How does liquid staking work?

In a typical liquid staking arrangement, you transfer tokens into a service that spreads them among proof-of-stake validators. That service then provides you with liquid staking tokens (LSTs), effectively representing your share of the stake pool. These LSTs continue to reflect rewards from the staked position, while letting you engage in other decentralized finance (DeFi) ventures.

If you want your staked assets back, you hand in the LSTs so the service can unwind your portion. Each platform may handle redemption differently, sometimes requiring a set “unlock” window.

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Liquid staking explained

A standard staking definition involves locking tokens for chain security. Liquid staking adds an extra mechanism: you still delegate your coins, but the system mints a receipt token in return. This second token is yours to trade, lend, or deposit in liquidity pools. As a result, you don’t have to abandon yield from staking or relinquish the chance to use your funds across various DeFi applications.

Some people like this approach because it preserves the chain’s security while avoiding the inconvenience of long unbonding periods. The minted token typically mirrors the growth of the underlying stake, though it can deviate based on market trends.

What’s the difference between liquid staking and staking?

Standard staking locks up coins for a set duration. If you want to sell or move them, you generally must wait out an unstaking phase. Liquid staking modifies that process by issuing a derivative token. This key distinction allows you to keep earning block rewards, but also remain free to shift your “liquid stake” into other DeFi activities.

While normal staking can be more straightforward, it ties up your funds. Liquid staking broadens your options and introduces complexities like derivative pricing and code or validator-based risks.

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Can you make money with liquid staking?

Yes. You can still collect staking payouts from the underlying PoS network, and you might generate further returns by lending out or using your liquid staking tokens (LSTs). That said, your outcome depends on broader market movements and the reliability of whichever protocol you choose. Any gains could be undermined if a derivative token’s price declines or a validator faces slashing.

The potential for multi-layered yields attracts many crypto enthusiasts, but it demands careful planning and awareness of each platform’s details.

What are the benefits of liquid staking?

When focusing on overall advantages rather than just “derivatives,” a few points stand out. Liquid staking grants you continuous liquidity, so you can keep your coins staked and also deploy them as separate tokens within liquidity pools or lending. This increases capital efficiency because you effectively stack two layers of yield: base staking rewards plus any DeFi returns.

Smaller investors also find it convenient. There is no need to run your own node or meet a large token threshold. The services handle backend tasks, letting you join with minimal friction.

Risks and limitations of liquid staking

By mixing staking with transferrable tokens, new vulnerabilities emerge. You may be partially slashed if the validator is penalized for negative activity. Because liquid staking tokens can trade on open markets, their price might lag behind or fall below the original asset if liquidity or confidence becomes an issue.

Smart contracts in these systems can also fail, especially if unaudited or targeted by malicious actors. Meanwhile, new regulations about staking might reshape whether certain services can operate in your region.

While these possibilities exist, many participants find that the additional yield and flexibility outweigh the dangers, as long as they choose reputable protocols.

Liquid staking tokens

When you stake coins through these platforms, you receive tokens that track your deposit. Examples include stETH from Lido or rETH from Rocket Pool. Each derivative is pegged in principle to the underlying currency, but daily market factors can push its trading price up or down.

People often treat these tokens much like other DeFi assets. They might trade them, lend them out, or combine them with further yield strategies. Some tokens pay out in a rebase-like format, while others rely on an exchange rate. Make sure you check how your chosen token handles reward distribution.

Learn more about staking crypto.

Liquid staking platforms to consider

Various providers cater to different blockchains:

• Lido: Major coverage, including Ethereum and Solana.

• Rocket Pool: Focuses primarily on Ethereum; more decentralized in design.

• Some exchanges: Certain centralized platforms (like Binance, Coinbase, Huobi) also supply liquid staking, though they might have fewer staking options.

When choosing, watch for fees, historical performance, and how easily you can redeem your deposit. Also confirm any lock-up durations, fees, or projected yields.

Is liquid staking taxable?

In most places, the staking proceeds count as income. Then, if you sell or trade your liquid staking tokens, that typically triggers a capital gain or loss event. Rules can differ depending on local laws, but the principle is that new tokens you receive or any LST trades create a potential tax obligation.

Maintaining thorough records of each step is crucial. If you spread your staked tokens across multiple DeFi platforms, you will need a robust tracking system, especially if you want to stay compliant.

Learn more in our DeFi tax guide.