Lido is a Runaway Success — But Does it Threaten Ethereum’s Existence?

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Lido’s dominant position as the top liquid staking platform on Ethereum (ETH) has made it a threat to Ethereum’s security.

At the time of writing, nearly 30% of total staked ETH was under the control of Lido’s centralized validators. Critics fear that if Lido’s staked ETH share keeps increasing, Ethereum will be exposed to systemic risks.

In this article, we explain why Lido’s dominance is becoming a concern.

Key Takeaways

  • Lido solved the illiquidity problem of Ethereum staking by creating receipt tokens called liquid staking tokens (eg. stETH).
  • Lido’s control of nearly ⅓ of staked ETH has drawn criticism from the Ethereum community.
  • Lido dominated the liquid staking sector with a market share of 87%, as of April 11, 2024.
  • Enshrining liquid staking into the Ethereum protocol has emerged as a potential solution.

Why is Lido a threat to Ethereum?

To understand what Lido is and where it comes from, we need to delve back to Ethereum’s transition to a proof-of-stake (PoS) blockchain in September 2022, where it ditched miners and replaced them with validators to secure the network.

The process of staking, which involves depositing and locking up 32 ETH tokens (worth over $111K at the time of writing) in order to become a validator, is an illiquid and expensive process.

Furthermore, running a validator comes with other implications, such as operational costs, hardware expenses, and the need for technical expertise.

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So in late 2020, the Ethereum staking platform called Lido was introduced to the world, which offered a way for users to stake amounts less than 32 ETH by pooling their tokens.

More importantly, Lido solved the illiquidity problem of Ethereum staking by creating a new line of receipt tokens, now referred to as liquid staking tokens (LST).

Lido’s offering has been so popular that the platform now accounts for nearly 30% of total ETH staked on Ethereum as of April 12, 2024. The platform is so dominant that it holds 87% market share in the Ethereum liquid staking market at the time of writing.

Lido’s control of nearly ⅓ of staked ETH has drawn criticism from the Ethereum community, many of whom fear that Lido has now become a threat to Ethereum’s decentralization.

Researchers also argue that the liquid staking sector is a winner-takes-all market where users “naturally” go for the biggest player based on familiarity, reputation, and LST liquidity. There are concerns about the impact of standard security measures like slashing when large amounts of ETH are staked through dominant validators.

The Sorry State of Solo Staking

One of the biggest threats to Ethereum’s decentralization is the falling rate of solo stakers. Since ETH staking was introduced in late 2020, the amount of ETH staked has been on an “only up” trajectory. In the period, the percentage of staked ETH from solo staking has fallen from about 17% in November 2020 to 1.1% in April 2024.

Solo staking is considered the gold standard of staking as it diversifies the validator pool and makes Ethereum more censorship-resistant. However, solo staking is not accessible to everyone. It is expensive (minimum 32 ETH stake), needs maintenance, and requires technical skills.

Therefore it is no surprise that the emergence of pooled staking services like Lido has played a key role in taking the shine off solo staking. At the time of writing, liquid staking was the most popular ETH staking method, contributing to over 33% of total ETH staked.

“Solo staking is trustless, but illiquid and inconvenient; liquid staking requires varying degrees of trust but is very convenient and importantly liquid,” said Ethereum Foundation (EF) researchers Ansgar Dietrichs and Caspar Schwarz-Schilling.

Two States Within the Liquid Staking Sector

To get a deeper understanding of the decentralization concerns about Lido, we need to study the liquid staking sector. At the time of writing, there are two types of liquid staking services providers (SSP): SSPs with permissionless node operators like Rocket Pool and SSPs with permissioned node operators like Lido.

Rocket Pool has permissionless node operators which means that anyone can become a validator by locking 8 ETH and an issuance bond to ensure honest behavior. The remaining 24 ETH is pooled from ETH stakers.

Lido, however, has a more centralized system. The Lido DAO approves professional node operators. The 32 ETH required to run a validator node is procured from ETH stakers.

Lido’s centralization tradeoffs have powered its explosive growth as the platform gobbles up all the ETH staking demand put before it. Meanwhile, Rocket Pool is limited by the number of validators willing to make the 8 ETH plus insurance bond deposit.

Governance of LidoDAO

The Lido DAO’s influence over the Ethereum ecosystem keeps growing with the popularity of Lido’s staking services. The Lido DAO holds the power to approve Ethereum validators and decide on key parameters of the liquid staking protocol that holds nearly 30% of total staked ETH.

Naturally, a burning question begs to be answered: How decentralized is the governance process of Lido?

Well, if we were to go by a class action lawsuit filed against the Lido DAO in December 2023, then the answer is “not so much”.

The lawsuit filed by Andrew Samuels to a US District Court alleges that 64% of Lido’s governance token, called LDO, is held by its founder and early investors, which include venture capital (VC) firms AH Capital Management Paradigm, Dragonfly Digital Management, and Robot Ventures.

“The functionality of the token as a governance mechanism is illusory for regular investors like Plaintiffs. Because 64 percent of the tokens are dedicated to the founders and early investors like Partner Defendants, ordinary investors like Plaintiffs are unable to exert any meaningful influence on governance issues,” read a statement in the lawsuit.

According to data compiled by CryptoRank, Lido DAO raised $73 million in May 2021 in a funding round where Paradigm was the lead investor. Later in March 2022, Lido DAO completed a $70 million funding round with Andreesen Horowitz as the lead investor.

Ways to Limit Lido

In August 2023, Ethereum core developer Superphiz announced on X that four liquid staking service providers – Rocket Pool, StakeWise, Stader Labs and Diva Staking – had committed to self-limit their staked ETH exposure to less than 22%.

However, over a year before the announcement, Lido DAO had already put the topic up for vote where the 99.8% of LDO holders had voted “no, don’t self-limit.”

Ethereum co-founder Vitalik Buterin weighed in on the conversation about the centralization forces at play in the liquid staking sector. In a September 2023 blog post, Buterin wrote that enshrining liquid staking into the Ethereum protocol could be a potential solution “to make liquid staking less centralizing.”

Enshrining refers to natively implementing the logic of a feature in the core code of an L1 protocol.

“Unlike most competing proof-of-stake chains, Ethereum does not have a mechanism to delegate stake to node operators built into the protocol, so the only way to stake directly in-protocol requires the laborious work of maintaining a node and forgoing liquidity on 32 ETH. Projects such as Lido and others have emerged to meet this need by laying the infrastructure via smart contracts to facilitate the delegation of stake,” said crypto market maker and investor GSR in a note.

But, GSR warned against a hard-handed approach, saying:

“No equivalent community understanding exists for stake centralization, however, and Ethereum would deservingly lose much of its credibility as a neutral platform if similarly severe social interventions were considered in response to Lido’s free-market success that followed in accordance with the protocol rules. Still, today’s state of affairs is precarious, and several Ethereum researchers have been delving into the potential of enshrining delegation into the protocol in an effort to minimize centralization risks.”

The Lido centralization debate continues to roll on. In February 2024, two Ethereum Foundation researchers proposed a drastic measure to introduce negative staking yields to cap ETH staking.

The Bottom Line

It is not that Lido is doing anything wrong by itself; it’s just that the consequences of its success have knock-on effects on the whole Ethereum ecosystem.

The trading off of decentralization for the sake of scale and efficiency is a common phenomenon in the blockchain industry. Crypto applications often prioritize user experience and growth in order to survive and thrive, which is acceptable as the priority of the industry must be the end user.

However, when it comes to Lido, we are not talking about a trivial application. Lido has become a crucial part of Ethereum security, and therefore, the calls to limit its “systemic threat” feel justified.

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Mensholong Lepcha
Crypto & Blockchain Writer
Mensholong Lepcha
Crypto & Blockchain Writer

Mensholong is an experienced crypto and blockchain journalist, now a full-time writer at Techopedia. He has previously contributed news coverage and in-depth market analysis to Capital.com, StockTwits, XBO, and other publications. He started his writing career at Reuters in 2017, covering global equity markets. In his free time, Mensholong loves watching football, finding new music, and buying BTC and ETH for his crypto portfolio.