Why Regulated Exchanges Need Liquid Staking
With decentralized platforms already dominating the liquid staking space, major CEX players have recently decided they want a piece of the action, seeking to generate income by providing traders with access to high-reserve pools.
So what is liquid staking?
First, let's go over the basics.
Liquid staking (or soft staking) refers to the process of staking digital assets in a liquidity pool. It differs from traditional staking by allowing users to access their locked funds to conduct other transactions, while still receiving rewards from their initial deposit.
In 2022, liquid staking saw a surge in popularity due to the widespread interest in decentralized finance (DeFi) opportunities. If you're interested in learning more about how holders of digital assets can profit from soft staking, check out this article.
Until March 7th, liquid staking was only available on decentralized platforms. However, due to its high profitability, it attracted a large number of users who joined the pools through the Liquid Collective protocol.
Centralized exchanges didn't want to miss out on the lucrative market segment and formed a consortium to integrate soft staking onto their platforms.
Who is promoting the use of Liquid Collective on CEXs?
Liquid Collective was officially launched for centralized cryptocurrency exchanges on March 7th, 2023. The protocol is managed by a group of crypto leaders, including Coinbase, Kraken, Acala, Alluvial, and Bitcoin Suisse.
Liquid Collective enables institutional players like Binance to provide their users with liquid staking. While Coinbase and Kraken have already been advertising their own staking services, they were required by the SEC to discontinue them.
Why is this so important for major players in the market?
The reason for this is that liquid staking is quickly becoming the standard practice. The upcoming Shanghai upgrade, scheduled for April by Vitalik Buterin, will unlock a significant amount of ETH, and holders will probably want to use their newly available assets in projects that enable them to earn on liquid staking. Consequently, platforms that do not yet offer this feature may lose in the competitive race.
So, we are witnessing a battle for customers between DeFi and centralized exchanges (CEXs).
What benefits will centralized exchanges gain from Liquid Collective?
We can name six reasons that led the top players in the cryptocurrency market to initiate widespread integration of the tried-and-tested standard of liquid staking
- Joining an existing project is much easier and less expensive than developing your own protocol from scratch.
- Regulated platforms will miss the boat if they are not ready to offer liquid staking to their customers immediately after the Shanghai upgrade.
- They will already intercept part of the commission reward that Liquid Collective receives for staking ETH.
- From a regulatory perspective, Liquid Collective appears to be reputable as it complies with KYC and AML requirements.
- Centralized exchanges will have the option to develop their own liquid staking product.
- Liquid Collective provides insurance coverage in case of network failure or hacking.
It's worth mentioning the weak points of this initiative.
A potential hack of Liquid Collective could have far-reaching consequences. It would impact millions of customers of traditional crypto exchanges who use the services of the decentralized protocol. This could be a collapse comparable in scale to the bankruptcy of FTX.
Matt Maximo, an analyst at Grayscale, raised another concern, stating: “If institutions and other regulated entities become the dominant ETH stakers through these liquid staking protocols, there could be a risk of centralization and censorship on the network.”
In other words, creating a consortium of centralized players may be beneficial for individual CEX exchanges, but destructive for the decentralized finance space as a whole.
