Imagine a simple situation. You have ETH, you stake it, and you start earning rewards. But after a while, an opportunity appears in DeFi — perhaps a lending protocol, liquidity farming, or another strategy where that same ETH could generate additional returns or be used as collateral. There is just one problem: your ETH is already locked in staking. So what do you do?
Liquid staking emerged as an answer to that question. In practice, it made it possible to stake cryptocurrency without completely giving up the liquidity of your capital. But to make that work, the market had to introduce another token.
How ETH Got a Representative
The mechanics work like this: a user sends, for example, 1 ETH to a liquid staking protocol and receives another token in return — a liquid staking token, or LST. It represents a claim on the asset being staked, along with the economic value generated by that staking position. So while the ETH itself is working inside the staking mechanism, its liquid representative remains in the owner’s wallet. It can be transferred to someone else, traded on the market, used as collateral, or deposited into another DeFi protocol.
A very rough analogy would be a depositary receipt or a claim ticket for an asset: the actual asset is held in one place, while the owner keeps an instrument that represents their rights to it and allows those rights to be used elsewhere. The crypto version is, of course, much more complicated, but the basic idea is similar.
If the underlying mechanics of staking still feel a little unclear, we covered them separately in What Is Staking and How Does It Work?
Keep the Capital Moving!
Let’s say you send 1 ETH into liquid staking. The ETH itself goes into the staking infrastructure, while an LST appears in your wallet. From there, you can simply hold the token and do nothing else. Economically, your position continues to benefit from staking. You can sell the LST without waiting for the normal process of exiting a staking position. Or you can put it to work elsewhere — for example, by using it as collateral in DeFi. Meanwhile, the original ETH continues earning staking rewards.
The token issued against that ETH can then be used in another protocol and potentially generate additional returns of its own. On the one hand, this gives investors several sources of yield at once. On the other, there is a rule that holds true surprisingly often in DeFi: when returns are stacked in layers, risks usually are too…
So why make things this complicated? Because traditional staking makes capital less flexible. That is not particularly attractive to a crypto market — or to ETH holders — that wants to participate in several strategies at once. In an ecosystem where capital is constantly flowing from one protocol to another, flexibility matters.
In DeFi, assets are used as collateral for loans, added to liquidity pools, traded, pledged, and plugged into other financial structures. A staked asset partially drops out of that economy. An LST puts it back in motion.
Are All LSTs Created Equal?
In short, no. stETH and rETH are a good example of why different LSTs should not be treated as interchangeable products. With liquid staking through Lido, a user may receive stETH. Its mechanism reflects accumulated staking rewards in one way. rETH from Rocket Pool works differently: its value relative to ETH changes as staking rewards accumulate.
For someone who only wants to understand the general idea, that difference may seem like a technical detail. In actual use, however, these details matter. How are rewards reflected? What exactly is sitting in your wallet? How do you get back to the underlying asset? Where can the token be traded? Liquid staking is not simply another button inside Ethereum. It is an additional layer of infrastructure built on top of the blockchain, and each protocol can implement it differently.
1 LST ≠ 1 ETH
If an LST represents staked ETH, it seems reasonable to expect its value to match the underlying asset perfectly at all times. But remember: the LST itself also trades on the open market. And the market owes you nothing…
Imagine that a large number of holders suddenly want to get rid of a particular liquid staking token. There are plenty of sellers and not enough buyers. The price of the LST can fall below the value of the asset it represents. This kind of divergence is commonly referred to as a depeg.
That does not necessarily mean the ETH inside the protocol has disappeared. But if you need cash right now and the market is only willing to buy your LST at a discount, the theoretical value of the underlying asset is not much comfort.
That is why it is important to understand that “this asset is backed by something” and “I can sell this asset for that exact value right now” are not the same thing.
The Liquid Staking Paradox
Traditional staking already comes with risks: the price of the cryptocurrency can fall, or a validator can perform poorly. Liquid staking does not remove any of those risks — it simply adds new variables on top. Now the reliability of the liquid staking protocol itself matters as well. Its smart contracts may contain vulnerabilities, an LST may lose some of its liquidity or temporarily diverge from the underlying asset, and if the user then deposits that LST into another DeFi protocol, yet another layer of dependency appears.
At the same time, using a large liquid staking protocol is usually more convenient: its token tends to have deeper liquidity, more DeFi integrations, and a larger market for trading. But if too much of the total stake becomes concentrated through a small number of services, another issue emerges — the decentralization of the network itself.
That creates a paradox: what is convenient for an individual user is not always ideal for the ecosystem as a whole. So judging liquid staking by the APY alone misses the point. What matters far more is understanding what stands between your ETH and the promised return. If it is one straightforward protocol, that is one thing. If there is a chain of LSTs, lending, liquidity pools, and several additional DeFi services layered on top, you are dealing with a very different level of complexity.
So What Did They Just Sell You?
Liquid staking is not really selling additional yield. What it is selling is flexibility — the ability to keep an asset staked without removing that capital entirely from circulation. For someone who actively uses DeFi, that flexibility can be genuinely useful. For someone who simply planned to hold ETH in a wallet for several years, it may have very little value at all.
In that sense, tools like liquid staking illustrate something about the crypto market as a whole: new technologies often do not eliminate an old trade-off so much as replace it with a new one. With traditional staking, the choice is between liquidity and putting capital to work in the network. Liquid staking softens that trade-off, but offers another one in return: more freedom, or less complexity.
