Liquid Staking Explained: Yield-Bearing Tokens You Can Use
In this lesson, we’ll explore the concept of liquid staking — how it differs from regular staking, how rewards are distributed, and why you’ll frequently encounter liquid-staked assets in decentralized finance (DeFi).
The most common example is liquid-staked Ethereum (stETH), but similar tokens exist for Solana, Avalanche, ATOM, and other blockchains.
The Problem with Regular Staking
Let’s start with the main limitation of traditional staking — illiquidity.
Suppose you have 10 ETH and decide to stake them with a validator.
The validator uses your ETH to help secure the network and pays you around 3% per year in staking rewards.
However, while your ETH is staked:
- You cannot trade or transfer it.
- You cannot use it in any other strategy.
- To withdraw, you must wait for a lock-up period (7–30 days depending on the blockchain).
Your assets are frozen, even though they generate rewards.
That’s the key drawback of traditional staking.
What Is Liquid Staking?
Liquid staking solves this problem.
It allows you to keep earning staking rewards while retaining liquidity — meaning you can use your staked assets elsewhere in DeFi.
In short, liquid staking lets you earn twice:
- From staking rewards, and
- From using the liquid staking token in other protocols (farming, lending, swaps, etc.).
Example: How It Works (stETH)
Instead of staking ETH directly with a validator, you delegate it to a liquid staking provider such as Lido Finance.
Here’s what happens step by step:
- You deposit 10 ETH to Lido.
- Lido delegates your ETH to professional validators.
- Validators perform standard staking duties — securing the network, validating blocks, and earning rewards.
- Lido issues you stETH — a derivative token representing your staked ETH.
Your stETH is fully backed 1:1 by real ETH locked with validators.
You can redeem it at any time for your original ETH plus rewards.
1 stETH = 1 ETH (subject to minor market fluctuations and small provider fees).
Meanwhile, your ETH continues earning staking rewards, which are distributed automatically among stETH holders.
Dual Benefits
Liquid staking gives you the best of both worlds:
- You earn staking income continuously.
- You retain liquidity, enabling you to use staked assets across DeFi.
Providers typically charge a 10% service fee on staking rewards.
So if base yield is 3% annually, your net yield is about 2.7%.
This is the main difference between liquid staking and traditional staking — you receive a yield-bearing token (like stETH) that:
- Represents your staked asset,
- Automatically accumulates rewards,
- And can be used across other protocols.
How Liquid Staking Tokens Work
When you hold stETH in your wallet, its balance automatically increases over time.
A smart contract periodically distributes staking rewards among all token holders.
Example:
- You deposit 10 stETH.
- Annual yield is 3%.
- After one year, your wallet shows 10.3 stETH — rewards added automatically.
Each stETH is redeemable for ETH at a 1:1 exchange rate (adjusted for accrued rewards).
You can withdraw anytime — no unbonding delay like in regular staking.
Cross-Network Use
Liquid staking tokens are widely used across DeFi because they are:
- Fully backed by real assets (1 stETH = 1 ETH).
- Yield-bearing — rewards accumulate automatically.
- Liquid — can be traded, lent, or used as collateral.
These tokens can move freely across Ethereum and Layer 2 networks like Arbitrum, Optimism, and Polygon.
Providers (like Lido) ensure that stETH remains functional and yield-bearing across these ecosystems, allowing you to:
- Provide liquidity,
- Lend or borrow,
- Participate in farming strategies, while continuing to earn staking rewards.
How the Exchange Rate Works
When you stake ETH via Lido, your ETH balance doesn’t grow directly — instead, your stETH value increases.
- On Ethereum mainnet: staking yield adds more tokens to your balance.
- On Layer 2 networks: yield is reflected in price appreciation —
e.g. after 1 year at 5% yield, 1 stETH ≈ 1.05 ETH.
This lets users bridge stETH to other networks and still earn staking income — it’s simply expressed in the price, not the token count.
Arbitrage and Peg Stability
If stETH temporarily trades below its fair value (for example, 1 stETH = 0.995 ETH), arbitrageurs step in:
- Buy discounted stETH.
- Bridge it back to Ethereum.
- Redeem it for 1 ETH at the provider rate.
This process restores the peg between stETH and ETH.
The peg remains stable through market arbitrage and provider-managed exchange rates.
Major Liquid Staking Providers
For Ethereum:
- Lido Finance
- Rocket Pool
- Coinbase Staking
- Frax ETH
For other blockchains:
- Marinade (Solana)
- Benqi (Avalanche)
- Stride (Cosmos/ATOM)
All operate on the same principle:
Users stake assets → validators secure the network → rewards distributed → derivative token issued.
Risks of Liquid Staking
Compared to regular staking, liquid staking introduces two additional risk layers:
1. Provider Risk
Reliability of the liquid staking service.
If the provider fails or is hacked, access to staking rewards may be disrupted.
2. Derivative Risk
Volatility of the liquid staking token (like stETH).
Although fully backed, its market price can fluctuate slightly (e.g., 0.995 ETH) due to:
- User redemptions and liquidity demand,
- Temporary withdrawal delays,
- Market panic or technical issues.
Example: During one transition period, stETH briefly depegged to 0.95 ETH.
Arbitrage traders bought it cheaply and earned a 5% profit when the peg recovered.
Additional Risk Factors
- Smart contract risk — vulnerabilities in provider contracts that issue and manage derivative tokens.
- Collateral risk — if used as lending collateral, a temporary price drop may trigger liquidation.
- Regulatory and market risk — external announcements can cause temporary volatility.
Comparing Risk Levels
| Type | Control of Funds | Liquidity | Risk Level | Example |
|---|---|---|---|---|
| Regular Staking | You delegate directly to validators | Locked (7–30 days) | Very Low | Native ETH staking |
| Liquid Staking | Through provider smart contracts | Fully liquid | Moderate | stETH, rETH, cbETH |
Regular staking is simpler and slightly safer.
Liquid staking offers more utility but introduces additional complexity.
Personal Approach
Many investors combine both:
- Use regular staking for long-term core holdings.
- Use liquid staking tokens (like stETH) for flexible DeFi strategies.
Personally, I sometimes use regular ETH as collateral instead of stETH, even though over $36 billion is locked in liquid staking.
The added risk — however small — doesn’t always justify the benefit.
Summary
Liquid staking allows users to:
- Earn staking rewards while retaining liquidity.
- Use yield-bearing tokens (like stETH) in DeFi protocols.
- Exit positions instantly, without unbonding delays.
However, it introduces:
- Provider risk,
- Derivative price risk, and
- Smart contract vulnerabilities.
It’s a powerful, flexible tool — but one that requires awareness and understanding.
These materials are created for educational purposes only and do not constitute financial advice.