Liquid Staking Tokens Explained: How stETH, rETH and cbETH Work
Liquid staking tokens let you stake ETH and keep your capital accessible. Here is how stETH, rETH and cbETH work, what the risks are, and what HMRC says about t
Over £15 billion worth of Ethereum is currently deployed through liquid staking protocols. UK holders are a significant part of that — and many of them do not fully understand what they actually own. Liquid staking tokens solve a real problem with Ethereum staking: your capital doesn’t have to be frozen while it earns yield. Understanding how these tokens work, which risks they carry, and what HMRC expects from you is not optional if you hold any.
When Ethereum moved to proof of stake in September 2022, staking promised reliable yield — around 3 to 5% annually — but came with a hard constraint. Capital was locked. There was no guarantee of when it could be withdrawn. Liquid staking protocols stepped in with a different model: stake your ETH through us, receive a liquid token representing your position, and do whatever you want with it in the meantime.
The three dominant tokens in this space — stETH from Lido Finance, rETH from Rocket Pool, and cbETH from Coinbase — each work differently under the hood. Each carries a different risk profile. And from a UK tax perspective, each triggers obligations that most holders underestimate until January rolls around.
Why Standard Ethereum Staking Falls Short
Solo staking Ethereum requires a minimum of 32 ETH per validator — approximately £62,000 at early 2026 prices. That threshold alone prices out the vast majority of retail holders. Beyond the capital requirement, solo staking demands technical setup: running validator software, maintaining uptime, and managing slashing risk if your node goes offline at the wrong moment.
Even after Ethereum’s Shapella upgrade in April 2023 enabled validator withdrawals, the process is not immediate. During high-demand periods — following a major market event or ahead of an upgrade — the unstaking queue can stretch to days or weeks. If ETH price moves sharply, you have no way to rebalance quickly. You are stuck watching from the sidelines of your own investment.
Centralised exchange staking — offering yield on ETH without technical setup — was the first workaround, but it simply moves the custody risk to the exchange. Liquid staking protocols took a different route: keep users in control of their assets while distributing validator duties across a network of operators. That architecture is what makes the liquid token model possible.
How stETH Works
stETH is issued by Lido Finance and is the largest liquid staking token by market cap and trading volume. When you deposit ETH into Lido, you receive stETH at a 1:1 ratio. Lido pools deposits and delegates them to a curated set of professional node operators who run validators on behalf of the protocol. As validators earn staking rewards, those rewards flow back to stETH holders.
The mechanism used to distribute rewards is called rebasing. Your stETH balance increases each day to reflect accumulated yield. If you hold 10 stETH and the protocol earns 3.5% annually, you will hold approximately 10.35 stETH twelve months later — without doing anything. The rewards are embedded in the token quantity itself rather than distributed as a separate payment.
Lido controls around 30% of all staked Ethereum as of early 2026, which is roughly 9.8 million ETH. That level of concentration has prompted sustained criticism from within the Ethereum developer community. The Ethereum Foundation has publicly warned about the systemic risks of any single staking protocol approaching a third of total stake. Lido’s governance is managed by a DAO, but validator selection flows through a relatively small set of whitelisted professional operators — a meaningful centralisation point for a protocol that advertises decentralisation as a feature.
How rETH Works
Rocket Pool’s rETH takes a structurally different approach. Rather than issuing a token that changes in quantity over time, rETH appreciates in value relative to ETH. When you exchange ETH for rETH, you receive fewer tokens than you put in — but each rETH represents a larger claim on ETH as rewards accumulate. The exchange rate moves upward continuously.
This non-rebasing structure is a genuine advantage for DeFi use. Rebasing tokens create accounting headaches for lending protocols, automated market makers, and yield aggregators — the token balance changes in ways that break standard ERC-20 assumptions. rETH behaves like a conventional token, which makes integration far cleaner. Aave, Morpho, and several Balancer pools accept rETH as a first-class collateral asset as a result.
Rocket Pool is also structurally more decentralised than Lido. Node operators must put up a minimum of 8 ETH of their own capital alongside pooled user deposits, creating direct financial alignment between operators and the protocol. There are over 3,600 active Rocket Pool node operators in 2026. The tradeoff is yield — rETH typically earns marginally less than stETH after fees — and liquidity, which is thinner in secondary markets and DeFi pools. For holders who prioritise Ethereum’s health over maximum yield, that is a reasonable exchange.
How cbETH Works
cbETH is Coinbase’s staked ETH product, issued through their retail staking infrastructure. The token appreciates in value like rETH rather than rebasing. Coinbase runs all the validators itself — cbETH is fully custodial. When you receive cbETH, you are trusting Coinbase to stake your ETH correctly, maintain uptime, and honour redemptions.
That custodial model has genuine advantages for UK holders. Coinbase holds FCA registration for crypto asset activities in the UK, which provides a regulatory baseline absent from decentralised protocols. Coinbase is covered under the Financial Services Compensation Scheme for some of its activities, though crypto holdings specifically sit outside FSCS protection — always worth confirming. The regulatory wrapping makes cbETH the most straightforward option if you want staking yield without interacting with smart contracts directly.
The yield is real but modest. Coinbase charges a 25% commission on staking rewards, leaving holders with around 3% annually in 2026. stETH holders pay Lido a 10% commission and typically earn around 3.5%. The gap is meaningful at scale. For holders prioritising simplicity and regulated counterparty risk over maximising yield, cbETH is sensible. For those comfortable with DeFi protocols, stETH or rETH outperform it.
Depeg Events and Liquidity Risk
Liquid staking tokens are designed to trade close to ETH in value but are not hard-pegged to it. They trade on open markets where price is determined by supply and demand. When sentiment turns negative or large holders are forced to sell, the spread between the liquid token and ETH widens — sometimes sharply.
The most significant depeg in history hit stETH in June 2022, during the Celsius Network and Three Arrows Capital collapse. Both entities held massive stETH positions and were forced to liquidate into a panicked market. stETH traded at a 5 to 6% discount to ETH for several weeks. Holders who sold during this period realised losses that would not have occurred if they had held native staked ETH. The peg recovered, but the damage to those who panic-sold was permanent.
When I looked into rETH’s liquidity profile in early 2026, the largest on-chain pool held around $220 million in combined assets — meaningful, but a fraction of stETH depth. Thin liquidity magnifies price impact for large exits. cbETH avoids this problem almost entirely because Coinbase manages redemptions directly, acting as a market maker of last resort for its own product. Each token’s liquidity risk is substantially different.
What HMRC Says About the Tax
UK tax treatment of liquid staking tokens is clearer than many holders hope and more expensive than most expect. When you exchange ETH for stETH or rETH, HMRC treats this as a disposal of ETH for Capital Gains Tax purposes. You are swapping one crypto asset for another. If your ETH had appreciated since you acquired it, you owe CGT on that gain at the point of the swap — 18% for basic rate taxpayers, 24% for higher rate taxpayers in 2026.
Staking rewards are treated as miscellaneous income. Rebasing increases to your stETH balance are taxable as income at the market value of the new tokens on the date they appear in your wallet. The same applies to the accumulated value in rETH — HMRC’s position is that the yield component is income, not capital, during the period you hold it. This creates a complex accounting trail that most holders do not set up properly from day one.
UK investors keep asking whether wrapping ETH in stETH is a way to defer CGT. It is not — it triggers it. Record all swap dates and GBP values at the time of each transaction. UK crypto tax platforms including Koinly, CoinTracker, and Accointing handle liquid staking token accounting if wallet data is imported correctly. Given HMRC’s increasing enforcement activity around crypto, getting this right from the start matters considerably more than it did two years ago.
DeFi Use Cases and Why the Yield Stacks
The structural purpose of liquid staking tokens is not just staking yield — it is keeping capital productive across DeFi at the same time. stETH and rETH are accepted as collateral on major lending platforms including Aave and Morpho. You can borrow stablecoins against them without selling your ETH exposure, accessing liquidity while your position earns staking yield on one side and lending collateral efficiency on the other.
Liquidity provision adds another layer. Providing stETH/ETH or rETH/ETH liquidity on Curve Finance or Balancer earns trading fees on top of the underlying staking yield. Some holders achieved combined yields of 8 to 12% annually in 2025 through this approach, though returns move with market conditions and pool competition. This yield-stacking strategy is legitimate and widely used. It also multiplies the number of taxable events you generate.
Each additional protocol layer introduces new smart contract risk. Curve Finance was exploited for over $70 million in August 2023 via a Vyper compiler vulnerability. Aave has faced oracle manipulation attempts. DeFi’s composability compounds in both directions — more yield potential and more attack surface. That reality does not make these strategies unviable, but it does mean sizing positions conservatively is the appropriate default. Putting 80% of your ETH holdings into a yield-stacking strategy built on three separate protocols is not diversification — it is concentration at the code layer.
What This Means for You
If you hold ETH and want staking yield without locking your capital away, liquid staking tokens are the most practical mechanism available to UK holders today. Your risk tolerance should drive which token you choose. stETH offers the best liquidity and highest yield — it is the default choice for most active DeFi users. rETH offers better decentralisation and DeFi composability for those who care about Ethereum’s health. cbETH suits holders who want a regulated wrapper with minimal protocol complexity.
The tax position is non-negotiable and frequently misunderstood. Every ETH-to-LST swap is a disposal. Every rebasing event in stETH is income. Set up a crypto tax platform before you start transacting, not after. The accounting is manageable if you track as you go. It becomes a significant problem if you reconstruct six months of DeFi activity from memory.
Start with an amount you could afford to lose entirely. The protocols covered here are among the most battle-tested in DeFi. None of them are risk-free. Smart contract exploits, regulatory intervention, and depeg events are all real historical outcomes, not theoretical edge cases. Liquid staking is a legitimate and useful part of a crypto strategy — approached with the same discipline you’d apply to any other financial instrument.
This article is for educational purposes only and does not constitute financial advice. Cryptocurrency investments involve significant risk. Always do your own research.
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