Q&A with Evan Weiss
March 7, 2023
What is liquid staking and how does it compare to traditional staking?
To understand liquid staking, let’s start with an explanation of traditional staking. First, consensus mechanisms allow you to come together with distributed individuals to agree on the state of a blockchain. In the early days, the only consensus mechanism was proof of work. The idea was to utilize electricity on powerful hardware to solve computationally challenging puzzles. This consensus mechanism is time and resource-intensive, and requires specialized technical knowledge to participate in securing the network. Your stake in the outcome is the time and resources you spend. This is also how proof of work networks provide security. If someone attempts to act maliciously by broadcasting fraudulent information, the network will quickly come to consensus and reject that block, meaning that the attacker has wasted a ton of electricity and computing resources.
Then, a new consensus mechanism emerged: proof of stake. In this mechanism, token holders (including non-technical ones) have the ability to lock their tokens up as collateral for validating transactions on a blockchain. If you do it right, you earn staking rewards—an incentive to tell the truth. If you don’t, you lose collateral by having tokens slashed and lost. As part of that staking process, you have what’s called a “bonding period.” By locking my tokens up, I’ve made a commitment to be part of the chain and tell the truth. That period can last anywhere from a few days to over a year depending on the blockchain, but the problem is that those tokens are locked and unusable while they are bonded. They’re inefficient.
Recently, we’re seeing a trend called liquid staking. With liquid staking, when I stake a token, I get a receipt token which I can sell or put into DeFi. That creates capital efficiency. Not only do I earn staking rewards, but I could also earn interest from lending, for example. It’s just a better product and that better product is already showing significant market share in the staking ecosystem (over 33% of Ethereum staking is liquid staking).
Can you explain the concept of a receipt token? How is this different from a staked token?
When you deposit a token through a liquid staking protocol, the staked token is locked. You earn rewards with the staked token, but you have to unbond the token to get access to it. The receipt token is a digital representation of your staked token on-chain. You can transfer, exchange, or utilize that receipt token in DeFi. When you want to get the staked token back, you go through the protocol, submit the receipt token, and get access to the underlying token. That said, if the liquid staking protocol is based on Ethereum, redeeming your receipt token is also dependent on withdrawals being enabled on Ethereum, which isn’t likely to happen until Ethereum’s scheduled Shanghai upgrade.
What is Liquid Collective?
Liquid Collective is a protocol focused on providing enterprise-grade liquid staking. The idea was to build a receipt token with sufficient liquidity, in a manner that is accessible for institutions and enterprises that highly value security and compliance. The receipt token is only as useful as the market around it. If there are a lot of receipt tokens, it’s less likely there will be significant liquidity for each one. A diversity of receipt tokens is great, but they all have their siloed ecosystems, fragmenting overall liquidity. One of the inspirations for Liquid Collective is to bring all the players together (in a web3 way) and collaborate with them to build a standard for liquid staking. The goal is to also bring a safe and trusted product to participants who utilize these platforms to stake.
With existing liquid staking solutions like Lido and cbETH, what unmet institutional needs does Liquid Collective fulfill?
Lido and cbETH both have their purposes, and they’re important products. When we were looking to build a liquid staking product at Coinbase Cloud, we knew our customers needed a few things such as a protocol with an enterprise-grade validator set. We also recognized that these large institutions would only be comfortable staking their tokens with a validator set that has extremely rigorous security, including regular PEN tests, double signing protection, and multi-regional, multi-cloud support given the risks of slashing events. A professional enterprise-focused validator set was an incredibly important requirement for our customers.
Another critical institutional need we identified was compliance. Major institutions want to make sure they know who they’re working with and they want to ensure their counterparties meet certain KYC and AML requirements. The protocol has an allowlist function that only accepts depositing or redeeming actions through the Liquid Collective smart contracts if you have been KYC'd, similar to USDC. This security-first and compliance-oriented approach, plus a focus on building collaboratively, are really the key differences that make Liquid Collective unique.
The other piece was liquidity. We looked at USDC’s success, and recognized their collaborative approach contributed to how they ultimately built the standard for enterprise stablecoins. We wanted to replicate that success by collaborating with Liquid Collective in a web3-native way with a diverse group of participants and incentives for others to join. Our belief is that collaboration is the best way to build a protocol with a receipt token that has deep liquidity.
You mentioned slashing risk, which is a common risk of participating in proof of stake networks. What is Liquid Collective doing to reduce this risk?
Liquid Collective recently launched an innovative slashing coverage program, which is also supported by the validator operators of the program like Coinbase Cloud.
The program offers three layers of protection against slashing. First, coverage provided by Nexus Mutual that scales and adjusts with the protocol’s assets. There is an umbrella coverage of up to 2 ETH per validator.
The second layer is a Slashing Coverage Treasury established by Liquid Collective. The protocol will allocate a percentage of all network rewards to the Treasury to cover losses on network-wide slashing incidents, and allow the Treasury to grow with the protocol.
The third layer is a Node Operator Commitment, which is where validator operators like Coinbase Cloud come in. Liquid Collective’s active set of validators will provide coverage, up to a cap, against slashing incidents and missed rewards that take place because of a fault of their infrastructure.
This is a great first step in bringing holistic slashing coverage to all LsETH stakers and I look forward to seeing the Collective continue to innovate in this area.
Tell us more about how the project came together from your perspective. Was there an “aha” moment when the idea of collaborating with companies like Figment and Kiln just clicked?
It all started with former Coinbase Cloud Head of Engineering, Aaron Henshaw, and his conviction that liquid staking is where the staking industry was headed. He was insistent that we needed a solution that made sense for our exchange and custodian customers, but working as a lone entity wasn’t as attractive for those customers who wanted to be direct owners in any product they supported. These types of customers also needed a diverse validator set, high security standards, and a strong compliance focus. There was a gap in the market for liquid staking solutions that meet those needs.
We started brainstorming with almost every major liquid staking solution in the ecosystem. Through these discussions, it became clear that there was a real opportunity to build a standard that was collaborative, open, and transparent–representing the ethos of web3. Additionally, by all working together, we could build something bigger than we could accomplish by ourselves.
From there, we met with Figment, Kiln, and Kraken, and got really excited about building this open standard. We saw the success of USDC, and we had confidence that together we could build something that would be really impactful in the ecosystem.
Can you share the story of the connection between Liquid Collective and Dee Hock, the founder of VISA? How does Dee’s legacy and vision inspire this effort?
Dee Hock’s legacy was this idea of figuring out how to get people to work together both in a collaborative and competitive way. Specifically, where can you find a mutual incentive that benefits everyone involved, and encourage them to work together to build something bigger than themselves. Finding this mutual incentive is what he believed in more than anything. If you can get people to understand that their self interest is tied to the overall good, you can build amazing things together.
Dee Hock’s successful approach is very relevant today and is resonant with the ethos of web3. I believe we’re still in the early days of web3, and there’s a unique opportunity to build together in an open and transparent way, bringing institutions and enterprises into the space and growing the pie together. Whether you’re the smallest or the biggest company participating in Liquid Collective, you can engage with this transparent and objective protocol and have a seat at the table in deciding its future.
Coinbase is proud to be part of this initiative. Coinbase Cloud, Coinbase’s developer and infrastructure-focused business, is part of the initial validator set of the protocol. We are helping provide a strong, secure foundation for the protocol with our staking infrastructure.
I feel super proud to work here, at one of the biggest companies in the space, as we come to the table and build something that’s bigger than ourselves, bigger than any of the participating individual companies.
How is Coinbase Cloud supporting Liquid Collective as a validator and member of the Collective?
Coinbase Cloud is a founding validator. We bring a lot of experience in running secure and scalable infrastructure on many proof of stake blockchains. As a leading web3 infrastructure provider, we will work closely with the Liquid Collective community to ensure that all validator operators servicing the protocol operate with rigorous security and reliability standards, and together we push the envelope on new technologies that make staking more secure. We believe that together, through collaboration, we can raise the bar for the entire validator ecosystem.
With a limited validator set by design, what are the most important validator capabilities and performance metrics to ensure the network is secure? How do you think about centralization here?
This is one of the most important questions. The protocol needs to grow in a responsible way while remaining a secure protocol that enterprises and institutions can utilize and trust. I think there’s two ways that we do that:
By working to increase the validator set over time based on objective criteria. Specifically, we’re working with a partner to develop an on-chain performance rating system to ensure that validators are highly performant and reliable on each protocol Liquid Collective supports.
We will also build off-chain standards that validators must meet (SOC compliance, PEN test, security and redundancy policies, etc.) to create that enterprise-grade security and reliability that regulated customers need.
With these objective and transparent standards, we can hopefully increase the security posture of everyone in the ecosystem, especially those looking to join the Liquid Collective community.
What’s the significance of the Liquid Collective name? What does it represent?
When the initial working group was thinking through names, we knew we wanted to brand this initiative in an understandable and accessible way. We focused on names based on concepts like water, rivers, and liquidity to get to the heart of the idea of liquid staking. The early supporters and the initial working group were all reading the One from Many book by Dee Hock, the founder and former CEO of Visa. We saw a lot of similarities with what we were trying to do and Dee’s legacy of collaboration to build a widely adopted standard. As we read the book and talked more as a group, we understood that what made our effort special wasn’t the liquidity, but the collaboration. This initiative is really true to the web3 ethos of working together and finding the right incentives for all participants.
During the naming process, there was also a nice idea of how water connects people. Water is a source of life, a shared resource, and a facilitator of travel, trade, and global connection. Water is often used to define borders but it is also what connects and unites us. The water metaphor helps tell the story of the collaboration and connection that we want to see happen with Liquid Collective.
Ok, so how can people participate in Liquid Collective?
As we continue to grow the Collective, there will be a place for everyone to get involved. This is all part of building an open protocol.
Anything else you’d like to share?
I think this effort is also the start of demonstrating that it’s possible to build services for large institutions in a web3 way.
I think of the Liquid Collective as the first ever enterprise services protocol where large and established companies can participate in a protocol, get services, be a member of the community, and collectively build a vision for the future. This is a really interesting shift away from enterprises merely relying on centralized entities as service providers, to becoming more embedded in the ecosystem, and helping build something from the ground up – in this instance, user-owned protocols that maintain a high standard for security and compliance.
We believe that Liquid Collective is the first opportunity to chart this path. With huge potential comes responsibilities though and we need to proceed in a way that is consistent with the principles and values of the ecosystem we’re building in.