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

Author: Tanay Ved, Source: Coin Metrics, Translated by: Shaw Golden Finance

Key Points

• The tokenized versions of ETH (such as WETH, LST, and LRT) enable ERC-20 compatibility, greater interoperability, and higher 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; some adopt a rebalancing design, while the wrapped versions appreciate in value 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 in more efficient ways, such as securing network security 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 Wrapped ETH, to offering staking yields and transferable liquid staking tokens (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 interwoven within the ecosystem, they will have significant impacts on liquidity, anchoring stability, and redemption dynamics.

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

Tokenized ETH Ecosystem

Currently, Ethereum assets mainly exist in the following forms: native ETH, wrapped ETH, liquid staking ETH (LST), and liquid re-staking ETH (LRT). While these variants may increase complexity, their emergence is aimed at addressing previous limitations, enhancing liquidity, composability, and capturing new on-chain yield opportunities.

Different Tokenization Performance 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 serving as a medium of exchange. However, its incompatibility with ERC-20 limited its use in early DeFi. 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 like Uniswap and Aave, where it serves as a core trading pair and collateral asset. By 2021, the supply of WETH exceeded 8 million, making it the primary tokenized form of ETH.

Liquid Staking Tokens (LST) and their Wrapped Versions

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

They are able to accumulate yields 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 worth of 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 employ a “looping” strategy to reinvest the returns into purchasing more stETH, thereby amplifying staking rewards. It also supports the treasury for lending and restaking, combining staking rewards with collateral utility to enhance capital efficiency. As the demand for tokenized and yield-bearing assets continues to grow, as demonstrated by LST, they are likely to play a central role in the DeFi market.

The table below summarizes the different versions of tokenized ETH:

Liquidity Staking Tokens (LST)

Pricing and Reward Mechanism

Although all liquid staking tokens (LST) represent a subscription right 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 price close to ETH by increasing the user's balance 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 are at a premium. During market pressures, low liquidity, or operational changes, wrapped LSTs can also easily experience price misalignment, which may affect market perception and lead to a decrease in premiums as demand fluctuates.

Price Comparison between DEX and CEX

stETH can be traded on decentralized exchanges like Curve (DEX) and centralized exchanges (CEX) such as OKX, Bybit, and Deribit. Prices usually remain consistent, and arbitrage activities help narrow the price gap, 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 cascade of liquidations and capital losses for institutions like Three Arrows Capital that had used stETH in leveraged loop strategies. Since then, reliance on a single trading platform has decreased, and the price discovery mechanism is more evenly distributed 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 redemption method is done through Ethereum's entry and exit queues, which control the flow of validators joining and leaving the network. These queues are controlled 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 the demand for staking and the pressure for redemption.

Due to stakers profiting from the rise in ETH prices 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 fallen to approximately 660,000 ETH (around 20,000 validators). During the same period, the amount of ETH entering the queue also exceeded 900,000, indicating strong staking demand after the Pectra upgrade, with a higher average effective balance.

How is the liquidity of LST?

Liquidity is an important factor for LST (and LRT), as users must rely on the secondary market for redemptions, especially when the exit queue lengthens. These redemptions typically occur 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 validator exit queue lengthens and liquidity is insufficient, dislocations may occur more frequently.

As mentioned above, the liquidity of LSTs like Lido's stETH is more dispersed across various platforms. Although most of the initial liquidity for 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 approximately $4.6 million in liquidity, with fluctuations within ±2% of the midpoint price (buy price $1.6 million/sell price $3 million).

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Conclusion

From wrapped tokens to liquid-staking tokens, various tokenized versions of ETH have now become the core of Ethereum's infrastructure and have gained widespread attention in PoS ecosystems like Solana. Wrapped tokens solve the early composability issues, while liquid-staking tokens )LST( and liquidity re-staking tokens )LRT( further enhance the capital efficiency and composability of ETH. At the same time, 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 Ethereum ETFs (the SEC recently clarified its stance on liquid staking tokens). At the same time, as the scale of tokenization and yield-bearing assets continues to grow and become more prevalent across the ecosystem, liquidity and redemption dynamics will be crucial.