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Staking on Lido vs Buying stETH – Which Option is Better?

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With Ethereum’s merge to proof-of-stake (PoS) around the corner, interest in staking on the new network is soaring. More specifically, liquid staking through protocols such as Lido are gaining momentum, as users seek to retain some utility on their staked ETH by being issued stETH in return.

One interesting phenomenon on Lido is the app recently pointing out that you can just buy stETH on the open market instead – at a discount of around 3%.

But, is buying stETH the same thing? And why is there a discount on stETH in the first place?

Let’s dive in.

What is stETH?

Lido staked Ether (stETH) is a token that is minted and issued on a 1:1 basis with Ether (ETH) when a user stakes ETH in the Lido protocol. 

The real ETH remains staked on the PoS beacon chain and collects staking rewards, while the issued stETH represents a transferable claim on that staked ETH and staking rewards.

Why is stETH trading at a discount to ETH?

Although stETH is often expected to trade 1:1 with ETH, one must also factor in a variety of variables that may impact the price. 

Most of these variables come down to two main things: 

  1. Lock-up time
  2. Risks involved

Lock-up time

As you may know, ETH staked on the beacon chain (via Lido or otherwise) cannot be withdrawn until the “Shanghai” Ethereum network upgrade, which isn’t expected until early 2023. As with many Ethereum upgrades, this has a chance of being delayed. 

Until then, stETH is effectively “locked-up” – stakers cannot access their ETH for other uses until the upgrade. 

Those who value accessing their ETH sooner, rather than waiting for the upgrade, may be willing to sell their stETH at a discount – placing downward pressure on the stETH price relative to ETH itself.

Risks

There are also plenty of risks to consider – many of which are unlikely, but could have a significant impact if they materialize. These include:

Smart contract risk

Since Lido is a decentralized staking platform, it is built on smart contracts. These smart contracts are only as good as the code they’re made up of – and like any code, there is a chance of a bug or vulnerability that puts funds at risk. 

Although Lido smart contracts have been audited by industry leaders, there is always a small chance that something was missed.

Staking penalties and slashing risks

In the Ethereum PoS model, all validators risk penalties and/or “slashing” for performing incorrect or malicious activity on the network. 

Simple staking penalties come from minor offenses such as producing incorrect data or not producing any network data at all, resulting in a penalty paid in ETH. 

Slashing is more serious and can result in a validator being kicked off the network completely, or forfeiting up to 100% of their stake. This can result from actions such as double-spend attempts.

If a Lido validator is penalized or slashed, the losses will be incurred across all stakers.

Lido DAO

The Lido decentralized autonomous organization (Lido DAO) is also a risk factor, which relies upon effective governance and execution of the community’s wishes. 

There are also 600,000 ETH held across accounts backed by a mutli-signature scheme, relating to the early stages of Lido. If enough of these keys are compromised or lost, this could result in the loss of those funds (representing under 20% of all ETH staked in Lido).

Ethereum protocol risk

Obvious but often overlooked, the success of Lido’s liquid staking model relies upon the Ethereum protocol itself. Although there’s a ton of confidence in Ethereum and its developers, it is still a new and ever-evolving technology which carries its own risks. 

Issues related to staking mechanisms, which are new on the network, would have a direct impact on Lido and stETH holders.

Tying it together

In summary, holding stETH comes with additional risks and downsides (but also some upsides) when compared to holding just ETH. 

The amount of perceived risk, combined with demand for ETH now (vs. redeeming ETH later with interest) all plays into the market price of stETH – which for now is below the market price of ETH itself.

Should I buy stETH instead of staking my ETH on Lido?

Yes. As long as there is a discount on the market price of stETH vs. ETH, you will most likely benefit from buying stETH on the open market rather than staking it via Lido.

Purchasing stETH at a discount, instead of staking it at a 1:1 exchange rate, will yield more stETH for the same investment – providing you with a larger stake of stETH. This provides you with a larger claim on ETH once it is redeemable. You will not miss out on anything by doing so, while also contributing to market demand for stETH (rather than increasing its supply). 

It is, however, important to also factor in gas fees and slippage into your equation, which may affect the overall discount.

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