Liquid Staking and the Limits of Policy

Abstract

We study the role of liquid staking and how it affects the interaction between issuance policy, economic productivity, and security in proof-of-stake blockchains, with a focus on the role of liquid staking. In a dynamic macro-finance framework, we show that issuance redistributes resources from productive on-chain activity to validators, which effectively acts as a tax on productive capital. This mechanism generates a Laffer-curve-type tradeoff: beyond an interior optimum, higher issuance weakens the productive base that finances security and reduces staking rewards. We then introduce liquid staking, which allows users to earn staking rewards while retaining liquidity for productive use. Liquid staking collapses the traditional tradeoff between staking and DeFi. When liquid staking tokens (LSTs) closely substitute for the native asset and benefit from strategic complementarities, issuance reallocates productive activity toward LSTs, compresses the feasible policy space, and can render issuance and slashing ineffective as policy instruments.