Liquid staking tokens explained

Staked ETH is locked behind an exit queue. A liquid staking token is a way around that: a token that stands for your staked ETH and can be traded at any time. This lesson explains how these tokens work and why they are not the same thing as ETH.

The basic idea

You deposit ETH into a staking pool. The pool stakes it and gives you a token as a receipt. The token represents your deposit plus your share of the rewards the pool earns.

You can hold the token, sell it, or use it in DeFi while the ETH behind it stays staked.

An example: stETH

Lido is a large, long-running pool of this kind. Its token is called stETH.

• Rewards arrive as more tokens. Once a day your stETH balance is adjusted to reflect what the pool's validators earned. You do nothing.
• Penalties arrive the same way. If the pool's validators are penalised or slashed, balances are adjusted down.
• There is a wrapped version. wstETH keeps a fixed balance and rises in value instead. Some DeFi services need that form.

Lido states that rewards are variable and not guaranteed.

Two ways out

• Redeem through the pool. You hand back the token and join a withdrawal queue. When your request is processed you claim ETH. How long that takes depends on the queue and on Ethereum's own exit queue from Lesson 46.
• Sell on a market. You swap the token for ETH straight away at whatever price the market offers.

It is not pegged to ETH

The market price can differ from the value of the ETH behind the token. Lido says plainly that stETH is intentionally not pegged.

In June 2022 this became obvious. Withdrawals from staking did not exist yet, so selling was the only exit. When two large holders, the lender Celsius and the fund Three Arrows Capital, ran into trouble, stETH was sold heavily and traded 5% to 6% below ETH.

Redemption now exists, which pulls the price back towards ETH over time. In a rush for the exit, the queue lengthens and the market price can still fall below the value of the ETH.

The risks stacked inside

A liquid staking token carries everything in ordinary staking and adds more.

• Smart contract risk. Your deposit sits in the pool's contracts.
• Operator risk. The pool chooses who runs its validators. Their penalties are shared among holders.
• Governance risk. Someone can change the pool's rules.
• Market risk. The token can trade below ETH just when you need to sell.
• Liquidation risk. If you borrow against the token and its price dips, the loan can be liquidated. Lesson 43 showed how.
• Concentration. One pool holding a large share of all staked ETH is a risk to the network itself, as Lesson 47 noted.

Tax

Receiving a token in exchange for ETH, and receiving rewards as extra tokens, both raise tax questions that many countries have not answered clearly. Lesson 60 returns to this.

Before you buy one

• Read how redemption works and how long the queue has been recently.
• Check the fee the pool takes from rewards.
• Check the token's price against ETH before you buy or sell.
• Do not borrow against it unless you can stand a sudden drop.