What is Liquid Staking on Ethereum?

Jump to the answer: Liquid staking is a mechanism that allows users to earn Ethereum staking rewards while keeping their capital liquid.

Liquid Staking has emerged as one of Ethereum's largest sectors, with billions of dollars in ETH locked in Liquid Staking Tokens (LSTs). Led by Lido back when Ethereum’s Beacon Chain launched in 2020, there are now dozens of protocols offering liquid staking services, including Rocket Pool, Frax, and Coinbase. In total, over a third of all staked ETH is staked through liquid staking protocols, amounting to over $30 billion in staked assets.

Typically, users would need to lock up their ETH, run nodes and maintain validators to stake Ethereum. By unlocking the potential of staked assets, liquid staking offers crypto enthusiasts new avenues for earning rewards while maintaining flexibility and liquidity. In this article, we'll delve into the intriguing world of liquid staking, understanding how it works, exploring popular platforms — like Rocket Pool, Lido Staked ETH and Frax ETH — and discovering the exciting potential of liquid staking tokens in 2024.

What is Liquid Staking?

Liquid staking is a mechanism that allows users to earn ETH staking rewards while keeping their assets liquid. Traditionally, when participating in proof of stake networks, users would lock up their assets for the opportunity to contribute to network security and earn staking rewards. However, the process of traditional staking results in illiquid assets and missed opportunities for investors.

With liquid staking, users can convert their staked assets into other tokens, known as liquid staking tokens (LSDs), also known as liquid staking tokens (LSTs). This innovation offers the dual advantage of earning staking rewards and retaining the ability to use those assets for other purposes, such as trading, providing liquidity, lending or accessing DeFi protocols.

How Does Liquid Staking Work?

Liquid staking is a fairly simple process where protocols maintain validator nodes and maintenance for LST holders. Let's take a closer look at what happens under the hood:

Protocols like Lido Finance pool ETH deposits to stake on Ethereum to earn rewards. For each stETH token Lido issues, 1 ETH is staked to an Ethereum node, earning rewards for doing so. 

stETH holders earn rewards passively from staking rewards. A user can swap for ETH on an exchange, and then add stETH to their portfolio by swapping ETH for stETH. stETH mimics the price of ether, but it earns rewards on a daily basis from staking. These rewards show up in your crypto wallet automatically; your stETH balance increases as rewards are earned. For example, 100 stETH earning 4% APY will show as 104 stETH after one year.

Liquid staking tokens can be freely traded on various decentralized exchanges (DEXs) and used within DeFi protocols. Users can participate in yield farming, lend or borrow against their liquid tokens or transfer them to other chains for cross-chain interoperability.

Ethereum Liquid Staking

Ethereum, the world's largest blockchain platform, has been making significant strides toward liquid staking adoption. Projects like Rocket Pool and Lido Staked ETH have emerged as leading platforms in this domain.

Lido Staked ETH is the largest liquid staking token by total value locked. The protocol was first to market, helping achieve its robust ecosystem integrations and large user base. However, concerns about Lido controlling too much of Ethereum’s network and ultimately centralizing Ethereum itself arose as Lido gained popularity.

Rocket Pool provides a more decentralized platform for Ethereum stakers, allowing users to deposit any amount of ETH into the pool or start their own mini-pool with 8 ETH and RPL tokens. The deposited ETH is then used to provide staking services, and in return, users receive rETH, which represents their staked ETH. Unlike stETH which is pegged to the price of ETH, rETH grows in price relative to ETH as rewards are accrued. For example, if ETH is worth $5,000 and rETH earns 3% APY, then one rETH would be worth $5,150 at the end of the year, given the price of ETH remains constant.

Liquid Staking APYs

One of the primary motivations for participating in liquid staking is the potential for attractive annual percentage yields (APYs). These APYs vary depending on factors such as network participation, amount of value staked and fees taken by liquid staking providers. 

Currently, users can expect to earn between 2.5% to 4% APY from liquid staking. Frax Finance’s sfrxETH comes in at the higher end of the spectrum, while Lido stETH and Coinbase cbETH are slightly less competitive. For those looking to earn higher APYs from liquid staking tokens, LSDFi applications such as OETH offer boosted APYs on liquid staking yield.

Should You Stake Ethereum?

It's essential to consider the risks and factors associated with liquid staking before deciding to stake Ethereum. While it offers enhanced liquidity, there may be a trade-off in terms of security compared to traditional staking methods. Users should carefully assess the reputation, security measures and track record of liquid staking platforms. 

Liquid staking introduces a novel dimension to the world of staking, enabling Ethereum holders to unlock the true potential of their assets. By leveraging liquid tokens and exploring platforms like Rocket Pool and Lido Staked ETH, investors can venture into new avenues of DeFi, maximize their returns and contribute to the growth of the Ethereum ecosystem.