diff --git a/nixos/lib/make-squashfs.nix b/nixos/lib/make-squashfs.nix
index b7c7078b73b1..4b6b56739948 100644
--- a/nixos/lib/make-squashfs.nix
+++ b/nixos/lib/make-squashfs.nix
@@ -1,15 +1,22 @@
 { lib, stdenv, squashfsTools, closureInfo
 
+,  fileName ? "squashfs"
 , # The root directory of the squashfs filesystem is filled with the
   # closures of the Nix store paths listed here.
   storeContents ? []
+  # Pseudo files to be added to squashfs image
+, pseudoFiles ? []
+, noStrip ? false
 , # Compression parameters.
   # For zstd compression you can use "zstd -Xcompression-level 6".
   comp ? "xz -Xdict-size 100%"
 }:
 
+let
+  pseudoFilesArgs = lib.concatMapStrings (f: ''-p "${f}" '') pseudoFiles;
+in
 stdenv.mkDerivation {
-  name = "squashfs.img";
+  name = "${fileName}.img";
   __structuredAttrs = true;
 
   nativeBuildInputs = [ squashfsTools ];
@@ -31,8 +38,8 @@ stdenv.mkDerivation {
     '' + ''
 
       # Generate the squashfs image.
-      mksquashfs nix-path-registration $(cat $closureInfo/store-paths) $out \
-        -no-hardlinks -keep-as-directory -all-root -b 1048576 -comp ${comp} \
+      mksquashfs nix-path-registration $(cat $closureInfo/store-paths) $out ${pseudoFilesArgs} \
+        -no-hardlinks ${lib.optionalString noStrip "-no-strip"} -keep-as-directory -all-root -b 1048576 -comp ${comp} \
         -processors $NIX_BUILD_CORES
     '';
 }
diff --git a/nixos/modules/virtualisation/lxc-container.nix b/nixos/modules/virtualisation/lxc-container.nix
index 1034c699629d..61d7c4cb73fe 100644
--- a/nixos/modules/virtualisation/lxc-container.nix
+++ b/nixos/modules/virtualisation/lxc-container.nix
@@ -37,7 +37,6 @@ in {
         ${config.nix.package.out}/bin/nix-env -p /nix/var/nix/profiles/system --set /run/current-system
       '';
 
-    # TODO: build rootfs as squashfs for faster unpack
     system.build.tarball = pkgs.callPackage ../../lib/make-system-tarball.nix {
       extraArgs = "--owner=0";
 
@@ -64,6 +63,23 @@ in {
       extraCommands = "mkdir -p proc sys dev";
     };
 
+    system.build.squashfs = pkgs.callPackage ../../lib/make-squashfs.nix {
+      fileName = "nixos-lxc-image-${pkgs.stdenv.hostPlatform.system}";
+
+      noStrip = true; # keep directory structure
+      comp = "zstd -Xcompression-level 6";
+
+      storeContents = [config.system.build.toplevel];
+
+      pseudoFiles = [
+        "/sbin d 0755 0 0"
+        "/sbin/init s 0555 0 0 ${config.system.build.toplevel}/init"
+        "/dev d 0755 0 0"
+        "/proc d 0555 0 0"
+        "/sys d 0555 0 0"
+      ];
+    };
+
     system.build.installBootLoader = pkgs.writeScript "install-lxd-sbin-init.sh" ''
       #!${pkgs.runtimeShell}
       ${pkgs.coreutils}/bin/ln -fs "$1/init" /sbin/init
diff --git a/nixos/release.nix b/nixos/release.nix
index abaa7ef9a711..60f4cc94399c 100644
--- a/nixos/release.nix
+++ b/nixos/release.nix
@@ -328,6 +328,21 @@ in rec {
 
   );
 
+  lxdContainerImageSquashfs = forMatchingSystems [ "x86_64-linux" "aarch64-linux" ] (system:
+
+    with import ./.. { inherit system; };
+
+    hydraJob ((import lib/eval-config.nix {
+      inherit system;
+      modules =
+        [ configuration
+          versionModule
+          ./maintainers/scripts/lxd/lxd-container-image.nix
+        ];
+    }).config.system.build.squashfs)
+
+  );
+
   # Metadata for the lxd image
   lxdContainerMeta = forMatchingSystems [ "x86_64-linux" "aarch64-linux" ] (system:
 
diff --git a/nixos/tests/lxd/container.nix b/nixos/tests/lxd/container.nix
index bdaaebfc0028..0ebe73d872f2 100644
--- a/nixos/tests/lxd/container.nix
+++ b/nixos/tests/lxd/container.nix
@@ -13,6 +13,7 @@ let
 
   lxd-image-metadata = releases.lxdContainerMeta.${pkgs.stdenv.hostPlatform.system};
   lxd-image-rootfs = releases.lxdContainerImage.${pkgs.stdenv.hostPlatform.system};
+  lxd-image-rootfs-squashfs = releases.lxdContainerImageSquashfs.${pkgs.stdenv.hostPlatform.system};
 
 in {
   name = "lxd-container";
@@ -23,7 +24,7 @@ in {
 
   nodes.machine = { lib, ... }: {
     virtualisation = {
-      diskSize = 4096;
+      diskSize = 6144;
 
       # Since we're testing `limits.cpu`, we've gotta have a known number of
       # cores to lean on
@@ -65,6 +66,16 @@ in {
         machine.succeed("echo true | lxc exec container /run/current-system/sw/bin/bash -")
         machine.succeed("lxc delete -f container")
 
+    with subtest("Squashfs image is functional"):
+        machine.succeed(
+            "lxc image import ${lxd-image-metadata}/*/*.tar.xz ${lxd-image-rootfs-squashfs} --alias nixos-squashfs"
+        )
+        machine.succeed("lxc launch nixos-squashfs container")
+        with machine.nested("Waiting for instance to start and be usable"):
+          retry(instance_is_up)
+        machine.succeed("echo true | lxc exec container /run/current-system/sw/bin/bash -")
+        machine.succeed("lxc delete -f container")
+
     with subtest("Container is mounted with lxcfs inside"):
         machine.succeed("lxc launch nixos container")
         with machine.nested("Waiting for instance to start and be usable"):