Liquid Staking and Restaking Explained: How LSTs Work and the Risks They Add

Staking locks up a proof-of-stake cryptocurrency like Ethereum to help secure the network in exchange for a yield, but traditional staking makes the underlying asset illiquid for as long as it stays locked. Liquid staking solves that problem by issuing a tradeable token that represents the staked position.

When an investor stakes through a liquid staking protocol, they receive a liquid staking token, or LST, such as stETH, in return for the deposited asset. That LST can be traded, used as collateral, or deployed into other crypto strategies while the original stake keeps earning network rewards in the background.

Restaking takes the same underlying stake and pledges it again to secure additional protocols beyond the base blockchain, stacking extra yield on top of the base staking reward. That extra yield comes with extra risk, since the same collateral is now backing more than one system at the same time.

This guide explains how liquid staking tokens actually work, what restaking adds on top, and the specific risks, from smart contract failure to slashing, that come with stacking yield this way.

How Liquid Staking Tokens Work

A liquid staking protocol pools deposits from many users, runs the validator infrastructure needed to stake on the underlying blockchain, and issues each depositor a token representing their proportional claim on the pooled stake plus accumulated rewards, all without the user needing to run their own validator node.

The LST's value tracks the underlying staked asset plus rewards, either through a rebasing mechanism that increases the token balance over time, or through an exchange rate mechanism where the token balance stays fixed but each token becomes redeemable for a growing amount of the underlying asset.

Because the LST is a standard token, it can be listed on exchanges, deposited into lending markets, or paired in liquidity pools, which is the core value proposition: an investor keeps staking yield while also retaining the flexibility to use that capital elsewhere in the crypto ecosystem.

What Restaking Adds on Top of Base Staking

Restaking protocols let a staker pledge an already-staked asset, or its LST, to also secure other services, such as oracle networks, bridges, or new blockchains that need economic security but do not want to bootstrap their own validator set from zero.

In exchange for taking on this additional responsibility, restakers earn extra rewards from each additional protocol they secure, on top of the base network's staking yield, which is the main appeal for yield-focused crypto investors willing to accept more complexity.

The tradeoff is that a restaker is now exposed to the slashing conditions of every protocol they secure, not just the base blockchain, so a single restaked position can carry several independent sources of penalty risk stacked on top of each other rather than a single, well-understood risk from the base chain alone.

Smart Contract and Protocol Risk

Liquid staking and restaking both depend on smart contracts to manage deposits, track balances, and handle withdrawals, and a bug or exploit in any of these contracts can put the entire pooled stake at risk, a scenario that has happened to smaller, less audited protocols in the past.

Protocol concentration is a related risk at the network level: if one liquid staking provider controls a very large share of a blockchain's total staked supply, it introduces a centralization risk to the base chain itself, which is why some networks actively discourage any single provider from dominating stake share.

Governance risk sits alongside these technical concerns, since large liquid staking protocols are often controlled by a token holder vote, and a change to fee structure, validator selection, or withdrawal mechanics can be approved through governance without every individual staker's direct input.

• Check whether the protocol's smart contracts have completed multiple independent audits
• Look at how large a share of total network stake the protocol controls
• Confirm whether a bug bounty program and insurance fund exist

Slashing Risk and How It Compounds With Restaking

Slashing is a penalty applied to a validator, and by extension the stakers behind it, for misbehavior such as going offline for extended periods or signing conflicting blocks, and a slashing event reduces the value of the staked position directly rather than just reducing future rewards.

With restaking, a single validator key backing multiple protocols means a slashing event on any one of those protocols can affect the entire restaked position, so the effective slashing surface grows with each additional protocol a restaker chooses to secure.

Reviewing each protocol's specific slashing conditions before committing to a restaking strategy is essential, since some protocols slash a small percentage for minor infractions while others impose much harsher penalties for more serious violations, and these terms vary significantly across the restaking ecosystem.

Liquidity and Depeg Risk of LSTs

An LST is supposed to trade close to the value of its underlying staked asset, but during periods of market stress, LSTs have historically traded at a discount, since withdrawal from the base staking protocol is not always instant and some sellers prefer to exit at a slight loss rather than wait.

This depeg risk matters most for investors who plan to use an LST as collateral in a leveraged position, since a temporary discount can trigger a margin call or liquidation even though the underlying staked asset itself has not actually lost value on the base chain.

Liquidity depth on the exchange or liquidity pool where an LST trades also matters directly, since a thinly traded LST can experience a much larger price impact from a single large sell order than a deeply liquid one, widening the effective discount during exactly the moment a staker most needs to exit.

Yield Sources and Whether They Are Sustainable

Base staking yield comes directly from network issuance and transaction fees, and it is generally the most predictable and sustainable yield source in this entire category, since it is defined by protocol rules rather than dependent on demand from other market participants in the broader market.

Restaking yield and additional incentive rewards from newer protocols are less predictable, since they often depend on token emissions from a young project trying to attract stake, and that kind of incentive can be reduced or removed once the protocol has attracted enough security without needing to keep paying a premium.

Before chasing the highest advertised yield, break down how much of the total return comes from durable base staking rewards versus temporary incentive emissions, since the incentive portion is the piece most likely to shrink once a new restaking protocol matures.

Tax and Regulatory Considerations

Staking and restaking rewards are generally treated as taxable income in most jurisdictions at the point they are received, separate from any capital gain or loss when the underlying asset or LST is eventually sold, so tracking reward events accurately matters for tax reporting purposes.

Regulatory treatment of liquid staking is still evolving in several major markets, and some regulators have questioned whether certain staking arrangements qualify as an unregistered securities offering, which is a risk factor worth monitoring for any investor holding a large LST position long term.

Exchange and platform policy can also change independently of formal regulation, since some centralized exchanges have restricted or delisted certain LSTs in response to regulatory pressure in specific jurisdictions, which is a practical liquidity risk separate from the underlying protocol's own technical soundness.

A Practical Approach to Sizing a Liquid Staking Position

Treat base liquid staking as the more conservative layer of a crypto yield strategy, and treat restaking as an additional, smaller allocation reserved for the portion of a portfolio where extra risk for extra yield is genuinely acceptable rather than a default choice for the entire staked position.

Spreading a liquid staking allocation across more than one reputable protocol reduces single-protocol smart contract and depeg risk, in the same way diversifying across brokers or exchanges reduces counterparty risk elsewhere in a crypto portfolio.

Reassess the position periodically rather than treating it as a set-and-forget allocation, since protocol risk profiles change as they grow, add new integrations, or accumulate a longer audit and incident history that either strengthens or weakens the original case for holding the position at its current size.

• Keep base staking and restaking allocations separate and sized independently
• Diversify LST holdings across more than one audited protocol
• Track reward events for tax reporting as they are received
• Avoid using LSTs as leveraged collateral without accounting for depeg risk