Ethereum's tokenization variants: from wrapped tokens to liquid staking tokens

Author: Tanay Ved

Source: Coin Metrics

Compiled by: Shaw Golden Finance

Key points

The tokenized versions of ETH (such as WETH, LST, and LRT) enable ERC-20 compatibility, greater interoperability, and improved on-chain capital efficiency.

Approximately 24% of ETH is staked through Lido, with stETH and its wrapped form wstETH becoming widely used forms of DeFi collateral, often employed in looping strategies to enhance yields.

The pricing and reward mechanisms of these tokens vary, with some adopting a rebalancing design, while the wrapped versions appreciate as the exchange rate with ETH rises.

As the scale of these assets expands, monitoring the validator queue, secondary market liquidity, and the premium/discount of LST to ETH will become very important for assessing redemption and liquidity risks.

Introduction

As a Layer-1 blockchain, Ethereum's value proposition goes far beyond digital currency. Its programmability allows assets to be utilized more efficiently, such as securing the network and serving as yield and collateral assets within its on-chain ecosystem. To enhance the usability and composability of ETH in these scenarios, various “variants” or tokenized versions of ETH have emerged.

From providing ERC-20 compatible wrapped tokens like Wrapped ETH, to offering staking yields and transferable liquid staking tokens like (LST), as well as other token variants that provide additional yields and utility. These tokenized forms of ETH have become an important part of the Ethereum infrastructure, unlocking interoperability and capital efficiency. However, as they become more layered and intertwined within the ecosystem, they will have significant impacts on liquidity, anchor stability, and redemption dynamics.

In this report, we will analyze the tokenized versions of ETH and explain the reasons for their emergence. Afterwards, we will focus on liquid staking tokens, analyzing their pricing mechanisms, reward structures, and utilities, while assessing the liquidity conditions and the risks that affect their stability.

Tokenized ETH ecosystem landscape

Currently, Ethereum assets mainly exist in the following forms: native ETH, wrapped ETH, liquid staking ETH (LST), and liquid re-staking ETH (LRT). Although these variants may increase complexity, their emergence aims to address previous limitations, enhance liquidity, composability, and access new on-chain yield opportunities.

Different Tokenization Performances of ETH and Their Interrelationships

Wrapped ETH (WETH)

As the native token of Ethereum, ETH is crucial for paying transaction fees, compensating validators to secure the network, and acting as a medium of exchange. However, due to its incompatibility with ERC-20, its use in early DeFi was limited. This led to the creation of Wrapped ETH (WETH), which is the ERC-20 version of ETH. WETH quickly became a core component of decentralized exchanges, liquidity pools, and lending protocols such as Uniswap and Aave, where it serves as the core trading pair and collateral asset. By 2021, the supply of WETH exceeded 8 million, becoming the primary tokenized form of ETH.

Liquid Staking Tokens (LST) and their wrapped versions

The transition of Ethereum to the Proof of Stake (PoS) mechanism has brought new opportunities. Before the Shapella upgrade, staked ETH was locked on the Beacon Chain, effectively lacking liquidity. Liquid staking tokens like Lido's stETH (LST) solve this problem by representing users in staking to validators and issuing transferable claims on the staked ETH.

They are able to accumulate returns while maintaining liquidity, which has driven the rapid adoption of lending protocols and liquidity pools. Wrapped versions like wstETH convert Rebase tokens into fixed ERC-20 tokens that are more suitable for integration. LST and its wrapped versions have replaced WETH as the mainstream tokenized form of ETH.

Lido has approximately 10 billion USD worth of wrapped staked ETH (wstETH) locked in DeFi lending protocols on the Ethereum mainnet, highlighting its role as a core collateral asset. In practice, users typically deposit LST to borrow ETH or stablecoins, and then utilize a “looping” strategy to reinvest the earnings to purchase more stETH, thereby amplifying staking returns. It also supports the treasury for lending and re-staking, combining staking rewards with collateral utility to enhance capital efficiency. As the demand for tokenized and yield-generating assets continues to grow, as demonstrated by LST, they are likely to play a core role in the DeFi market.

The table below summarizes the different versions of tokenized ETH:

Liquid Staking Token (LST)

Pricing and Reward Mechanism

Although all liquid staking tokens (LST) represent the right to subscribe to ETH, their trading prices may vary depending on their design and the method of calculating staking rewards. Rebase tokens like Lido's stETH are structured to maintain a close price to ETH by increasing user balances over time. In contrast, wrapped LSTs like wstETH or Coinbase's cbETH, which are designed to be compatible with the ERC-20 protocol, keep the balance fixed and appreciate in value through a continuously rising exchange rate with ETH.

As shown above, the trading price of Lido's stETH is close to the underlying asset ETH, while wstETH and Coinbase's cbETH have a premium. During market pressure, low liquidity, or operational changes, wrapped LSTs can also experience price dislocation, which may affect market perception and lead to a decline in premium as demand fluctuates.

Price comparison between DEX and CEX

stETH can be traded on decentralized exchanges such as Curve (DEX) and centralized exchanges (CEX) like OKX, Bybit, and Deribit. Prices usually remain consistent, and arbitrage activities tend to narrow the price spread, but pressure events can lead to temporary market dislocations. During the collapse of Terra/Luna in May 2022, stETH on Curve dropped to about 0.935 ETH (a deviation of 6.5%), triggering a chain liquidation and capital losses for institutions like Three Arrows Capital that had used stETH for leveraged looping strategies. Since then, reliance on single trading platforms has decreased, and the price discovery mechanism has become more balanced between DEX and CEX.

Redemption and Liquidity

There are two main ways for stakers to redeem ETH: through Ethereum's validator system or through secondary centralized and decentralized exchange markets. The primary method of redemption is conducted through the Ethereum entry and exit queues, which control the flow of validators joining and leaving the network. These queues are governed by a churn limit (churn limit), meaning that only a fixed number of validators can enter or exit each cycle (epoch) (approximately 6.4 minutes). The queue length is represented by the number of validators, ETH, or time, reflecting both staking demand and redemption pressure.

Due to stakers profiting from the rise in ETH and some looping strategies being unwound, the amount of ETH in the exit queue has recently exceeded 900,000 ETH (approximately 33,000 validators). As of September 8, the amount of ETH in the exit queue has decreased to about 660,000 ETH (approximately 20,000 validators). During the same period, the amount of ETH entering the queue has also exceeded 900,000, indicating strong staking demand following the Pectra upgrade, with a higher average effective balance.

How is the liquidity of LST?

Liquidity is an important factor for LST (as well as LRT) because users must rely on secondary markets for redemptions, especially when the exit queue becomes longer. These redemptions are typically carried out through on-chain or off-chain trading venues, where LST can be exchanged for ETH or WETH. These centralized exchanges (CEX) and decentralized exchanges (DEX) can facilitate efficient arbitrage, but when the exit queue for validators gets longer and liquidity is insufficient, decoupling situations may occur more frequently.

As mentioned above, the liquidity of LSTs like Lido's stETH is more dispersed across various platforms. While most of the initial liquidity of stETH was concentrated in Curve's stETH/ETH pool, it has gradually expanded to other DEXs and CEXs such as Balancer. The stETH-ETH spot market on exchanges like Deribit, Bybit, and OKX has a liquidity of approximately $4.6 million, with fluctuations within ±2% of the midpoint price (buy price $1.6 million/sell price $3 million).

Conclusion

From wrapped tokens to liquid staking tokens, various tokenized versions of ETH have now become the core of Ethereum's infrastructure and have also gained wide attention in PoS ecosystems such as Solana. Wrapped tokens solved the early composability problem, while liquid staking tokens (LST) and liquidity re-staking tokens (LRT) further enhance ETH's capital efficiency and composability. Meanwhile, their resurgence and the past chaotic situation have once again raised concerns about liquidity, redemption, and pricing risks, which could potentially spread.

With the new liquidity pools deployed on-chain, new opportunities for yield and interoperability are emerging, from digital asset treasury reserves to potential staking-based Ethereum ETFs (the SEC recently clarified its stance on liquid staking tokens). Meanwhile, as the scale of tokenization and yield-bearing assets continues to grow and becomes more widespread across the ecosystem, liquidity and redemption dynamics will be crucial.