Liquid Staking
Definition
A DeFi innovation that lets you stake crypto while receiving a tradeable derivative token representing your staked position, maintaining liquidity while earning staking rewards.
Liquid staking solves the biggest problem with traditional staking: illiquidity. When you stake ETH directly with Ethereum, your tokens are locked and you can't use them for anything else. Liquid staking protocols like Lido, Rocket Pool, and Coinbase's cbETH let you stake and receive a liquid derivative token (stETH, rETH, cbETH) that represents your staked position plus accumulated rewards.
These liquid staking tokens can be used throughout DeFi: as collateral for borrowing on Aave, in liquidity pools on Curve, or simply held in your wallet while earning staking rewards. This "capital efficiency" means your ETH is earning staking yield AND being productive in DeFi simultaneously.
Lido is the largest liquid staking protocol, holding over $15 billion in staked ETH. The stETH token rebases daily (your balance increases as rewards accrue) and is one of the most widely integrated tokens in DeFi. Other approaches include rETH (Rocket Pool), which increases in value rather than quantity.
The risks include smart contract risk (a bug in Lido's contracts could affect billions), depeg risk (stETH trading below ETH's value, as happened during the 2022 market stress), centralization concerns (a single protocol controlling a large share of staked ETH), and slashing risk (though this is absorbed by the protocol's insurance fund).
Liquid staking tokens have tax implications. Receiving stETH for depositing ETH may be considered a taxable swap. The daily rebase of stETH balance may constitute taxable income. Tax treatment varies by jurisdiction and is still evolving.
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Frequently Asked Questions
Is liquid staking better than regular staking?
Liquid staking offers the same rewards plus the flexibility to use your tokens in DeFi. The tradeoff is additional smart contract risk from the liquid staking protocol. For most users who want to use their capital in DeFi, liquid staking is preferable. For pure simplicity, direct staking is fine.
Can stETH lose its peg to ETH?
stETH traded at a discount during the 2022 market stress (around 0.93 ETH) due to forced selling and withdrawal delays. Since Ethereum enabled withdrawals, depegs have been minimal because stETH can be redeemed for ETH. However, in extreme market stress, temporary depegs remain possible.