With a financing of $12 million, Liquid Collective, a new player in the LSD industry, aims to establish industry standards for liquidity staking.

With $12 million in funding, Liquid Collective aims to set industry standards for liquidity staking in the LSD market.

Compliant and decentralized, Liquid Collective aims to capture the vast market of liquidity staking.

Author: Peng SUN, Foresight News

Many people believe that the liquidity staking track is already saturated, with various new projects emerging one after another. However, according to Dune data, the current staking rate of ETH supply is only 20.51%. This “saturation” is more of an “inwardness”, and the actual situation is difficult to achieve larger-scale adoption. In the narrative of LSDFi being constructed as the underlying asset of the next bull market, the current staking rate of ETH is clearly insufficient.

Liquid Collective is born for this reason. It is a multi-chain liquidity staking protocol designed to provide institutions with non-custodial decentralized liquidity staking solutions. At first glance, the protocol is aimed at institutions, but upon careful consideration, Liquid Collective targets the broader user base behind exchanges and other institutions, and attempts to build industry standards for liquidity staking through compliance and decentralization. Currently, the protocol only supports Ethereum and has opened ETH withdrawals, with plans to launch multi-chain functionality in the future. Not long ago, its developer Alluvial completed a $12 million Series A funding round with participation from Distributed Capital and IOSG, among others. Today, Foresight News takes everyone on a journey to explore what Liquid Collective is doing.

Tokenization and Contractization: The Core Logic of Liquid Collective

Liquid Collective is a decentralized liquidity staking protocol, and its core component is a smart contract. Users can deposit any amount of ETH into the smart contract, without the limitation of 32 ETH. When the balance of the smart contract reaches 32 ETH, the ETH in the contract will be staked to node operators in a cyclical manner. Node operators include Coinbase Cloud and Figment, which operate validation node infrastructure on Liquid Collective and receive network rewards. Liquid Collective itself does not operate validation nodes.

When it comes to liquidity staking, what caught my attention initially was the dividend model. The current LSD dividend mechanism is mainly based on Rebase and Reward-bearing, and manual claiming has been largely eliminated. Lido’s stETH uses the rebase mechanism, eliminating the need for manual claiming and compounding, and instead maintains a 1:1 anchoring relationship between LSD and staked assets. Another approach is the Reward-bearing mechanism adopted by Rocket Pool and others, which is based on Compound’s cToken contract and introduces an “exchange rate” between LSD and staked assets, with staking interest and network penalties reflected through the “exchange rate”.

The dividend method of the Liquid Collective protocol is not uncommon, as it also uses the cToken model.

Typically, when a user deposits ETH into the Liquid Collective protocol, they receive LsETH. However, the total supply of LsETH does not change with the quantity of staking rewards and network penalties at the protocol layer, but is balanced through the “exchange rate” between LsETH and ETH. For example, if we stake 100 ETH through Liquid Collective and receive 100 LsETH at a 1:1 ratio, and a month later the staking reward is 20 ETH, assuming no network penalty fees incurred in between, the total amount of ETH at the protocol layer would be 120. At this point, if we want to exchange 100 LsETH for 120 ETH, we need to multiply by an “exchange rate” of 1.2. Similarly, at an exchange rate of 1.2, only by staking 120 ETH can we obtain 100 LsETH. Here, the calculation of the exchange rate is the total balance of staked ETH divided by the total supply of LsETH. The oracle reports data from the consensus layer to the execution layer every 24 hours, and reports the balance of staked tokens, accrued staking rewards, and deducted penalty fees to the core contract of Liquid Collective to calculate the new exchange rate.

The benefits of using cToken contracts based on ERC20 are that user staking rewards and compound interest are automatically performed without manual operation, minimizing gas consumption. At the same time, due to the real-time change in the exchange rate, LsETH is essentially no different from other tokens. Users can use LsETH for trading, collateralized lending, and even re-stake it on Ethereum through EigenLayer.

Compliance is the foundation

Why does Liquid Collective create an institutional-level liquidity staking platform? On the Liquid Collective website and documentation, one point that is often emphasized is “compliance” and “security,” requiring users and node operators to complete KYC/AML (anti-money laundering) authentication.

The reason behind this is that in addition to native staking, the staking services provided by centralized exchanges, staking and service providers often have low entry barriers, making it difficult to distinguish illicit funds. Institutions may also have black boxes, where users do not know the flow of funds, and it is more likely to be a scheme to absorb and earn interest. Whether encrypted assets are staked in the network, no one knows, let alone network security. To a large extent, the U.S. Securities and Exchange Commission (SEC)’s crackdown on exchange staking services is due to this reason:

  • In August 2022, Coinbase stated that the U.S. SEC is investigating its cryptocurrency staking services, including Coinbase’s staking program, asset listing process, asset classification, and stablecoin products.

  • In February of this year, the SEC struck first against Kraken, claiming that when investors provide tokens to Kraken’s “staking as a service” provider, they lose control of the tokens and bear the risks associated with these platforms with almost no protection. At the same time, Kraken announced the termination of its staking as a service program for U.S. users. SEC Chairman Gary Gensler stated that staking service providers must register and provide comprehensive, fair, and truthful disclosure and investor protection.

  • The SEC’s actions have had a chain reaction. On February 15th, the Korean regulatory agency announced that it would conduct a comprehensive review of the staking service environment of domestic cryptocurrency exchanges.

  • On March 23rd, Coinbase received a Wells Notice from the SEC, focusing on staking services and asset listings.

  • On March 24th, the platform Uphold, which provides cryptocurrency trading and digital asset debit cards, sent an email to customers stating that it will end its staking services for U.S. customers on April 27th, 2023.

  • On July 15th, Coinbase announced that users from California, New Jersey, South Carolina, and Wisconsin in the United States temporarily cannot use the staking services.

All of this shows the regulatory pressure faced by institutional staking services, and “compliant” staking services have emerged as a result.

  • On April 8th, InCore Bank, a financial institution, announced that it will use SDX Web3 services to provide Ethereum staking services to its customers. The bank stated that customers using its Ethereum staking services must fully comply with KYC and AML requirements.

To some extent, what Liquid Collective is doing is a response to regulatory scrutiny and avoiding sanction screening. But at the same time, Liquid Collective may truly have a “childlike heart”, aiming to achieve non-custodial, decentralized solutions while ensuring compliance and enhancing the security of the Ethereum network. As mentioned earlier, when users deposit ETH, it enters the core smart contract of Liquid Collective, and only when 32 ETH is accumulated, it is allocated for staking by node operators. In other words, everything is visible on the chain, and users always have ownership of their assets from depositing ETH to holding LsETH to redeeming ETH. This simplifies the staking process and eliminates concerns about intermediaries acting maliciously.

For institutions, unlike traditional Ethereum staking, Liquid Collective provides liquidity for staked assets. LsETH can be used for trading and integrated with DeFi. In other words, exchanges no longer need to worry about sacrificing liquidity and other income opportunities when users stake ETH.

Establishing industry liquidity staking standards and becoming the Circle of LSDFi

In Liquid Collective’s narrative, the benchmark is the consortium-managed USDC rather than GUSD managed by a single exchange, with a market value difference of 71 times.

For Liquid Collective, a decentralized and compliant liquidity staking solution is not the end goal. The ultimate goal is to establish an industry standard for liquidity staking based on this solution. Liquid Collective believes that the variety of liquidity staking products in the current market leads to fragmentation, with different protocols competing for DeFi resources, different standards of LST tokens limiting liquidity, and lacking compliance and composability.

Therefore, Liquid Collective is building an industry consortium for decentralized management by bringing together major participants in the DeFi ecosystem. This consortium includes The Liquid Foundation, Alluvial, Coinbase, Figment, Kiln, Acala, Rome Blockchain Labs, Kraken, Staked, Bitcoin Suisse, and other Web3 organizations, involving integrators, cross-chain builders, and node operators.

It seems that Liquid Collective has all the advantages of security, compliance, efficiency, and decentralization. In terms of staking method, it achieves on-chain transparency through smart contracts. In terms of the LST model, it is fully tokenized, completely unleashing capital efficiency. In terms of node operators, it encourages the use of multi-cloud, multi-region, and multi-client infrastructure. In terms of security, in addition to KYC and AML, it also uses NEXUS MUTUAL Coverage for Slashing event insurance.

Perhaps we may worry about the high leverage of fully tokenized LsETH, but it seems that Liquid Collective, which implements KYC, also does not have to worry about unrecoverable bad debts during liquidation. As mentioned earlier, the current circulating ETH staking rate is only 20.51%, with Lido accounting for 31.77% of it. And Liquid Collective, targeting enterprises, still has ample room for development. An exchange with unique user advantages is the biggest growth point and the starting point for establishing “standards”. The next bull market is bound to have a larger volume of funds and will carry a larger leverage mechanism. When LSD replaces ETH as the new underlying asset, Liquid Collective will have even more room for imagination.