
DeFi protocols that pool users' ETher for staking are exposed to funds tied to money laundering, scams, sanctioned addresses and malicious actors, according to a new report released by digital asset infrastructure provider Northstake.
While the number of clean and dirty funds is small, it may still present challenges for institutional investors faced by strict regulations, which may come as a hindrance to their investments.
The report looked at three top Ether liquid staking protocols and found each had been exposed to funds linked directly to illegal activities, as well as those connected to high-risk crypto exchanges and gaming sites that don't require users to pass know-your-customer checks.
Sebastian Heine, Northstake's chief of risk and compliance, said that they are likely underestimating exposure.
Heine said the actual amount of illegal or otherwise questionable crypto found in the staking protocols Northstake has been analyzed.
The report doesn't identify the liquid staking protocols it analysed. Lido and Rocket Pool, two of the biggest liquid staking protocols, did not immediately return DL News' requests for comment.
In return, they stake depositors' Ether and give out placeholder tokens called liquid staking tokens. However, they are sometimes called liquid staking derivatives, though some note that the term 'derivatives' comes with regulatory baggage.
These liquid staking tokens are activated by a process known as liquid staking, allowing holders to use them again, like as collateral for taking out DeFi loans.
This year, the Ether liquid staking market has surged. In January, Lido, the largest provider of Ether liquid staking, held $5.8 billion in deposits. Over the course of the year, that figure rose to $14.5 billion - a 150% gain.
There is a lot of institutional stakeholders must consider, said James Butterfill, head of research at digital asset manager CoinShares.
Butterfill said the company had no plans on extending the deal, and that he did not plan on doing it in the near future.
But Northstake's figures must be put in perspective, he said.
As in traditional finance, it can be challenging to know one's exposure to illegal or questionable funds. Northstake CEO Jesper Johansen says crypto is different.
The Ether liquid staking protocols usually don't require user to pass any form of know-your-client or anti-money laundering checks - DeFi is largely permissionless after all.
Although institutional investors may be hesitant due to the counterparty risk associated with liquid staking protocols, retail investors are well-known, who are not affected by potential exposure to illegal funds.
Tim Craig, the DeFi Correspondent at DL News, is based in Edinburgh.