LsETH is a fungible receipt token based on the Ethereum ERC-20 cToken model. When a user deposits ETH to the Liquid Collective protocol, they receive an equivalent amount of LsETH that evidences their legal and beneficial ownership of the deposited ETH, as well as any network rewards that accrue to the ETH as a result of staking minus protocol service fees and network slashing penalties, if any.

LsETH User Agreement

By obtaining LsETH, participants agree to the terms of the LsETH User Agreement, which remains in effect for as long as the participant holds LsETH.

The LsETH User Agreement is a legal agreement that outlines the terms and conditions of using the Liquid Collective protocol and holding LsETH. It contains important information about the protocol's token specifications and ownership characteristics, protocol service fees, slashing and slashing coverage, AML/KYC compliance, and risks associated with staking on Ethereum via the Liquid Collective protocol.

Each unit of LsETH is designed to serve as an electronic document of title to a corresponding amount of fungible ETH within the protocol. The LsETH User Agreement provides that LsETH is a cryptographic receipt that evidences legal and beneficial ownership of a corresponding amount of ETH, which is subject to increase as a result of the accrual of Ethereum network rewards.

To ensure open transparency into the agreement's terms, the LsETH User Agreement is additionally both encoded into the metadata of the LsETH smart contract and stored on-chain in IPFS here.

You can learn more about the LsETH User Agreement and its innovations in our post.

cToken

LsETH implements the cToken model, which uses a floating conversion rate—a.k.a. the protocol conversion rate—between a receipt token (e.g. LsETH) and the staked tokens to reflect the value of accrued network rewards, penalties, and fees associated with the staked tokens.

Because of the cToken design, LsETH's Conversion Rate may fluctuate. Depositors in the cToken model do not receive more or less tokens as their staked tokens accrue network rewards or penalties. Instead, the conversion rate for each cToken owned by the depositor will increase or decrease (i.e, the LsETH will evidence legal and beneficial ownership of more or less ETH) in an amount that reflects accrued network rewards or penalties. This is in contrast to other token models, such as aTokens, which issue new net network reward tokens on a unit basis.

Conversion Rate

The internal Conversion Rate is the rate at which Liquid Collective redeems LsETH from/to ETH on deposits and redemptions. In other words, the Conversion Rate is the amount of ETH for which LsETH can be redeemed. The Conversion Rate is independent of the price at which ETH or LsETH may trade on the open market.

The value of LsETH is bound to this internal Conversion Rate which fluctuates over time according to the network rewards earned by the validators. The Conversion Rate is computed as the total balance of staked ETH over the total supply of LsETH. If accrued network rewards are greater than penalties and fees, the internal Conversion Rate will increase to reflect the net network rewards collected by the protocol.

The Conversion Rate is updated every 24 hours at Oracle Report Time, which is when Liquid Collective accounts for network rewards earned.

Formula

What can you do with LsETH?

• Hold LsETH and accrue network rewards

• Exchange LsETH for another token

• Use LsETH as collateral to participate in a wide range of DeFi and dapp activities

What are the tax implications?

While the status of liquid staking activities under the Internal Revenue Code of 1986, as amended, remains uncertain, certain market views have developed around the U.S. tax consequences of liquid staking, including the following:

• Depositing ETH and receiving LsETH may not be deemed a taxable event. Unlike a traditional token exchange (e.g., trading ETH for another token), depositing ETH may not be a token exchange because LsETH is a receipt token that evidences legal and beneficial ownership of the deposited ETH.

• Additionally, because LsETH is based on the cToken model, the accrual of network rewards may not be deemed taxable events, especially when compared to the unit incremental basis in aToken models (or standard staking) for the accrual of network rewards.

Every 24 hours, Oracles report the new balance of staked ETH from accrued network rewards or fees. The Conversion Rate is computed as the total balance of staked ETH over the total supply of LsETH. If accrued network rewards are greater than penalties and fees, the protocol Conversion Rate increases to reflect the net Ethereum network rewards collected by the protocol.

Because of LsETH's cToken design, the Conversion Rate may fluctuate. In contrast to other token models, such as aTokens, that issue new net network reward tokens on a unit basis, stakers on the Liquid Collective protocol will not receive more or less tokens as they receive network rewards or penalties.

Instead, the Conversion Rate for each unit of LsETH owned by the depositor will increase or decrease (i.e., the LsETH will evidence legal and beneficial ownership of more or less ETH) in an amount that reflects accrued network rewards.

Protocol Service Fee

The Liquid Collective protocol charges a Protocol Service Fee set at 10.0% of network rewards. Liquid Collective’s service fee is split amongst split amongst Node Operators, Platforms, Wallet & Custody Providers, Service Providers, the protocol’s Slashing Coverage Treasury, and the Liquid Collective DAO, which comprises a broad and dispersed community of protocol participants. All service fees are distributed in LsTokens, which are the native receipt tokens of the protocol (e.g. LsETH).

Network reward collection & Conversion Rate variation

Every day the Liquid Collective protocol accounts for Ethereum network rewards including consensus layer network rewards and execution layer fees minus possible penalties, which results in updating the data reflecting the total supply of ETH.

If network rewards have been earned on a given day, then the protocol collects the Protocol Service Fee as a percentage of the earned network rewards. The Protocol Service Fee is collected by minting LsETH, which results in an increase in the total supply of LsETH.

Under normal validator operations, the protocol earns network rewards; as such the total supply of ETH increases and the Conversion Rate increases accordingly.

Example

Assuming

• totalETHSupply = 125 ETH

• totalLsETHSupply = 100

• protocolFee = 10%

So conversionRate = 125 / 100 = 1.25

Today the protocol earns 10 ETH thus the protocol fee is 10% * 10 ETH / 1.25 = 0.8 LsETH

And the new conversionRate = (125+10) / (108+0.8) = 1.58

Calculating rewards and fees

Each time the Oracle contract reports consensus layer data to the River contract, the protocol programmatically distributes network rewards including consensus layer network rewards and execution layer fees.

Fees received by validators for the execution of transactions are distributed on the execution layer directly. The Liquid Collective protocol automatically stakes the execution layer fees to increase the protocol’s overall potential reward rate by increasing the number of validators in the protocol's active set.

Network reward computation

Each time the Oracle reports consensus layer data, the River smart contract:

• Pulls execution layer fees from the EL Fee Recipient contract

• Updates consensus layer data including the Liquid Collective active validators count and total Liquid Collective active validators balance

The network reward is computed as:

EL Fee Recipient Contract

The EL Fee Recipient Contract receives all of the execution layer fees including transaction fees and MEV priority fees. The River contract periodically pulls that ETH on every Oracle report.

Network reward distribution

If the earned reward is positive, it is distributed between:

• LsETH holders receive 85% of the network rewards, proportional to their LsETH holdings, through an accrual of the Conversion Rate

• Collector that receives the Protocol Service Fee via minting LsETH, which is currently set at 10%

Reward and penalty socialization

Liquid Collective socializes network rewards and penalties between holders proportionally to their LsETH balance. The protocol aims to enforce fairness between participants, making sure that no participant gets treated favorably compared to others.

This means that stakers on Liquid Collective are exposed to the performance of all validators across Liquid Collective as a whole.

Examples:

• If a validator receives a massive MEV network reward, then this network reward is socialized amongst every LsETH holder.

• If a validator gets slashed, then the penalty is socialized amongst every LsETH holder.

This socialization of network rewards and penalties is realized by the LsETH Conversion Rate which applies to every LsETH holder equally. Every 24 hours, Oracle reports the new balance of staked ETH across the protocol accounting for accrued network rewards and penalties, resulting in updating the Conversion Rate, which applies to every LsETH holder.

Liquid Collective users can deposit ETH to stake on Ethereum. Users can also redeem LsETH for the underlying staked ETH plus network rewards earned, and minus any fees or penalties.

Deposit and Redemption Buffers

The Liquid Collective protocol automatically maintains ETH Deposit and Redemption Buffers. These buffers are designed to ensure that flows in and out of the protocol are managed efficiently between Ethereum’s execution and consensus layers, which enables seamless redemptions of LsETH for ETH via automatic rebalancing.

The protocol’s Deposit Buffer includes ETH pending to be deposited to Ethereum’s consensus layer, while the Redemption Buffer includes ETH pending to be supplied for redemptions.

• ETH deposits enter the Deposit Buffer to be programmatically staked in Ethereum’s consensus layer

• Ethereum execution layer fees received by Liquid Collective validators automatically enter the Deposit Buffer to be programmatically staked

• Ethereum consensus layer network rewards received by Liquid Collective validators automatically enter the Deposit Buffer to be programmatically staked

• Withdrawn validator consensus layer ETH from validator full exits, or slashed validator exits, automatically enter the Redemption Buffer to fund LsETH redemptions

• Funds from Liquid Collective’s Slashing Coverage Program enter the Deposit Buffer according to the Slashing Coverage Program to be programmatically staked

Queues, stacks, and buffers

In addition to the Liquid Collective protocol’s Deposit and Redemption Buffers, the protocol’s Withdrawal Stack, along with Ethereum’s activation and exit queues, play an important role in deposits and redemptions on the Liquid Collective protocol.

Visualization of Withdrawal Stack, Redemption Queue, and Deposit and Redemption Buffers

Below is a step-by-step diagram showing how a request will flow through the protocol’s buffers and stacks.

Deposit ETH

When a user deposits ETH they receive the LsETH receipt token at the current Conversion Rate, which evidences legal and beneficial ownership of the staked token, plus network rewards received and minus any fees or penalties.

Deposited ETH automatically enters the Liquid Collective protocol’s Deposit Buffer. As ETH in the Deposit Buffer reaches a fungible bulk of 32 ETH it is programmatically staked, funding new validator keys and being pushed to Etheruem’s activation queue.

LsETH are minted on deposit, so depositing does not affect the Conversion Rate.

Example

Assuming

• totalETHSupply = 125 ETH

• totalLsETHSupply = 100 LsETH

So conversionRate = 125 / 100 = 1.25

A user deposits 10 ETH and receives 10 / 1.25 = 8 LsETH

And the new conversionRate = (125+10) / (100+8) = 1.25 remains unchanged

Interface level smart contract flow

For more technical audiences, a sequence diagram showing the interaction between smart contracts is included below:

Redeem LsETH

The LsETH receipt token can be redeemed for ETH at the current Conversion Rate, to effectively withdraw the staked token plus network rewards received and minus any fees or penalties.

Three-stage redemption process

LsETH redemptions take place via a three-stage process performed programmatically by the Liquid Collective protocol:

1. Request: the LsETH holder requests a redemption via a Platform (e.g. in the Coinbase Prime app), surrendering the amount of LsETH that they would like to redeem. This LsETH will eventually be burned.

2. Satisfaction: after the protocol completes any required validator exits and the corresponding amount of ETH is withdrawn as according to the protocol Conversion Rate, the request is satisfied and can be claimed at any time.

3. Claim: the redemption request is claimed, triggering the actual transfer of ETH to the redeemer.

Redemption architecture

When a LsETH holder requests a redemption the request is added to the protocol’s Redemption Queue. On each Oracle report, completed approximately every 24 hours, the protocol assesses the unsupplied ETH demand for redemptions.

When there is unsupplied ETH demand:

• The Liquid Collective protocol programmatically rebalances ETH between the deposit and Redemption Buffers to preserve capital efficiency by minimizing consensus layer operations. The protocol prioritizes moving ETH from the Deposit Buffer to the Redemption Buffer to satisfy the unsupplied redemption requests.

• If there is still unsupplied redemption demand, the protocol requests validator exits by signaling Node Operators. Upon receiving this request, the appropriate number of validators are entered to Ethereum’s exit queue, where they are subject to Ethereum’s exit queue timeline.

• All Liquid Collective validator keys have their withdrawal credentials set to the address of Liquid Collective’s Withdraw contract, which is automatically pulled to the Redemption Buffer upon Oracle report. The withdrawn ETH is then used by the protocol to satisfy the unsupplied redemptions.

1. A user decides they want to redeem their LsETH for ETH via the Liquid Collective protocol

2. A user's redemption request is enqueued in the Redemption Queue pending satisfaction

3. On each Oracle report, the Liquid Collective protocol evaluates pending LsETH redemption requests and programmatically pulls any ETH from the Deposit Buffer to the Redemption Buffer to satisfy the requests

   • If the balance in the Deposit Buffer is insufficient to satisfy all pending redemption requests the Liquid Collective protocol initiates the exit of a corresponding amount of ETH by programmatically requesting Node Operators to submit validator exits

4. Any redemption request that has been satisfied by the Buffer can be immediately claimed by the user

5. For redemption requests that require a validator exit to satisfy, the validator key enters Ethereum’s exit queue, waits the full network withdrawal time, and, once exited, the validator’s ETH balance is automatically sent by Ethereum to Liquid Collective’s withdrawal address

6. On the Oracle report following the validator exit, the withdrawn ETH satisfies pending redemption requests

7. The user can now claim their ETH

Most stakers can complete this process easily via their preferred Liquid Collective Platform (e.g. in the Coinbase Prime app). At the protocol level, at a high level this request process is executed via interacting with the LsETH contract interface.

• When a redemption request is submitted by calling the requestRedeem function, a redeem request id is returned by either using the Alluvial /redeems endpoint or subscribing to RequestedRedeem events.

• To indicate whether the request has been satisfied, the redeem request id can be submitted along with calling the resolveRedeemRequests function to return withdrawal events corresponding to that redeem request id.

• Once satisfied, the request can be claimed by calling ClaimRedeemRequests along with the redeem request id and corresponding withdrawal event id, which returns a list of claim statuses.

Interface level smart contract flow

For more technical audiences, a sequence diagram showing the interaction between smart contracts is included below:

Redeem status matrix

Platforms can learn more about this process in the Platform redemption guide

Redemptions and the Conversion Rate

When users request to redeem LsETH, they will receive ETH based on the available ETH from exited validators or pending deposits, up to the user's LsETH balance multiplied by the protocol conversion rate at the time of the request. If pending deposits are insufficient to fulfill the redemption request, the protocol initiates validator exits to cover the redemption. At the time of the redemption request, the protocol assumes ownership of the user’s LsETH, and the user will no longer be eligible to receive future network rewards. Once validators have fully exited and their effective balance is available, the final ETH amount is determined by the proportion of LsETH being redeemed relative to the total ETH available to withdraw. This means the user remains exposed to penalties and slashing risks until the validators have fully exited.

Example

Assuming

• totalETHSupply = 162 ETH

• totalLsETHSupply = 108 LsETH

So conversionRate = 162 / 108 = 1.5

A user converts 8 LsETH and receives 8 * 1.5 = 12 ETH

And the new conversionRate = (162-12) / (108-8) = 1.5 remains unchanged

Interface level smart contract flow

For more technical audiences, a sequence diagram showing the interaction between smart contracts is included below: