What is stETH? What is Lido?
Learn how you can use stETH to earn yield on your ETH.
Today, we’ll learn about how to easily stake your ETH through the Lido protocol.
TLDR; Earn rewards on top of your ETH for validating transactions on ETH 2.0 while retaining full control of your assets. Compound your yield by using your stETH to interact with other DeFi protocols.
What is Staking in Ethereum?
To understand what staking is, you need to have a high level understanding of how blockchains work. The key concept to understand is the difference between Proof of Work (PoW) blockchains and Proof of Stake (PoS) blockchains.
In Proof of Work blockchains, like Bitcoin and ETH 1.0, miners validate transactions and use tons of computing power to solve difficult cryptographic problems. The details of the cryptographic problems are unimportant, but just know that they are very computationally intensive and require a lot of electricity to solve. Miners compete with one another to be the first to solve the puzzle. The first miner who is able to solve that puzzle “mines” bitcoin or ether as a reward for solving the puzzle, validating the transactions, and creating the latest block.
In Proof of Stake blockchains, such as ETH 2.0, transactions are validated in a different way. Instead of solving computationally difficult problems, ETH holders “stake” their ETH. These stakers then are then selected at random to validate transactions and receive rewards for validating those transactions.
Proof of Stake means you don’t need expensive computer equipment to secure the network; you simply need to own and agree to stake your ETH! When you’re selected to validate transactions, new ETH is “minted” and given to you as a reward. PoS blockchains are also much more energy efficient than PoW blockchains because they don’t require huge amounts of electricity to create new blocks.
Today, the annual percentage yield (APY) for staking ETH is around 5-6%. That’s an extra 5-6% return just for holding ETH!
Finematics has a great video about ETH 2.0 and staking if you want to dive deeper.
How to Stake ETH
To stake ETH, you’ll need to deposit 32 ETH to activate validator software.
Wait, what? 32 ETH is a lot of money! At the time of this writing ($2,400/ETH), it’s about $77,000!
Most people getting started don’t have that kind of capital to move around, nor do they want to deal with running a validator. So how can you help the Ethereum network and earn staking rewards if you don’t own 32 ETH?
There are lots of other people who don’t have 32 ETH just laying around. Instead, these people come together and deposit their ETH in a pool. They can then use their collective 32 ETH and earn rewards for staking. The rewards for the pool are split proportionally among the depositors in the pool.
Some exchanges, like Coinbase, will let you stake your ETH right on the platform. This is probably the easiest way to begin staking your ETH, but it’s not always the best solution. Like all other centralized exchanges, Coinbase ultimately has control over whether or not you can buy, sell, or send assets off their platform.
How can you stake your ETH in a decentralized, permissionless fashion?
Lido & stETH
Lido is a protocol that allows users to pool their ETH together to earn daily staking rewards for validating transactions. There’s no minimum level of tokens required to join a pool and users can leave whenever they choose. So far, Lido may just seem like a decentralized version of Coinbase’s staking program.
But one of the huge benefits of Lido is that the protocol allows you to keep the liquidity of the ETH that you’ve staked! That means you can use it to interact with other DeFi protocols while the underlying ETH still earning staking rewards. Here’s how it works.
First, a user deposits ETH into a Lido pool. For each ETH the user deposits, Lido mints 1 stETH (staked ETH) and gives it to the user. stETH represents the user’s stake in the Lido pool and earns daily staking rewards (in the form of more stETH).
This stETH is pegged 1:1 the the price of ETH. So the price of 1 stETH should be roughly the same as 1 ETH.
The Benefits of stETH
First, stETH allows the user to retain full control over their ETH. The user is free to buy or sell stETH on decentralized exchanges (DEXs) like Uniswap at any point in time. There are no lockups or third parties that can limit your ability to liquidate your stETH.
Secondly, you are able to use your stETH to interact with a number of different DeFi protocols to further compound your yield.
For example, you could provide liquidity to the eth+steth pool on Curve. Right now, you’d earn 3.14% APY (because the pool is split 1/2 ETH, 1/2 stETH, the staking rewards from stETH are diluted).
However, on top of the base liquidity provider rewards, the depositor can earn additional rewards from Curve and Lido for providing liquidity to the pool. Curve and Lido want to ensure that liquidity in the pool is available, so in order to incentivize people to provide liquidity, they offer rewards in the form of CRV and LDO tokens. This is sometimes referred to as “liquidity mining.” So technically, by providing liquidity to the pool below, you’d be making around 11% yield on your ETH.
Risks of stETH
Nothing in life is without risk.
If the price of ETH drops, so will the price of stETH. So while you’ll still earn staking rewards, a decline in the price of ETH could offset any staking rewards that you earn and cause you to lose money.
Slashing risk - if ETH 2.0 validators fail to validate transactions, they will lose their staked ETH. Lido seeks to mitigate this risk by diversifying across a number of professional and well-reputed validators. Lido also uses fees from the protocol to purchase insurance from Unslashed to protect against slashing risk.
Theoretically, Lido’s smart contracts could contain some vulnerability that could allow malicious actors to harm users. However, Lido has been in operation since December 2020 and its code is open-sourced, audited and covered by an extensive bug bounty program to minimize smart contract risk.
Disclaimer: The above references an opinion and is for information purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice.