Liquid Staking Explained: How Liquid Staking Tokens Work and Their Risks

Traditional staking locks your tokens. Liquid staking gives you a receipt token you can still use. It has become one of the largest sectors in decentralized finance, especially on Ethereum. Here is how it works and what can go wrong.

The basic idea

1. You deposit tokens (for example ETH) into a liquid staking protocol.
2. The protocol stakes them with validators.
3. You receive a liquid staking token (LST) representing your deposit plus future rewards.
4. You can hold the LST, sell it, or use it as collateral in DeFi — all while still earning staking rewards.

Two ways LSTs pass on rewards

• Rebasing tokens: your token balance increases over time as rewards are added. One token remains roughly equal to one underlying ETH.
• Value-accruing tokens: your balance stays the same, but each token becomes redeemable for more ETH over time, so its price rises relative to ETH.

The economic result is similar. The difference matters for accounting, DeFi integrations and, in some countries, tax treatment.

Why people use liquid staking

• No lock-up in practice — you can sell the token instead of waiting in an exit queue.
• No minimum — stake any amount.
• Composability — use the LST in lending, liquidity pools or other strategies to earn additional yield.

The risks

Smart contract risk

Your funds depend on the protocol's code. Bugs or exploits can cause losses. Prefer protocols with long track records, multiple audits and bug bounties.

Depeg risk

An LST is supposed to track the value of the underlying asset, but on the market it can trade at a discount. During market stress, many holders may sell at the same time, pushing the price below its redemption value. If you need to sell during a depeg, you lose the difference.

Validator and slashing risk

If validators used by the protocol are slashed, the loss is shared by all token holders.

Centralization and governance risk

Large liquid staking protocols control a big share of staked supply, and governance token holders may control upgrades or fee changes.

Leverage risk

Some users borrow against their LST to buy more and stake again, multiplying yield. If the LST depegs or borrowing rates rise, these positions can be liquidated. See how leverage works.

Fees

Liquid staking protocols typically take a percentage of staking rewards — often around 10%. A 3.5% gross staking yield becomes about 3.15% net.

Taxes

The tax treatment of depositing into a liquid staking protocol and of the rewards depends on the country and the token design. In some jurisdictions swapping ETH for an LST may be considered a disposal. Keep detailed records and check local guidance.

Model your yield

Enter the gross rate and the protocol's fee as the commission in the staking APY calculator to see your net APR, APY and projected balance.

CryptoMathly provides educational estimates only and is not financial, investment or tax advice. Crypto assets are volatile and you can lose money. Always verify figures with a qualified professional.