stETH Thoughts: What Are the Deep Advantages Under Its Dominant Position?
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stETH Thoughts: What Are the Deep Advantages Under Its Dominant Position?
The Lido protocol is managed by the Lido DAO, which distributes ETH and stETH rewards. As the most liquid and widely used staking token, stETH offers low risk and high returns, with growing liquidity on centralized exchanges.
Navigating Web3 tides with focused insightsAuthor: magicdhz
Translation: Baihua Blockchain
Key Takeaways:
Managed by the Lido DAO, the Lido protocol is an open-source middleware that routes ETH, stETH, and Ethereum rewards among a set of validators and ETH stakers.
stETH is the most liquid Liquid Staking Token (LST) and the most widely used form of on-chain collateral.
The liquidity of stETH and its use as collateral are also growing on centralized exchanges, indicating institutional preference for trading and holding stETH over ETH.
Through diversified validator delegation, stETH carries lower risk and offers higher probability-adjusted returns.
As traditional finance seeks exposure to ETH staking yields, this could lead to the development of "TradFi ETH" products—stETH as a coordination tool can resist centralization trends.
1. Introduction: stETH > Traditional Finance ETH (ETF)
On May 20, 2024, Eric Balchunas and James Seyffart raised the odds of spot ETH ETF approval from 25% to 75%. ETH surged approximately 20% within hours. However, under SEC requirements, issuers revised their S-1 registration statements to remove staking rewards from the ETFs. As a result, investors holding spot ETH ETFs will not receive Ethereum staking rewards, possibly because offering staking-enabled ETH products requires clearer regulatory guidance. Regardless, at current rates, investors choosing to hold spot ETH ETFs will forgo around 3–4% annualized yield generated from consensus and execution layer rewards. Therefore, there is strong incentive to incorporate staking into ETF products to reduce dilution.
The Lido protocol is an open-source middleware that autonomously routes pooled ETH deposits to a set of validators according to delegation standards. The Lido DAO, governed by LDO holders, manages certain parameters of these delegation standards, such as protocol fees, node operators, and security requirements. However, the protocol is non-custodial—the DAO cannot directly control the underlying validators. Accounting for about 29% of total network staked ETH (9.3 million ETH, or $35.8 billion), stETH is critical infrastructure in the staking industry, with high performance, delegation quality, and staking practices.
Spot ETH ETFs may be the most convenient way for traditional finance investors to gain ETH exposure today, but these products fail to capture Ethereum issuance or crypto-economic activity. As more traditional financial venues connect directly to tokens, holding Lido’s liquid staking token stETH is arguably the best product to gain exposure to both ETH and Ethereum staking rewards, due to its key utility within existing market structures:
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stETH is the most liquid and highest-volume ETH-staked asset on decentralized exchanges (DEXes).
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stETH is the most widely adopted form of collateral in DeFi, surpassing even major stablecoins like USDC and ETH itself.
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stETH is the most liquid and yield-bearing L1-native asset on centralized exchanges (CEXes), increasingly serving as an alternative to spot ETH trading and as collateral.
With the emergence of spot ETH ETFs, stETH's dominance is likely to persist as investors become more informed about Ethereum and seek additional returns from consensus and execution layer rewards—favorable for reinforcing a stronger stETH market structure. Looking further ahead, as traditional financial institutions eventually integrate staking into their offerings (termed “TradFi ETH”), Lido DAO governance and stETH growth become crucial to maintaining a sufficiently decentralized validator set on Ethereum.
Therefore, “stETH > TradFi ETH” because it offers superior returns, greater utility than adjacent products, and serves as a coordination tool against centralization.
2. Lido Protocol
Lido’s middleware consists of a set of smart contracts that programmatically allocate users’ ETH to vetted Ethereum validators. This Liquid Staking Protocol (LSP) aims to enhance Ethereum’s native staking capabilities. It primarily serves two parties: node operators and ETH stakers, addressing two core issues: the high entry barrier for validators and the liquidity loss from locking up ETH for staking.
Although hardware requirements for running a validator on Ethereum are not as demanding as on other chains, node operators must stake exactly 32 ETH increments per validator to participate in consensus and earn Ethereum rewards. Raising such capital is difficult for potential validators, and allocating ETH in fixed 32 ETH chunks can be highly inefficient.
To streamline this process, Lido routes investor ETH into a validator pool, effectively lowering the high economic threshold. Additionally, through rigorous evaluation, monitoring, and delegation strategies across node operators, the Lido DAO mitigates risks associated with the validator set. Operator statistics and metrics from the validator pool can be found here.
In return for their ETH deposit, investors receive stETH, whose value proposition is simple. Running a validator or staking ETH requires locking ETH in a contract, whereas stETH is a liquid utility token usable across CeFi and DeFi.
1) stETH
stETH is a Liquid Staking Token (LST), a type of utility token representing the total amount of ETH deposited into Lido, plus staking rewards (minus fees) and minus penalties. Fees include staking commissions collected from validators, the DAO, and the protocol.
When a user deposits 1 ETH into Lido, 1 stETH token is minted and sent to them, while the protocol records their share of ETH in the pool. This share is recalculated daily. stETH acts as a claim token redeemable for the user’s proportional share of ETH in the pool. By holding stETH, users automatically earn Ethereum rewards via a rebase mechanism—essentially, as rewards accrue to the validator set, the protocol mints and distributes additional stETH tokens based on each account’s share.
stETH rewards are a function of ETH issuance, priority transaction fees, and MEV rewards. ETH issuance is the reward validators receive for participating in consensus and correctly proposing blocks. Currently, issuance stands at 917,000 ETH per year (though discussions exist about changing this monetary policy). Priority fees are paid by users to prioritize transaction inclusion. MEV rewards represent an additional revenue stream from running MEV-Boost, which facilitates a market by allowing validators to capture part of the block reward. These rewards are calculated based on demand for Ethereum block space. According to mevboost.pics, validators earned approximately 308,649 ETH (~$7.04 billion at the Jan 1, 2024 ETH price) in 2023 via MEV-Boost. Taking all factors into account, simply holding stETH could yield investors between 3–4% annualized returns in 2024.
In summary, unlike spot ETH ETFs, stETH is a liquid product that allows investors to own ETH while capturing Ethereum’s cash flows. Furthermore, stETH is one of the most commonly used assets across various DeFi environments.
2) Utility of stETH
The key features that make stETH an ideal asset are its liquidity and collateralizability. Normally, unstaking ETH takes several days, as stakers must wait in an exit queue whose duration depends on queue size. This can create duration mismatch—where ETH’s value changes significantly between withdrawal request and redemption.
The core value proposition of stETH is its liquidity. Instead of waiting in the exit queue, stakers can simply sell stETH on decentralized (DEX) or centralized (CEX) exchanges to exit their position. A keen observer will note that eliminating duration mismatch transfers risk to secondary markets’ willingness and ability to absorb stETH inventory. Nevertheless, given the approval of spot ETH ETFs and trends in stETH characteristics and underlying market structure, we can reasonably expect further adoption of stETH—and deeper liquidity.
3) Liquidity of stETH
Notably, in 2023, stETH reserves in liquidity pools on Ethereum and Rollups declined. This was due to the DAO adjusting incentives for on-chain stETH LPs, meaning LPs who previously farmed LDO rewards withdrew their liquidity. By 2024, reserves stabilized. Shifting from subsidized LPs (who typically withdraw during stress periods) to genuine, unsubsidized stETH LPs represents a healthier on-chain liquidity landscape for stETH. Despite these market corrections, stETH remains one of the most liquid assets in DeFi and ranks in the top ten for TVL on Uniswap.
During the same period, stETH trading volume and pool utilization increased. Trends in the following charts indicate:
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Liquidity providers are more stable and consistent
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The market for stETH liquidity is approaching a more stable equilibrium
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More participants are becoming comfortable trading stETH
These market structures provide a stronger, organic foundation for expansion compared to overspending LDO incentives on seasonal liquidity providers. As shown below, stETH dominates trading volume and liquidity compared to other Liquid Staking Tokens (LSTs).
Liquidity is critically important—arguably the greatest determinant of risk management in financial markets. An asset’s liquidity profile significantly impacts its risk-adjusted returns and thus its attractiveness to investors. This makes stETH a better choice for investors and traders seeking Ethereum rewards, as demonstrated in a Blockworks panel discussion featuring major native crypto institutions like Hashnote, Copper, Deribit, and Cumberland. The chart below shows the trend of native crypto institutions adopting stETH on centralized exchanges: more native institutions and market makers prefer holding and trading stETH. Note: Global bid data for February and March is partially incomplete due to exchange changes in order book rate limits.
4) stETH as Collateral
stETH is also the most popular form of collateral in DeFi, surpassing even ETH and popular stablecoins like USDC, USDT, and DAI. The chart below shows how it has gradually risen to this position since launch, now accounting for roughly one-third of total market share.
Treating stETH as a high-quality collateral option increases capital efficiency and may help exchanges and lending platforms generate additional volume. In February, Bybit announced raising stETH’s collateral factor from 75% to 90%. Since then, stETH trading volume on Bybit has nearly increased tenfold.
It appears that stETH’s on-chain market structure has reached a more stable equilibrium, potentially laying a solid foundation for gradual long-term growth. Off-chain, we observe increasing institutional adoption, as investors show preference for staked ETH over plain ETH. While we also expect other liquid staking tokens (including possibly liquid staking warrants) to gain market share, stETH’s existing market structure, dominance, and first-mover advantage should allow it to maintain a strong market position. Moreover, Lido and stETH possess several favorable characteristics compared to other staking options. Compared to other staking mechanisms, Lido’s design has three key features: non-custodial, decentralized, and transparent.
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Non-custodial: Neither Lido nor node operators hold custody of user deposits. This reduces counterparty risk—node operators never control users’ staked ETH.
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Decentralized: No single organization validates the protocol; technical risk is distributed across a set of node operators, improving resilience, availability, and rewards.
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Open-source: Anyone can review, audit, or propose improvements to the protocol’s code.
When comparing stETH to other Liquid Staking Tokens (LSTs) and staking service providers, Rated data shows minimal differences in rewards among top node operators by total staked amount—around 3.3–3.5%. However, considering operational factors such as maintenance, cloud infrastructure, hardware, code upkeep, client types, and geographic distribution, even small reward differences reflect significant underlying risks.
stETH carries lower risk because it ensures exposure across multiple operators running different machines, codebases, and clients in diverse locations, managed by separate teams. This reduces downtime risk and defaults are more dispersed. In contrast, other staking providers operate more centrally, posing potential single points of failure. For more details on this topic, see the comprehensive research report by Blockworks analyst 0xpibblez.
5) Probability of stETH Outperformance
Referring to the first chart below, we observe that execution-layer rewards (priority fees + base MEV) are more volatile than consensus-layer rewards (issuance). The second chart below provides a magnified view of this volatility over the past month. This stems from the cyclical nature of on-chain activity—during high-activity periods, more valuable blocks lead to higher execution-layer rewards, while consensus-layer rewards remain constant. This means realized staking rewards depend on the probability of a validator proposing the next block, capturing the variability of execution-layer rewards.
Because stETH stakes across a broad and diverse set of operators and represents 29% of total staked ETH, it has a higher probability of capturing variable block rewards compared to individual validators, smaller operators, or smaller validator sets. This means it consistently achieves higher average reward rates.
In other words, in extreme cases, when an independent validator proposes an exceptionally valuable block—even if total returns are much higher (e.g., earning 10 ETH from a single block with 32 ETH staked)—the probability of this happening is extremely low, roughly one in a million (32/32,400,000). They essentially win a lottery. In contrast, Lido’s validator set has about a 29% chance of capturing such valuable blocks. Thus, stETH holders choose—and reinforce—a higher probability of shared rewards.
In summary, another reason stETH is a superior choice for gaining exposure to staked ETH rewards is that it generates highly competitive returns on a probabilistic and risk-adjusted basis.
3. Lido Governance: Growing Importance of stETH for Decentralization
Approval of spot ETH ETFs brings expectations for additional products, the most obvious being staked ETH products. During his bull market hiatus, crypto-native legend DegenSpartan wrote a post titled “How Many Trojan Horses Can We Launch?” In this short blog, DegenSpartan stated: “After spot ETFs, we can still expect more [TradFi] onramps—options, fund inclusion, mutual funds, retirement accounts, dollar-cost averaging, structured products, dual currencies, Lombard loans, etc.”
While U.S. capital markets will gain greater access to ETH, bringing more permanence (structural tailwinds), it remains unclear how TradFi will integrate other digital assets or derivatives and what side effects they might have on decentralization.
1) TradFi ETH vs. stETH
Philosophically, we believe LSTs are the best way to maintain a sufficiently decentralized, secure, and high-performance validator set. Grandjean et al. calculated Ethereum’s HHI index (a metric assessing market concentration and competitiveness) and found that Lido has improved decentralization (as shown by lower HHI readings in the chart below).
While viewing Lido as a single entity results in a high HHI (i.e., less network decentralization), we do not believe this characterization accurately reflects Lido’s market presence, as the protocol is not managed or controlled by a single organization, and the validator set comprises various independent entities. While large LSPs pose risks, implementing proper governance mechanisms and protocol oversight—such as dual governance—should mitigate their severity. Moreover, the integration of DVT is expected to further decentralize the operator set.
That said, given the economic incentives of staking ETH—or the dilution faced by holding native ETH—it is plausible that traditional finance will eventually offer staked ETH products. Some possible (purely hypothetical) outcomes include:
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Traditional finance explicitly adopts stETH and all its benefits
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Traditional finance closely collaborates with Coinbase or other large staking providers to build this framework, where cbETH or tradfiETH becomes the official TradFi staked ETH product
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Traditional finance develops its own practice—investing in proprietary node operations, self-custodying staked ETH, and issuing tradfiETH products.
“While all of this is fine for BTC [and ETH], future developments are somewhat unknown.” – DegenSpartan
We believe, and evidence suggests, that scenario (1) is the better solution for the network. If staked ETH trends toward TradFi ETH, on-chain staking risks will tend toward centralization. Therefore, in a world where well-capitalized incumbents develop centralized staking products, as long as Lido maintains sufficient decentralization, both stETH and the DAO are critical to preserving Ethereum’s overall integrity—because the DAO governs stETH delegation and indirectly influences network performance, security, and decentralization.
2) Risks
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Volatility and Liquidity: When ETH volatility spikes, investors prefer selling stETH on public markets rather than waiting in the withdrawal queue. During high-volatility periods, insufficient liquidity could cause stETH prices to deviate from its 1:1 peg with ETH, creating subsequent risk until market conditions normalize.
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Recursive Risk: A common method to amplify rewards (e.g., for airdrops or liquidity mining), users take leveraged positions—borrowing stETH, borrowing ETH, buying stETH, lending more stETH, and repeating until fully leveraged. During volatile periods, recursive users face liquidation risk, which may trigger amplified risks related to volatility and liquidity.
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Protocol and Governance: Risks associated with LSPs holding significant market share. stETH delegation is governed by the DAO. While the DAO is moving toward dual governance—which would reduce these risks—if stETH captures a dominant share of staked ETH, concerns about concentration of ETH power into LDO governance are justified.
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Smart Contract: The Lido protocol is executed via a suite of smart contracts, including deposit, withdrawal, delegated staking, slashing, and key management. These systems carry unforeseen bugs or malicious upgrades.
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Competition: The LST market is large, and more restaking protocols are entering the space. Traditional finance also has the capacity to develop its own staking products, which may be more accessible to certain investors given current market structures.
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Regulation: Although spot ETH ETF approval may make staking providers safer on average, staked ETH will still face regulatory scrutiny. Relevant legal debates include (but are not limited to) the role of staking providers, the distinction between “management” and “administration” under the Howey test, and whether LSPs qualify as “issuers” (per the Reve test).
4. Final Thoughts
By today’s standards, stETH is arguably the best product available to gain exposure to staked ETH participation. It is the most liquid LST on-chain, the most widely used form of collateral in DeFi, and these market structures are rapidly expanding off-chain—as evidenced by rising trading volumes on exchanges (particularly Bybit and OKX).
While holding stETH carries risks, these robust market structures are likely to persist and may further expand, driven by stETH’s attributes, Lido’s protocol, growing demand for Ethereum-wide alignment, and upcoming catalysts. These catalysts on the roadmap include Distributed Validator Technology (DVT), dual governance, pre-confirmations, allocation of additional resources for restaking stETH, and an improved governance structure supporting Ethereum research. More importantly, if traditional finance develops staked ETH products, stETH and the Lido DAO will play an increasingly vital role across Ethereum’s broader ecosystem.
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