What Is Liquid Staking?

Liquid staking is a method of staking a proof-of-stake asset while receiving a tradeable token that represents the staked position and its accruing rewards. The underlying asset stays staked and continues to earn, but the receipt token can be sold or used elsewhere, so the capital is not fully immobilized the way it is with ordinary staking.

This approach became prominent on Ethereum, where staked ether is represented by liquid staking tokens issued by protocols. The article below explains how liquid staking works and where its risks lie. It is educational only and is not financial advice; the mechanics carry real risk, and rules and tax treatment differ by jurisdiction.

What is staking, briefly?

Staking locks crypto to help secure a proof-of-stake blockchain, and in return the staker earns rewards. The drawback is liquidity: staked assets are committed, and unstaking can involve a waiting period, during which the capital cannot be used for anything else. Liquid staking was designed to address exactly this limitation.

What is liquid staking and how does it work?

With liquid staking, a user deposits an asset such as ether into a liquid staking protocol. The protocol stakes that asset on the user’s behalf, typically spreading it across many validators, and in return mints a liquid staking token, or LST, that represents the deposit plus the rewards it earns over time.

That token is the key innovation. It can be held while the underlying stake keeps earning, or it can be traded, lent, or used as collateral in other applications. In effect, staking and unstaking become as simple as swapping a token, and the staked capital can do a second job in decentralized finance at the same time.

The value of the LST is designed to track the underlying staked asset, either by increasing in quantity or by rising in redemption value as rewards accrue. When the user wants out, they redeem or sell the token to recover the underlying value, subject to the protocol’s rules and any withdrawal queue.

How do liquid staking tokens track their rewards?

Liquid staking tokens generally use one of two models to reflect earnings. In a rebasing model, the number of tokens in a holder’s wallet gradually increases as rewards accrue, so the balance grows while each token stays roughly equal to one unit of the underlying asset. In a reward-bearing model, the token count stays fixed but each token slowly becomes redeemable for more of the underlying asset, so its value rises over time.

Both models aim for the same outcome: the token represents a growing claim on staked assets. The difference matters mainly for accounting and for how the token behaves inside other applications, where a changing balance and a changing price are handled differently. Understanding which model a token uses helps a reader interpret why a balance or a price is moving.

Why is liquid staking used across DeFi?

Once a staked position exists as a transferable token, it can plug into the rest of decentralized finance. Holders may use liquid staking tokens as collateral to borrow against, supply them to liquidity pools, or hold them simply to keep earning staking rewards without locking their capital away. This composability, the ability to reuse the same position in multiple places, is a large part of why liquid staking grew so quickly.

That reuse, however, is also where risk multiplies. Each additional application layered on top of a liquid staking token adds its own smart-contract exposure and its own failure modes, so a token that is convenient in isolation can become part of a more fragile chain when it is stacked into several protocols at once.

Liquid staking vs regular staking: what is the difference?

The central difference is what happens to liquidity. The table below compares the two approaches.

Why does liquid staking matter?

Liquid staking matters because it removes a core trade-off. Previously, a holder had to choose between earning staking rewards and keeping their capital free to use. Liquid staking lets both happen at once, which is why it became one of the largest categories in decentralized finance.

It also lowers the practical barrier to participation. Rather than needing the full amount to run a validator directly, users can stake almost any amount through a protocol and receive a token in return. That accessibility broadens who can take part in securing a network.

What are the risks and limitations?

Smart-contract risk is the most fundamental. Liquid staking relies on the protocol’s code to hold deposits, run validators, and issue tokens correctly. A bug or exploit in that code could put deposited assets at risk, a hazard that direct solo staking does not add in the same way.

Depeg risk is specific to the receipt token. Although an LST is meant to track the underlying asset, it can trade below that value during market stress or heavy selling. A holder who sells while the token is depegged can realize a loss even though the underlying stake is intact.

Slashing risk still applies underneath. If validators used by the protocol are penalized for faults, that loss can be passed through to token holders. On some networks, simultaneous slashing of many validators is penalized more heavily, which concentrates the downside.

Centralization risk is a network-level concern. When a single provider handles a large share of all staked assets, it gains significant influence over the underlying blockchain. Developers have repeatedly warned that heavy concentration in one provider could weaken the network’s decentralization and resilience.

The bottom line

Liquid staking lets a holder stake a proof-of-stake asset and still keep usable capital, by issuing a tradeable token that represents the staked position and its rewards. The convenience is real, but it comes with added smart-contract risk, the possibility that the receipt token depegs, underlying slashing exposure, and broader centralization concerns. This explainer describes the mechanism only and is not financial advice; because outcomes and tax rules vary by jurisdiction, anyone considering liquid staking should understand each risk and consult a qualified professional.