After almost two years, Ethereum finally completed its transition to Ethereum 2.0 (also known as the Merge) in September 2022. However, users still couldn't withdraw their staked ETH until the Ethereum Shanghai upgrade, scheduled for March 2023. This upgrade will resolve the issue of illiquidity, but staking on Ethereum remains complicated and costly. For instance, to secure the network, one needs to lock at least 32 ETH, which is a substantial amount to tie up.
To address this staking challenge on Ethereum 2.0, Lido, a liquid staking solution, developed a platform that allows users to stake any amount of ETH and retain its liquidity through a token called stETH.
What is stETH?
stETH is a special token used in Lido (LDO) that represents the Ether you stake. When you stake 1 ETH on Lido, you get 1 stETH in return. The cool thing about stETH is that you can use it just like regular ETH in DeFi platforms like Curve, Aave, and Maker. You can sell it, spend it, or even use it as collateral for borrowing on crypto lending platforms. After the Shanghai upgrade, you can also use stETH to get back your staked ETH.
How stETH Works
stETH works using oracles and a rebase function. Every day at 12 PM UTC, the stETH token balances are updated based on changes in the total staked ETH, which is reported by an oracle. When you stake your ETH with Lido, you start receiving daily rewards from the first day of staking. The rewards are distributed to all stakers, even if their ETH is still in the queue waiting to be staked. Since the rewards are tied to the balance rebase, stETH holders will see their wallet balance automatically change without any additional transactions.
The rebase mechanism of stETH also works with various DeFi platforms, so if you spread stETH and stake it in these protocols, you can get additional rewards. The staking rewards for stETH may be lower than those of the Ethereum Beacon Chain because there is a queue for staking, and only a few validators are accepted each day. As a result, the rewards are shared among all stETH holders. However, the reward rate for stETH will increase over time as more validators are activated by Lido.
Use Cases
stETH is a token version of ETH that you stake on Lido. It works similarly to ETH, especially in the DeFi ecosystem. Here are some ways you can use stETH:
Liquidity Pools: You can provide liquidity by participating in liquidity pools in DeFi. Lido has partnered with platforms like Curve, SushiSwap, 1inch, and Bancor to make stETH useful in these pools. By providing liquidity, you can earn rewards in the form of LDO tokens and the native tokens of the DeFi platform.
Yield Farming: Yield aggregators, like Harvest Finance and Yearn Finance, can use stETH to offer additional rewards to users participating in yield farming. They use strategies to maximize rewards by spreading assets across multiple DeFi platforms.
Lending: You can use stETH as collateral on Aave, a crypto lending platform. This allows you to keep earning staking rewards while using stETH as collateral for borrowing other assets like ETH. You can also use stETH on Inverse Finance, where Anchor is a money-market protocol for lending and borrowing assets using synthetic tokens. Note that this Anchor is different from Terra/Luna's Anchor Protocol.
How Ethereum Merge Affects stETH
Lido offers a way for ETH holders to stake their ETH and earn passive income. Even after the Ethereum Merge, stETH remains valuable for a few reasons:
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Lido provides a more affordable staking option compared to the high minimum amount of ETH required for staking directly on Ethereum post-Merge.
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Users can't unstake ETH before the Ethereum Shanghai upgrade, but they can swap stETH tokens on decentralized exchanges (DEXs) and use them in DeFi applications to earn more rewards.
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Lido has made a special upgrade for the Merge, providing additional rewards for validators who also act as block proposers to receive priority fees.
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Lido's community and node operators are discussing the possibility of distributing Maximum Extractable Value (MEV) rewards to validators and stakers.
Effect of Ethereum Shanghai Upgrade on stETH
The Ethereum Shanghai upgrade enables withdrawals on the ETH staking contract, making staking ETH less risky. Even after the upgrade, there will still be demand for liquid staking like stETH. This is because stETH allows for quick buying and selling in the market, unlike actual staked ETH which is more challenging to access.
Moreover, stETH remains a good alternative for many users since staking directly on Ethereum is expensive and complicated. People who believe in Ethereum's potential may see stETH as a chance for arbitrage due to price differences between the two. However, catching such opportunities requires patience and careful consideration.
