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Liquid staking protocols deliver staking returns through tokens known as liquid staking Tokens (LSTs): you simply deposit ETH, withdraw your LST, and then hold it to earn rewards.
The mechanisms used to transfer the rewards, however, vary between protocols.
Let's dive into three of the most popular liquid staking token models and discover why Swell's reward-bearing token is the optimal choice.
Types of liquid staking tokens
Most liquid staking protocols reward users through one of three token models:
1. Rebasing tokens
2. Dual-tokens
3. Reward-bearing tokens
Rebasing tokens
Rebasing tokens, such as Lido's stETH, are inflated over time to reflect the staking yield.
This means that as the holder of a rebasing token, you receive staking rewards in the form of new tokens. Intuitive, right?
But while this approach may make it easy to visualize the rewards that you are earning, it has a couple of big drawbacks:
1. Lack of DeFi compatibility
Rebasing tokens are more difficult to integrate with DeFi protocols, as the supply of the token itself is regularly changing. Thus to actually deploy your rebasing token to DeFi, you will first need to wrap it. (That is, swap it for another token of equal value via a smart contract, adding another layer of complexity and risk).
2. Tax inefficiency
Depending on your jurisdiction, rebasing transactions may be considered taxable events.
Furthermore, the wrapping and unwrapping of the rebasing tokens may also be taxable, depending on your jurisdiction.
Disclaimer: Swell does not provide tax, legal, or accounting advice.
Dual token model
Other projects, such as Frax, use a dual token model.
This entails having one token that is pegged to Ethereum as a derivative, and another that varies in price depending on staking returns.
Having two tokens grants some additional flexibility enables easy compatibility with DeFi, but splits your staked ETH into two types of token that are more cumbersome to manage.
Reward-bearing tokens
Swell takes a different design approach that makes liquid staking as simple as possible — without compromising on your ability to easily access DeFi.
This is achieved through our reward-bearing liquid staking token: swETH.
swETH is an ERC-20 token that represents your staked ETH on Ethereum, including returns from staking. As staking rewards are received, swETH increases in value, without any change to the quantity of tokens.
The value of swETH against ETH is tracked via an exchange rate that keeps track of the relative value of
1. Total ETH staked on the consensus layer including rewards, and;
2.l The original amount of ETH that has been staked.
As a reward-bearing token, swETH has the advantage of being:
1. Tax efficient
swETH minimizes the creation of potentially taxable rebasing and wrapping transactions.
2. DeFi ready
As reward-bearing tokens can easily be integrated in smart contracts, swETH can easily be deposited in DeFi protocols. This is mission critical for our stake and vault model, which will enable you to easily juice your yields by staking ETH and deploying your swETH to DeFi in one seamless transaction.
3. Easily traded elsewhere
All holders of swETH receive staking rewards by simply holding the token, whether it was obtained through Swell or on a secondary market.
