Summary
Since the transition to Proof of Stake was introduced into the Ethereum roadmap, we have believed that the total amount of ETH staked could reach 50-80% of total supply. This thesis has positioned staking as a core theme in Ethereal’s portfolio. We led/co-led investments in Obol and Eigenlayer within this theme, both of which are innovating at the heart of staking to enable new paradigms with a security-first approach.
The success of the Shapella upgrade has increased confidence in staking by facilitating easier outflows and inflows of staked ETH. We have witnessed a steady increase in the amount of staked ETH. One thing to note however is the dynamic nature of the activation and withdrawal queues, which could lead to periods of increased egress times and demand for ETH liquidity from staked assets.
Only 20% of total ETH supply is currently staked compared to 80% at the top end of our thesis. This 400% growth, when compounded with an assumed 300% growth in the medium-term Ethereum price, could mean 1200% growth from the current staking market of $50 billion.
To date, institutional stakers’ allocations to staking have been minimal. We’ve been thinking about institutional staking and what it would take to convince institutions to stake, as it is clear that existing solutions were not feature-complete.
From our research, we learned that providing a KYC solution was only the tip of the iceberg. Institutions require superior standards of staking operators, staking integrations into trusted crypto vendors, choices between modular and integrated staking management solutions, ability to structure staking yield-centric financial products, transparent reporting and analytics, tax information, slashing insurance, and most importantly, strong levels of trust and reputation.
Once in a while, we have the good fortune of meeting a team that checks all the boxes that we outline in our hypothesis for what a product should look like. This is where Alluvial comes in. With their ability to build a differentiated product and also create a crypto-native coalition of world-class operators, technology providers and distribution partners, we believe that this collective will pave the path towards institutional adoption of staking.
Why is now the right time to focus on ETH staking as an opportunity?
The Merge was completed successfully, and partial withdrawals were enabled through Shapella
Prior to the Merge, there was significant apprehension around staking. Once completed, many of these perceived risks were alleviated, and stakers can now partially withdraw their stake as they choose to. In addition, the security of the staking contract has become more battle-tested with time and increased usage, which further reduces concerns around the security risks of staking.
Clearer opportunity cost of staking returns with idle ETH
Ethereum is emerging as the premier smart contract blockchain. This drives expectations of increased network activity, increases expectations of higher staking yields, and results in investors staking more ETH to increase their exposure to staking rewards (which are paid in ETH). Foregone yield now becomes more costly as non-stakers forgo the receipt of block rewards. This dilutes their ownership of the network compared to those that stake.
Why haven’t institutional investors allocated to staked ETH?
Liquidity concerns
The sacrifice in liquidity as a byproduct of staking is a major concern for institutions. This arises because the network only allows a certain amount of stakers to deposit and withdraw funds at a particular point in time. If stakers want to withdraw funds over and above the limit, they are subject to a withdrawal queue that can extend days and perhaps weeks.
Operator trust and reputation
Institutions that stake ETH often hire operators to manage the staking process on their behalf. In many cases, institutions are unsure how to perform diligence on operators. Performing diligence requires deep technical expertise and there are no standardized benchmarks to aid the process given the nascency of the industry.
Regulatory requirements
Institutions require operators, custodians and other technology providers to adhere to standards seen in traditional markets, including storing auditable trail of work, standardization of diligence processes, KYB, etc. Likewise, institutions require all of the product’s users to undergo a KYC process with high pedigree. Users should not, for example, inadvertently be exposed to unlawful activity, such as pooling funds with sanctioned entities. Institutions want a staking product built to minimize regulatory risk.
Internal risk requirements
Institutions have different preferences for how to access staking products based on internal risk requirements. For example, some would require staking products to be integrated with their trading venue, while some may prefer API offering or an integration directly into their staking operator. A successful enterprise-grade liquid staking product should offer a comprehensive suite of choices.
The Alluvial Opportunity
Existing liquid staking solutions have catered to crypto-native retail users and have not been able to meet the enterprise-grade needs of institutions. As a result, institutional liquid staking is a blue-ocean category that no player has successfully penetrated.
Alluvial stood out as the only team that was highly experienced in the institutional domain with the capability of architecting a product to address the market need. As the institutional liquid staking market grows, we believe Alluvial, as a software development team behind the Liquid Collective protocol, will be a driving force in creating and leading the category, and will play a pivotal role in onboarding institutions to stake ETH through Liquid Collective. Liquid Collective is an enterprise-grade solution offering integration services to businesses and is the first liquid staking product that may serve both institutional and/or retail customers.
Designing a standard through leadership and collaboration
Alluvial’s challenge is to create a product regarded as the standard for institutional staking. Without any defined standards for validator operations, KYC/AML, or product delivery across the fragmented industry to begin with, Alluvial itself would have to first explore, define, and create the standards. This required ideological and operational alignment from various types of stakeholders in the industry in a near chicken-egg-like situation. Stakeholders include staking operators (“validators”), other companies that would eventually help deliver or support liquid staking products through their own services (“integrators”), Alluvial as the smart contract builder and supplier of ancillary services, and users.
The Alluvial team took the crypto-native ethos of collaboration and first-principles building to the market.
It was incorporated with the backing and design support of leading companies including Coinbase, Kraken, Figment and Kiln to lay the foundations for industry alignment. It then led social initiatives that unified ecosystem stakeholders under a common mission in support of Liquid Collective. For example, it played a key role in supporting the Proof of Stake Alliance to advocate for clear policies on the staking ecosystem and educate legislators to create a clearer path for compliance. The team is also collaborating with experts at Rated Network to create industry-wide operating standards for validators to encourage enterprise-grade security practices, and validator performance measurement.
To encourage further alignment of validators and integrators, Alluvial built upon its social initiatives by designing the economics of its liquid staking product to be inclusive and positive-sum for all participants involved. The Alluvial team continues to onboard the best-performing integration partners across all categories of the industry - from trading to custody to validators - to share in the success of the product via economic incentives. This de-risks at the bootstrapping stage of the product, builds a strong product moat, and unifies the voice of the industry.
Product differentiation via inclusion
The key distinction in Alluvial’s offering is that it appeals to institutional stakers as well as retail stakers. Alluvial includes the institutional staker by solving the concerns we noted above:
Liquidity: The receipt token will be tradeable at major centralized exchanges such as Coinbase and supported by other major services such as custody and prime services.
Security: Alluvial designed the enterprise-grade standards for operators in collaboration with a broad and distributed group of industry-leading providers. Liquid Collective will onboard operators that adhere to these standards to manage the staking of funds via the protocol, working with the best providers in a multi-operator, multi-cloud, multi-region, and multi-client setup.
Operator Trust: Alluvial designed the institutional-grade standards for operators. It will onboard operators that adhere to these standards to manage staked funds in its product.
Regulatory: The product is built to be compliant. Users will be KYC’d at the integration venues, and all validators will be held to the Alluvial standards of excellence.
Internal risk: The product leverages integrations into major crypto-related asset management venues to increase the ease of use and elevate trust. Some examples of these venues include centralized exchanges such as Coinbase, custody providers such as Anchorage, and direct staking services such as Figment. A robust slashing coverage program including Nexus Mutual cover, is provided to every Liquid Collective participant to mitigate against slashing risk. Over time, Alluvial will build ancillary services such as performance and compliance reporting.
For the retail staker, the product employs the familiar deposit/withdrawal mechanism similar to other liquid staking services. It also allows LsETH (the receipt token) to be used on-chain as an ERC-20.
Introducing the Liquid Collective (TLC)
A high amount of coordination is needed at the onset of the vision to create the standards and align the industry’s key stakeholders under them. Once the foundations have successfully been laid ongoing product management can be sustained through stakeholder coordination. At this point, Alluvial’s work to set up the product will largely be achieved. If the product vision is successful, the product will custody a large amount of Ethereum’s supply and coordinate this among many stakeholders delivering the product. This collective will be a strong stakeholder in the Ethereum ecosystem. As a result, in line with Alluvial’s ethos to build with crypto-first principles, it should be governed and directed by the voices of the Ethereum community. Alluvial may hand over ownership of the product to a DAO called The Liquid Collective (“TLC”) to manage.
We’re excited about the prospects for Alluvial as it unlocks the next stage of growth for the staking industry.
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