Understanding Liquid Staking

What is Staking?

Staking is a

cryptoeconomic mechanism

that uses rewards and penalties to incentivize proper network behavior, thereby enhancing the underlying security. In proof-of-stake (PoS) blockchains like Ethereum, participants run

validator

nodes by putting tokens at stake. Validators are essential to maintaining network consensus — the process by which all participants agree on the blockchain's new global state¹.

One of the important fields of the validator object ↗ is the effective_balance², which represents the validator's "active" balance and determines its influence in the protocol. This balance serves as the validator's "weight" in consensus duties, which are:

• Attesting to its view of the chain³
• Proposing beacon chain blocks
• Signing off on blocks in the
  sync committees
  that support
  light clients

The Beacon Chain uses both rewards and penalties to incentivize proper validator behavior⁴. Reward amounts are calculated based on mathematical formulas considering multiple variables, participation rates, timing, and network conditions⁵. Validators also earn rewards from priority fees and MEV (Maximum Extractable Value).

Learn more about rewards and penalties — ethereum.org ↗

The Traditional Staking Dilemma

Traditional PoS staking follows a simple premise: lock tokens and earn rewards. While this model secures the network, it has a major drawback — staked ETH is illiquid. Once staked, it cannot be used elsewhere in decentralized finance (DeFi). This creates a fundamental dilemma: stakers must choose between earning rewards and keeping their ETH liquid, but never both.

Solution

Liquid staking transforms your stake into a tradeable asset through tokenization. When you stake through a liquid staking protocol, you receive liquid staking tokens (LSTs) representing your claim on the underlying staked assets plus accrued rewards. Unlike native staking where tokens are locked, LSTs remain liquid and

composable

. This unlocks the entire DeFi ecosystem while your original stake continues earning validation rewards. You can now earn from multiple sources:

• Staking rewards from your underlying validators;
• DeFi yields from a multitude of opportunities: collateral for lending, yield farming strategies, or trading on decentralized exchanges (DEXs);

… while keeping your stake transferable and easily convertible back into ETH.

Liquid staking represents an epistemic shift in how staking works. With LSTs, you maintain exposure to staking rewards while having liquidity, breaking the disjunctive premise of traditional staking.

Staking Options

In order to participate in the Ethereum consensus mechanism, a staker must deposit 32 ETH.

The default way to stake — called solo staking — can be prohibitive because of the minimum required 32 ETH and the technical expertise required to run a node. This accessibility barrier led to the emergence of staking service providers that require no programming knowledge or hardware setup: staking-as-a-service (SaaS) and centralized exchanges (CEXs). However, both come with significant concessions: SaaS providers still require the full 32 ETH minimum and offer no liquidity benefits, while centralized exchanges have one fundamental flaw — centralization, which contradicts crypto's core decentralization principles.

Decentralized liquid staking protocols emerged as a response — they don't have a deposit minimum, instead "pooling" capital from many depositors, and issuing tokens that represent depositors' share of the staking pool. These tokens are typically tradable on decentralized exchanges and are accepted as collateral in lending protocols, enabling frictionless entry and exit from staking, as well as participation in DeFi.

By nature of their service, liquid staking protocols are non-custodial and permissionless. However, their weakness is the standardized nature of the service — users don't have the flexibility to control how and on what terms their assets are staked, and must always stake ETH on third-party nodes to access liquidity, commingling assets with other depositors. Such protocols also mostly rely on opaque node operator sets, often creating centralization around dominant node operators and leaving participants without transparency about stake allocation.

This opens room for an innovative approach to liquid staking pioneered by StakeWise.

1. Users submit transactions to the network of nodes, and the goal of the consensus protocol is that all correct nodes eventually agree on a single, consistent view of the history of transactions. That is, the order in which transactions were processed and the outcome of that processing. ↩

2. Unlike the actual balance (which changes with every block), effective balance updates only once per epoch. It also "snaps" to the nearest 1 ETH increment due to a mechanism called hysteresis — this prevents constant fluctuations from affecting consensus calculations. ↩

3. Each attestation contains three votes: a source checkpoint vote, a target checkpoint vote (both for Casper FFG finality), and a head block vote (for LMD-GHOST ↗ fork choice). More on Gasper consensus in the whitepaper ↗ ↩

4. Validators earn rewards for contributing to chain security and face penalties for failing to contribute. Receiving a penalty is not the same as being slashed. Being slashed is a severe punishment for very specific misbehaviours (that could potentially be part of an attack on the chain), and results in the validator being ejected from the protocol in addition to some or all of its stake being removed. Penalties are subtracted from validators' balances on the Beacon Chain and effectively burned, so they reduce the net issuance of the Beacon Chain. ↩

5. For detailed reward calculations and formulas, see: eth2book ↗ ↩