Simulations Show Leverage Staking Amplifies Crypto Liquidations by 1600%

New research simulations reveal that the practice of leverage staking within Liquid Staking Derivatives (LSD) protocols significantly amplifies the risk of market-wide liquidations, potentially escalating them by 16 times in adverse conditions. This finding highlights a critical vulnerability threatening the stability of the broader decentralized finance (DeFi) ecosystem. The analysis, shared by HackerNoon, underscores how this high-yield strategy can trigger intensified selling pressure and propagate contagion effects.

Liquid Staking Derivatives, such as Lido's stETH on Ethereum, allow users to stake their cryptocurrency while maintaining liquidity through a tradable token. This innovation enables "leverage staking," where users iteratively re-stake borrowed assets to multiply potential returns. While offering attractive Annual Percentage Rates (APRs)—with 81.7% of observed positions yielding higher than conventional staking—this strategy introduces substantial systemic risks.

The simulations, conducted by researchers including Xihan Xiong, Zhipeng Wang, Xi Chen, William Knottenbelt, and Michael Huth, demonstrate that even small devaluations of LSD tokens, like stETH, can lead to cascading liquidations. During a simulated stETH devaluation, the total liquidated amount escalated to 497,375 ETH, a 16-fold increase compared to scenarios without leverage staking. This rapid unwinding significantly depresses token prices and can trigger further liquidations across the market.

A key historical example is the May 2022 Terra Luna collapse, which saw stETH de-peg from Ethereum, trading at a 6.5% discount on Curve Finance. This dislocation triggered cascading liquidations and substantial capital losses for major entities, including Three Arrows Capital, and impacted various lending protocols. The research indicates that both forced liquidations and voluntary deleveraging by users contribute to increased selling pressure, further exacerbating price declines.

The study concludes that leverage staking not only heightens individual portfolio risks but also poses broader systemic threats, affecting even ordinary, non-leveraged positions. This contagion effect underscores the urgent need for robust risk assessment frameworks and improved parameterization within DeFi lending and staking protocols to enhance the resilience and sustainability of the LSD ecosystem.