Lido Rising Veil: How to Consolidate Its Leading Position in the Ethereum Staking Market

Author: Ebunker

Lido protocol data soared in May

With solid fundamentals, a strong ecosystem and a trustworthy community, Lido Finance, the largest liquidity staking protocol, has become the LSD staking platform with the highest market share, and can be said to be a successful example of the DeFi ecosystem.

The revenue of the Lido protocol comes from charging users 10% of their staking rewards as a fee, which is distributed among the Lido DAO, node operators, and the insurance fund. After the launch of the Lido V2 version, due to users being able to flexibly exchange stETH back to ETH, its pledge data continued to rise, and its revenue surged by 22% in May, making it the fastest growing DeFi protocol.

Judging from the TVL data, Lido has become the largest DeFi protocol with an asset value of 12.7 billion US dollars, and its TVL is more than twice that of the second-ranked Makerdao.

Lido’s TVL has been rising since this year and has benefited from the implementation of the Ethereum Shanghai upgrade. Since the launch of the Lido V2 version, its TVL has increased by 15%.

Since the majority of liquidity on Lido consists of ETH, an increase in TVL shows that stakers are coming back to the protocol to lock up more tokens. This is also evidenced by the Lido protocol’s steady increase in active users over the last month, as shown in the chart above.

Judging from the ratio of LSD APR and the market value/TVL of the protocol’s native token, Lido’s data is basically not inferior to other competing products, and it belongs to the type with high security and stable income, which is also an important reason for its stable position.

Lido's main competitive advantage

**Lido mainly obtains continuous advantages from its: 1) LSD natural advantages; 2) long-term stable operation. **

First of all, stETH has a natural advantage. Its holders benefit from the deep liquidity of the token, making it one of the favorite liquid mortgage options for hardcore users. Widespread collateral integration in DeFi increases the token’s use cases. stETH can be used in the entire Defi ecosystem. It can provide liquidity for exchange pools on Lido or other platforms, and it can also be lent out on some platforms. For mature capital looking for the best combination of investment attributes, It is clearly more attractive than regular LSD, which further enhances the competitive advantage of Lido staking derivatives.

Lido has been operating smoothly for many years, and the gap between Lido and its closest competitors (Rocker Pool, Frax) will become wider and wider over time. At the same time, it will squeeze profits and squeeze the market space of other competitors, making the More and more stakers choose Lido.

Lido's Decentralized Persistence

**First, Lido is actively operating using a DAO governance structure. ** Lido supporters can use LDO tokens to vote on proposed updates to the platform and participate in decisions on the overall direction of the organization.

**Secondly, the launch of Lido V2 also marks a further step on the road to decentralization. **In V2's pledge routing, anyone can develop an entry for new node operators, from independent validators to DAO organizations to distributed validator technology (DVT) clusters, thereby creating a more diverse validator together ecosystem.

Moreover, Lido’s Ethereum staking protocol has been upgraded to support a buffer pool, allowing stETH holders to quickly exit staking from Lido, achieving a key milestone in the Ethereum staking ecosystem that truly "allows staking" + "exits staking".

**Additionally, Lido is recruiting more Lido node operators to increase the diversity of its underlying layer. **Meanwhile, Lido's executive layer client diversity is improving over the past two quarters. Lido has been insisting on a diverse set of operators and validators, thereby reducing the risk of dropped calls or censorship, while maintaining network performance and neutrality.

Proposal for Lido's Dual Governance Mechanism

While adhering to decentralization, Lido is also trying to reduce the risk of its own system. The dual governance proposal of LDO+stETH is a self-improvement attempt. The Lido ecosystem is currently governed by its protocol token, LDO, which empowers users to vote on events, upgrades, and changes on the platform. The price of stETH and ETH maintains a 1:1 redemption ratio, and this currency represents the ETH holdings pledged by users.

Considering the huge amount of pledged ETH controlled by the protocol, Lido's core developers believe that they must change the governance model of Lido DAO and propose a dual governance proposal of "LDO+stETH" to resist moral hazard (Lido's pledged ETH has reached 719 10,000 ETH, 1 million more than when the proposal was proposed). This proposal aims to solve the principal-agent problem that arises in the current state of governance, where LDO holders (agents) may act in their own interest, disregarding the interests of stETH holders (principals).

Stakers actually care more about the interests of the Ethereum network, while the interests of LDO holders are not completely consistent with it. In the worst case scenario, LDO holders could theoretically do evil and steal ETH staked in smart contracts, abusing their control over the liquidity staking code. This is because Lido DAO has the ability to upgrade the stETH contract to enable it to burn stETH from any address and mint it to other addresses. This means that while the DAO does not directly control the ETH backing stETH, it can, by modifying the code, steal funds from users, destroy their stETH and mint it elsewhere.

The goal of proposing a dual governance plan is to better adjust the incentive mechanisms of both parties to prevent such incidents from happening. Under the scheme, LDO holders can still propose protocol changes, but stETH holders are also given veto power to reject proposals deemed “key governance decisions.” This is critical to protect the interests of stakers and prevent governance from being taken over or the protocol out of balance.

Although the proposal has not yet been implemented, as the number of stETH continues to rise, the dual governance proposal will be put on the table again.

Lido benefits from SEC regulation of CEX staking

Last week, the SEC sued Binance and Coinbase. The scope of the charges against the two exchanges varies, but there is a common theme — the SEC is going after the two CEXs for staking services to their U.S. users. While the SEC’s complaint does not target Ethereum staking solutions, the agency has hinted at their willingness to go after Ethereum staking.

In February of this year, as part of a settlement agreement with the SEC, Kraken was forced to terminate its Ethereum staking service for US users. SEC Chairman Gensler claimed that "everyone in this market should be aware of this." The SEC's pursuit of centralized exchange pledges will further help Lido occupy a larger ETH pledge market share.

Despite opening withdrawals following the Shanghai upgrade, Lido has maintained its dominance over Ethereum staking, with deposits increasing by over 900,000 ETH ( 15 %) this month. Lido's market share increased from 31.4% to 31.5% - evidence that the agreement has turned past success into a continuation of future dominance.

Risks from excessive growth of Lido staking

After overwhelmingly voting against self-limiting deposits in June 2022, the Lido governance organization has chosen to continue to ignore the threat posed by its rising stake ratio. On the surface, self-limiting deposits does go against the best interests of LDO token holders and damages Lido's profitability, but the risk of not self-limiting the entire staking system is also very real.

** Recently, more and more Ethereum holders have turned against Lido, and some believe that if Lido refuses to self-limit, the community should forcibly correct its behavior. **While this claim is worrisome, it is unlikely that we will see such controls enforced at the base layer, as this would involve a hard fork, potentially disrupting Ethereum's fragile social consensus layer.

Ethereum developers such as Danny Ryan have warned of the dangers of staking “cartelization,” noting that Lido can extract high profits compared to non-staking pool capital. Bankless, a proponent of Ethereum, reports that the Lido community should be concerned about the prospect of excessive growth in its staked share (staking centralization), dampening future demand for Ethereum block space.

Currently, the platform’s pledged volume is approaching the first threshold, which is about 33.3% of ETH staked. Theoretically speaking, if this threshold is reached, Ethereum is more likely to be manipulated by attackers. This would result in a downgrade of core properties of Ethereum’s value proposition, giving would-be attackers greater power over the chain. If Lido continues to grow at an uncontrolled rate, it will inevitably exceed these thresholds and pose a systemic risk to the ecosystem. Therefore, the continuous increase of the pledge share is a double-edged sword for Lido. Lido itself still has a long way to go in terms of decentralization and improvement of system risk.