriented users especially would like to keep their investment liquid, not only so that they can avail of decentralized finance (DeFi) but also for cases when they need to take profits, rebalance or spread the risks and act quickly.
Liquid staking solves the problem of lock-ups, be they caused by the stake locking or unstaking delay. By using third-party protocols for liquid staking though, users can solve these problems and gain double the benefit of using the same funds.
Considering the processes involved, liquid staking requires some prior knowledge of crypto and DeFi. Of course, newcomers to crypto are free to give it a try, and the interfaces are generally not too hard to parse. The hard part comes after you receive the liquid staking tokens — how to earn and not lose.
Liquid Staking vs Staking
There is an obvious difference between the terms but what exactly does it imply? To give you the idea, staking is a long-term strategy, while DeFi protocols where you can use the “staked” tokens more often than not bring profit in the short term. Liquid staking lets you enjoy the best of both worlds at the cost of some extra effort.
And for good measure, let’s highlight even more key differences between the two modes of staking:
| Point of comparison | Regular Staking | Liquid Staking |
| Lets you use your crypto? | Not always | Yes |
| Secure? | Protocol-level security | Depends on the components |
| Costs? | Deposit and withdrawal incur gas fees | Gas fees on each smart contract interaction plus provider commission |
| Returns? | Protocol-level baseline staking reward | Baseline staking reward plus any returns (or losses) on actions made with these tokens |
As already briefly mentioned, instead of outright locking your stake, some arrangements delay the stake’s withdrawal to make the shift in the network-securing stake a bit smoother. Some blockchains use both, some only opt for one of the limitations but they all create difficulties for the end users the same. So, to circumvent this inconvenience entirely, you can go for liquid staking.
Some of the important points to remember before opting to do it:
- Your assets will be contributed to the staking pool run by the protocol. As a result, due diligence on the provider is strongly advised;
- Not all proof-of-stake blockchains turn your stake into locked assets (i.e. Cardano);
- Token transfers and delegation transactions incur gas fees. As a result, liquid staking ends up a little less economical, not to mention the provider fees they impose on your rewards.
The tradeoff here is that you entrust a service provider to do staking on your behalf and rely on them to keep the rewards coming. In return, you get more flexibility in terms of the stake size, duration, and most importantly, the way you will use your crypto tokens. But more about that later.
How Liquid Staking Works
Now that we have got the terms out of the way, it’s time to review the process to further grasp how this kind of crypto tokens works and what are its use cases. Before diving deep into what makes these protocols click, let’s have a basic overview of the process you are going to deal with when you avail of a liquid staking protocol.
Step 1: Asset Deposit
Starting with these applications is as easy as connecting a wallet and depositing your stake. One of the appealing qualities here is that liquid staking protocols often have more lax requirements than the underlying networks. For example, Ethereum liquid staking is still popular because it is the only way to stake less than 32 ETH required to run a validator.
Step 2: Protocol Staking
This happens behind the curtains from the user’s point of view: the protocol takes your stake and distributes it across several validators in the blockchain network. Using a single validator would expose every user of the liquid staking protocol to the risk of slashing should it go offline or lag behind.
Step 3: Token Minting
This step is what the users come there for! In exchange for your stake deposit, the protocol mints so-called liquid staking tokens (also abbreviated as LSTs) and sends them to your wallet. Essentially, they are a claim to your share of the stake accumulated by the provider but the best part is that these tokens accumulate rewards too. Another thing worth knowing right out the gate is that each liquid staking protocol uses their own LST: one of the most popular ones, Lido, mints stETH in exchange for your ETH but there are also rETH, aETH, etc. They are not interchangeable.
Step 4: Reward Accumulation
Whether you choose to have your LSTs sit idly or put them through the DeFi wringer, they will keep accumulating staking rewards! Either your token balance or the redemption rate (the amount you will get when you withdraw the stake) increases over time.
Key Components of Liquid Staking
There are quite a few technologies that make this whole deal happen, from various smart contracts which secure, track and distribute the spoils to other decentralized finance (DeFi) protocols that imbue these tokens with value and usability of their own.
The key features of liquid staking rely on tokenization, the creation of blockchain-based tokens that represent something, in this case ownership of the staked assets. They also remain fully transferable and usable in DeFi applications. At the start, you will receive liquid tokens that 1:1 represent your initial stake but as time goes on, the ratio will grow. When the quantity of tokens grows, it is called a rebasing model, and when the rate at which you can redeem the initial stake shifts to your favor, that is an appreciation model.
Tokenization is not possible without smart contracts but so are the rest of the liquid staking protocols’ features. In other words, the role of a smart contract in a liquid staking protocol is to make all its components come together and work, no less. Accepting your stake deposit and distributing it between validators? There’s a smart contract for that. Minting/burning and keeping track of LSTs? That’s a job for a smart contract. Calculate and distribute the rewards? You guessed it.
In a more general sense, liquid staking protocols can be thought of as multi-layer structures. There is an infrastructure layer, where staking itself is handled; the tokenization layer, which distributes the LSTs; and the utility layer, which transforms liquid staking tokens from simple receipts into productive financial instruments.
How To Use Liquid Staking Tokens?
What kinds of opportunities the liquid staking protocols unlock? You are already earning daily staking rewards but there are a few options in DeFi to boost it even further:
- Provide liquidity for a DEX. This will let you earn a share of trading fees for the pair;
- Trade liquid tokens for other assets on a DEX. Even the underlying assets are fair game;
- Lend them in a lending protocol or use as collateral for borrowing;
- Leverage your stake by swapping liquidity tokens for the original ones and staking them again.
Be mindful of the risks these strategies have: a bad leveraged trade of loaned funds can lead to a liquidation, for instance. What else would justify applying risk management when using liquid staking tokens?
On top of liquidation, the protocol’s integrity is also something to keep in mind: have a contingency plan for the locked funds and connected wallets even if you spread your risks and use only audited protocols. Follow the news in the project’s communities (on X (Twitter), Discord, Telegram etc.), as well as the crypto-related news in general. The sooner you are able to react to complications like hacks, regulatory developments or market-wide crashes, the better!
It might be a good idea to start small. Get to know the strategies better and once more confident and prepared, godspeed! But hopefully, after you finish reading our guide.
The Benefits of Liquid Staking
The comparison above showed some upsides to going for liquid staking over the regular, but let’s recount them once again. Here is what you get to enjoy:
- Get to use your funds right away;
- Conversely, receive your stake immediately upon withdrawal;
- Trade, lend, farm — do whatever to participate in DeFi with the freshly received liquid tokens;
- Extra options: earn or bear interest on the stake equivalent, compound etc.
In addition, liquid staking has a positive effect on the DeFi ecosystem:
- Improves the capital efficiency of the underlying cryptocurrency;
- Enhances liquidity sources for financial applications;
- Healthy for network security for incentivizing staking;
- Makes staking more accessible thanks to lowering some thresholds imposed by the protocol.
Risks Involved in Liquid Staking
So far, everything sounds great, doesn’t it? But if you suspect it sounds a little too good to be true, you are right. Naturally, there are potential risks inherent to staking and DeFi to consider before engaging in liquid staking, with its own risks on top.
Before going into detail about which risks would concern you as a user, liquid staking has a problematic aspect to it that we have mentioned in passing: if it is so convenient, does it not mean that more users would stake with these pools instead of becoming validators themselves? To address centralization risks, most protocols operate pools of validators but they can still end up controlling a good chunk of value securing the network. Most proof-of-stake networks give those contributing to the network’s security as validators a say in how it develops or how it works in practice. Counterparty risk is something that affects both you and the blockchain ecosystem as a whole: you have to put trust into the provider to manage your stake as agreed but also not to use your stake to compromise the network’s integrity.
Ironically, when liquid staking, you still need to consider liquidity. ETH is more or less ubiquitous in crypto but do you know how to use stETH or aETHb? Even when you do, swapping and cashing out might be a problem when there is high demand. It has happened before: when Celsius became insolvent, the stETH pools on Curve Finance were empty, preventing users from…doing anything, really.
Due to the role of smart contracts in the whole setup, vulnerability and exploit risks compound. Using battle-tested and regularly audited protocols can only mitigate these risks but not erase them completely. Still, it is miles better than using dubious platforms, so due diligence is really your best bet here.
So far, we have been talking about how you can earn with the same funds. Bear in mind that you can lose funds as well. Be it an unreliable pool provider that gets your stake slashed, a bad trade with the liquidity token, or simply volatility and depreciation of the crypto market, this method is not guaranteed to bring you profits.
Even if you do nothing but the value of your staked asset goes below the starting point, you can experience impermanent loss. It can very realistically get to a point where your accrued reward would not be enough to compensate for the drop in market value.
This is because the crypto market is not a stranger to volatility. Some protocols do not provide immediate unbonding that would let you react to a market storm. Get the full idea of terms and conditions of the platform of your choice well before you start.
Liquid Staking Protocols
Lido
Ethereum’s Beacon Chain is notorious for its strict requirements for running a validator: a minimum of 32 ETH, which is approaching $77,500 at the time of writing. Almost as soon as the Beacon Chain became the validation layer, Lido DAO started offering its liquid staking solution: deposit any amount of funds into a pool (you have the choice) and receive the stETH derivatives that represent your staked ETH immediately. These stETH are pegged to ETH in a 1:1 ratio and can be withdrawn at any time.
Lido is not limited to Ethereum, working on Polygon and offering Solana, Moonbeam, and Moonriver derivatives as well. Across all these networks, Lido has verified 54 node operators. Note that there is a reward fee collected by Lido DAO — 10%.
Binance-staked ETH
In hindsight, a DeFi product like this seems like a no-brainer: the Binance exchange has built their way to the top with an incredibly wide array of features, including staking. Why not throw an LST into the mix to bring more users to stake with them? By now, this protocol has amassed over $6B in total value locked.
The wrapped Beacon Ether (WBETH) users receive in exchange for staking through Binance can be traded on and off the exchange. It is both on Ethereum and BNB Smart Chain, giving users the choice of which ecosystem to apply their tokens in. WBETH (Binance) uses an appreciation model, raising the redemption ratio daily.
Jito
The popularity of liquid staking protocols on Ethereum is easily explained but why are they popular on Solana, too? There is no minimum requirement to stake SOL and you can keep using the coins as usual. One answer is the warm-up and cool-down periods, effectively reducing the time you stake by around 5 days. Another reason lies in the key features of protocols like Jito.
They introduce their platform as a set of solutions that make the most out of so-called MEV (in this case, Maximal Extractable Value). Without going too deep into technicalities, it refers to transaction reordering within a block or batch that increases validators’ revenue from each block. In other words, using MEV on top of the protocol-native staking rewards, Jito’s liquid staking offering promises increased returns compared to just staking Solana. Thanks to this, it is the LST with the most value locked on this chain today.
Rocket Pool
Another classic by now liquid staking platform on Ethereum is Rocket Pool. They advertise it by claiming it is a fully decentralized protocol and more interestingly, they take no fees from rewards whatsoever.
Their model gives a very simple answer to how it achieves this. Instead of requiring 32 ETH minimum per validator, they let you start staking with a node for 16 ETH and match the rest with ETH taken from the pool. Contributing to this pool (staking without a node) requires as little as 0.01 ETH. Everyone accrues rewards in proportion to their deposits, as on the Ethereum network itself. The major upsides to doing this over native staking are lower entry thresholds and no need to bother with infrastructure and hardware.
StakeWise
Last but not least, let’s highlight another established Ethereum liquid staking protocol. Its value proposition is simple and elegant: stake ETH on your terms and use your stake in DeFi. What makes it different is a focus on speed: staking and unstaking takes seconds, and staking rewards are accrued with osETH (or osGNO on Gnosis) every second as well. In the DeFi space, where complex financial transactions occur in the blink of an eye, this is a major edge over competitors.
Ankr Staking
Ankr’s general mission is to build a web3 infrastructure network but its products each serve its own purpose. Ankr Staking is a suite of DeFi products, which includes liquid staking among other things. Ankr Staking supports Ethereum, Avalanche, Fantom, Polygon, Polkadot, Kusama, and BNB Chain. To start using it, head to the Staking app main page, connect your wallet, choose an asset, the amount of it, and then the liquid derivative. Ankr will provide you with two options: reward earning (its amount grows) or bearing (redemption rate grows).
Frax Finance
Frax Finance is a fractional-algorithmic stablecoin protocol. Its flagship product is the FRAX stablecoin but it has a wrapped version of ETH, too. According to the documentation, frxETH is a stablecoin loosely pegged to ETH, with the target 1:1 ratio. frxETH can be deposited to the vault in exchange for sfrxETH, another token that accrues vault yield. Both frxETH and sfrxETH can be used in the Frax ecosystem: for instance, Fraxswap or Fraxlend.
How to Get Started with Liquid Staking
Okay, now that you know how it all works, let’s equip you with a recap that can be turned into a handy guide that covers all the bases, from prep to ongoing management.
Step 1: Choose Your Staking Protocol
The protocols we reviewed are just the tip of the iceberg, so before you start liquid staking, you have to know where. It is a good idea to not only choose by supported chains and assets but also to take some time to review the track record of any liquid staking protocol, with its security audits and incident history. Window-shop on resources like Staking Rewards to compare APY as well as fee structures. Finally, get to know the LST before you’re stuck with it: decide between rebasing (like stETH) and appreciation tokens, review how well they are supported in their respective DeFi ecosystems.
Step 2: Set Up Your Wallet and Assets
It should go without saying but we’ll say it anyway. Make sure you are using compatible wallets and have enough native cryptocurrency to meet the requirements. Do not forget to include gas fees into the calculations: you won’t probably notice them if you are depositing Solana but on Ethereum, those fees quickly add up.
Step 3: Carry Out the Staking Process
The liquid staking providers won’t hold your hand too much but they usually do not make it counterintuitive. Go with the flow but remember a few things. Do not connect your wallet on fishy or any websites other than the official one. It’s best to not go all in and keep diversification in mind, along with extra expenses like smart contract call gas fees. The transaction can take a few seconds or minutes to be confirmed, so try to stay patient. Once it’s done and you receive the LSTs, check once more that it’s the right amount.
Step 4: Manage Your Liquid Staking Position
By that moment, you should have done all the needed steps to use a liquid staking service. But your involvement doesn’t stop there—let us suggest a few risk management best practices to follow.
Any stake, even a delegated one, requires monitoring: check in regularly to see how your validator is performing and how the protocol is doing. You can also keep a hand on the pulse by subscribing to the official social media channels and announcements. Once again, instead of putting all your eggs in one basket, try various protocols at once. Finally (appropriately), have an exit plan always in place. When redemption is not an option, swapping an LST on a DEX is a valid strategy as well—explore your options.
Conclusion
All in all, liquid staking is a curious solution that solves a purely crypto-native issue. We hope you walk away from the article with a better understanding of what liquid staking is, and maybe even continue with your own research.
The ChangeHero blog is a good place to start! If that is more your thing, we also have social media for daily content and live updates: X, Facebook, and Telegram
Frequently Asked Questions
Is liquid staking safe?
The act of liquid staking — depositing funds to a third-party protocol — is riskier than self-staking due to counterparty trust and more components involved. Awareness about the risks would be even more appropriate for the subsequent use of the liquid staking tokens.
What are the advantages of liquid staking tokens?
There are multi-faceted advantages to liquid staking protocols. On a network level, they help distribute staked assets between a larger variety of validators. To a user, liquid staking services provide an opportunity to utilize the same funds they dedicated to a proof-of-stake protocol.
What are liquid staking tokens?
Liquid staking tokens are derivatives minted by these smart-contract-powered blockchain platforms. These derivatives are accepted in some DeFi products as an equivalent of the original tokens staked. As a result, liquid staking tokens can be used for liquidity mining, yield aggregation, lending and more.
What are the disadvantages of liquid staking?
There are a number of risks associated with liquid staking, so this method is recommended to experienced users. When liquid staking tokens act as leverage, chances of liquidation increase. The more protocols you use with these tokens, the more smart contract risk and fees you accumulate. Checking the conditions of a chosen protocol is also advised: some take a commission on yields, and some will not let you unbond immediately.
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