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Risks of Staking and Liquid Staking (LST)

· 6 min read

In this lesson, we’ll review all the major risks associated with both regular staking and liquid staking (LST).
You’ll learn which risks are theoretical, which have actually occurred in the past, and how users can protect themselves from them.

1. Risks in Regular (Non-Liquid) Staking​

Let’s start with traditional staking, where you delegate tokens directly to a validator node through your own wallet, without intermediaries.

Main Risk: Slashing​

Slashing means that a portion of a validator’s staked tokens can be confiscated (burned) if they violate network rules — for example, by going offline or acting maliciously.

Validators stake tokens as collateral for good behavior.
If a validator fails to produce blocks, double-signs, or breaks consensus rules, a portion of their stake (and potentially part of the delegators’ stake) can be penalized.

  • This risk exists across all Proof-of-Stake networks — Ethereum, Solana, Avalanche, Polygon, and others.
  • Liquid staking providers (like Lido or Benqi) also delegate user assets to validators, so the same principle applies.

✅ In practice:
Slashing is extremely rare.
Major providers like Lido Finance use strict validator selection criteria, requiring technical audits, uptime reliability, and reputation verification.

So far, there has never been a major slashing event that affected user balances or the peg of liquid staking tokens (like stETH).

Still, slashing remains the primary theoretical risk in both staking and liquid staking systems.

2. Smart Contract Exploits (LST-Specific Risk)​

Liquid staking operates through smart contracts — they manage deposits, assign funds to validators, and distribute staking rewards automatically.

Each of these processes relies on on-chain code, which introduces technical vulnerabilities.

What Could Go Wrong​

  • A bug in the contract could allow unauthorized withdrawals.
  • Reward distribution logic might be manipulated or frozen.
  • Attackers could exploit an upgrade vulnerability or logic flaw.

How Providers Mitigate It​

Top-tier providers like Lido Finance conduct regular independent audits (monthly or quarterly).
Before every major update, all contracts are reviewed by cybersecurity firms to identify vulnerabilities.

As a user, you should always check whether a liquid staking provider has recent and verified audit reports before depositing funds.

3. Price Deviation (Depeg) Risk​

Depeg happens when the market price of a liquid staking token (e.g., stETH, sAVAX, JitoSOL) deviates from its official provider rate.

Normally, an LST represents the value of the underlying staked asset plus accumulated rewards —
for example, 1 stETH = 1 ETH + staking yield.
However, on decentralized exchanges (DEXs), the market rate can temporarily diverge.

Causes of Depeg​

  1. Large sell orders by users seeking instant liquidity.
  2. Low liquidity pools for smaller or newer LSTs.
  3. Market panic during volatility.
  4. Lack of redemption functionality or delayed withdrawals.

Example​

If many users sell stETH on Curve during high volatility, its price might drop to 0.98 ETH.
Arbitrage traders then buy discounted stETH, redeem it later for 1 ETH via Lido, and profit from the difference.
This mechanism naturally restores the peg over time.

Depegs are usually short-lived and self-correcting, but they can trigger temporary losses for users relying on LSTs as collateral in lending markets.

4. Collateral Shortage and Redemption Failure​

If a liquid staking provider fails to maintain full collateral backing (meaning they don’t hold enough base assets to match all issued LSTs), users may not be able to redeem their tokens.

This leads to panic selling and sharp price drops on DEXs.

Example: Ethereum’s PoS Transition​

During Ethereum’s early Proof-of-Stake phase, users could stake ETH but could not withdraw it for nearly a year.
Many panicked and sold stETH below 1 ETH, causing a temporary depeg.
After withdrawals became available, the peg was fully restored.

Thus, the inability to redeem (whether temporary or permanent) is one of the most serious risks in liquid staking.

Two Causes​

  1. The provider has no collateral (due to a hack or fraud).
  2. The collateral exists but redemption isn’t yet enabled on-chain.

In both cases, the result is the same:
Users cannot redeem LSTs → panic selling → price deviation → loss of confidence.

5. Liquidation Risk in Lending and Looping Strategies​

This risk applies when using LSTs as collateral in lending markets or looping strategies.

If the market price of the LST drops (due to depeg or volatility), the collateral value decreases.
If it falls below the liquidation threshold (usually around 95% loan-to-value ratio), your position is automatically liquidated by the lending protocol.

Example​

You deposit stETH and borrow ETH to loop staking.
If stETH temporarily falls to 0.97 ETH, your collateral weakens.
If you’re near the limit, your position gets liquidated.

Tip:
Avoid borrowing at maximum capacity.
Keep a 20–30% safety buffer to prevent liquidation during brief depeg events.

In practice, these liquidations are rare and easily avoided with conservative borrowing limits.

6. Asset Price Decline (Market Risk)​

Regardless of how you stake, your tokens remain subject to market volatility.
Even if you earn staking rewards, the token’s price in fiat (USD) can decline due to overall market trends.

This applies to both staking and liquid staking —
the yield may soften the loss, but it doesn’t fully offset a major market downturn.

Example:

You stake ETH at 4% annual yield, but ETH drops 30% in price —
your portfolio still loses value in dollar terms.

This is a natural investment risk and not specific to staking mechanics.

Summary of Risks​

Regular Staking​

  1. Slashing — partial loss of tokens if a validator misbehaves or goes offline.
  2. Market Volatility — token price decline despite earning staking rewards.

Liquid Staking (LST)​

  1. Slashing — same as in regular staking, since validators still secure the network.
  2. Smart Contract Exploits — potential code vulnerabilities in deposit or reward contracts.
  3. Depeg (Price Deviation) — temporary difference between LST and base token value due to liquidity or panic.
  4. Liquidation — collateral-based strategies may face forced liquidation during depegs.
  5. Collateral Shortage / Redemption Failure — inability to redeem LST for the base token if collateral is missing or locked.
  6. Asset Price Decline — inherent market risk of token value fluctuation.

Key Takeaways​

  • Slashing and smart contract risks are largely technical and rare in practice.
  • Depeg and liquidation risks mostly affect users engaged in DeFi strategies, not passive holders.
  • Market volatility remains the most consistent risk for all staking participants.
  • Choosing reputable, audited providers (like Lido, Rocket Pool, or Benqi) drastically reduces technical risks.
  • Maintaining a conservative borrowing ratio and monitoring liquidity pools helps prevent unwanted liquidations.

In the next lesson, we’ll explore DeFi yield-based staking — how it differs from consensus staking and how tokens can earn additional yield through decentralized finance protocols.

These materials are created for educational purposes only and do not constitute financial advice.