Most passive income strategies in crypto quietly strip you of one of the most valuable things you own: optionality. You lock up your assets, collect a yield, and watch the market move without you. By the time your tokens unlock, the window is closed.
That is the dirty secret behind standard staking. The yield is real. The trap is also real.
Liquid staking tokens fix this problem. But they introduce a different set of risks that almost nobody explains clearly. This post will.
What Is a Liquid Staking Token?
When you stake cryptocurrency on a proof-of-stake network, you hand your tokens to a validator. In exchange for securing the network, you earn yield. The catch: your tokens are locked. You cannot trade them, use them as collateral, or deploy them anywhere else while they are staked.
A liquid staking protocol changes the equation. You deposit your crypto into the protocol, it stakes on your behalf, and in return you receive a liquid staking token (LST). That LST represents your staked position plus the yield it is accruing. You can trade the LST, use it in DeFi, or hold it. Your underlying stake keeps earning. Your LST keeps moving.
The most well-known example is Lido Finance on Ethereum. You deposit ETH. You receive stETH. Lido stakes that ETH across a network of validators. Your stETH balance increases over time to reflect the staking rewards being earned. You can sell stETH any time on a secondary market, use it as collateral in lending protocols, or just hold it and watch the balance grow.
This is the core mechanic. Simple in concept. More complicated in execution.
Why Bitcoin Holders Should Care
Bitcoin does not have native staking. It runs on proof-of-work. That means there is no built-in mechanism to earn yield on BTC just by holding it. This has historically pushed BTC holders toward lending platforms, which carry their own risks.
Newer protocols are now building liquid staking infrastructure for Bitcoin specifically. Projects like Babylon are working on enabling Bitcoin holders to participate in securing proof-of-stake networks while retaining BTC exposure. The BTC gets used as cryptoeconomic collateral, and the holder receives a yield-bearing derivative in return.
This space is early. The infrastructure is newer, the smart contract risk is higher, and the yield sources are less mature than what exists on Ethereum. But the direction is clear. The demand for BTC yield without custody risk is enormous, and builders are responding.
If you hold BTC long-term, this is a category you should understand now, before it is mainstream.
How LSTs Actually Work: The Mechanics
There are two structural approaches to how liquid staking tokens handle yield.
The first is a rebasing token. Your balance of the LST increases over time. If you deposit ETH and receive stETH, your stETH balance goes up as staking rewards accumulate. The price of stETH stays close to ETH, but you hold more of it. This is how Lido's stETH works.
The second is a reward-bearing token. Your balance stays the same, but the token itself appreciates against the underlying asset. Rocket Pool's rETH works this way. You deposit ETH and receive rETH. Over time, rETH becomes worth more ETH because the protocol's rewards are baked into the exchange rate. You hold the same number of rETH tokens, but each one is worth more ETH when you redeem.
Both approaches achieve the same goal. The difference matters for tax treatment in some jurisdictions and for how other DeFi protocols can integrate the token.
Step-by-Step: How to Actually Start
This is not theoretical. Here is how you go from zero to earning yield with LSTs.
Step 1: Get your crypto in order. If you are staking ETH, you need ETH in a self-custody wallet. MetaMask is the standard for Ethereum. Make sure you understand how to use it before you interact with any staking protocol.
Step 2: Choose your protocol. For Ethereum, Lido and Rocket Pool are the two protocols with the longest track record and the most on-chain activity. Lido is more centralized in its validator set. Rocket Pool is more decentralized. Both matter. Rocket Pool requires you to trust the rETH mechanism. Lido requires you to trust a larger validator set. Neither is risk-free. Pick your poison deliberately.
Step 3: Deposit and receive your LST. Go to the protocol's official site. Do not use a link from Twitter or Discord. Type the URL directly or use a trusted bookmark. Connect your wallet, input the amount you want to stake, and confirm the transaction. You will receive your LST in your wallet within minutes.
Step 4: Decide what to do with the LST. You have three options. Hold it in your wallet and let it accrue value passively. Deploy it in a DeFi protocol to earn additional yield (with additional risk). Or hold it on a hardware wallet for security while monitoring its performance.
Step 5: Secure your position properly. If you are holding significant value in LSTs, keep them on a hardware wallet. Liquid staking tokens sit in your wallet like any other token, which means if your hot wallet gets compromised, so does your staked position. A Trezor hardware wallet keeps your private keys offline and removes that attack vector. You can get one at https://affil.trezor.io/aff_c?offer_id=137&aff_id=135511. If you are holding LSTs long-term, hardware storage is not optional.
A Real-World Case Study: stETH During the 2022 Depeg
Lido's stETH is the most battle-tested LST in existence, and its history includes one of the best risk lessons in crypto.
During a period of intense market stress, stETH traded at a notable discount to ETH on secondary markets. Theoretically, one stETH should equal one ETH. In practice, the peg broke. This happened because withdrawal functionality was not yet enabled, and panicked sellers flooded exit liquidity. People who needed to liquidate their position had to take a loss on the peg.
This is the core risk of LSTs that most blog posts skip. The LST is only as liquid as its market. If everyone wants out at the same time and there is not enough liquidity on the other side, the peg breaks. You are not selling your staked ETH at par. You are selling a derivative of it at whatever the market will bear.
The peg did eventually recover. People who held through the stress period came out fine. People who panic-sold took real losses. The lesson is clear: liquid staking tokens carry secondary market risk that standard staking does not.
The Contrarian Insight Nobody Talks About
Most coverage of liquid staking frames it as a pure upgrade over standard staking. More flexibility, same yield, no downside. That framing is wrong in one important way.
Liquid staking tokens compound your smart contract risk, they do not reduce it. When you stake directly with a validator, your primary risk is slashing and validator downtime. When you use a liquid staking protocol, you add a layer of smart contract exposure on top of that. If the Lido contracts get exploited, every stETH holder is affected. If the Rocket Pool smart contracts fail, rETH holders face losses. The underlying network risk does not go away. You just added protocol risk on top of it.
The deeper you go into DeFi with LSTs, the more layers of smart contract risk you stack. Using stETH as collateral in a lending protocol means you are now exposed to the Ethereum network, the Lido protocol, and the lending protocol. Three separate failure modes instead of one.
This is not a reason to avoid LSTs. It is a reason to size your position with these layers in mind. Most people do not.
Realistic Expectations
Liquid staking tokens are a legitimate tool. The yields are real. The liquidity benefit is real. The risks are also real and underexplained.
The yield you earn comes from network inflation and transaction fees on the underlying protocol. It is not magic. It is not sustainable at arbitrary levels. As more capital flows into liquid staking, yields get diluted. The rates you see today will not hold indefinitely. Check current yields on-chain before making any decision. Do not rely on screenshots or blog posts, including this one.
The LST peg to its underlying asset is a mechanism, not a guarantee. Secondary market conditions can and do break it temporarily. If you cannot hold through a depeg, you should not hold LSTs.
If you are new to this, start small. Pick one protocol. Understand how the token you receive actually works before you deploy it anywhere else in DeFi.
Your first action step: Go to DefiLlama's liquid staking section. Look at the total value locked in the major protocols. Look at the current yield rates. Compare Lido and Rocket Pool side by side. Do not touch a single dollar until you understand what you are looking at.
Disclosure: This post contains affiliate links to Trezor. BitBrainers may earn a commission at no extra cost to you. This is not financial advice.
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