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The Lido Dual-Governance Model: A Paradigm Shift

Lido, a key player in the world of cryptocurrency, is contemplating an innovative dual-governance model that will integrate LDO and stETH. In this new arrangement, LDO would continue to serve as Lido's governance token while stETH holders would gain the right to veto proposals that may impact them adversely.

Balancing Power Between LDO and stETH Holders

The core objective of this proposal is to align the interests of LDO and stETH holders more effectively while ensuring that Lido's overall governance remains in the hands of LDO holders. Rather than transforming stETH into a governance token, the proposed model empowers it with a protective mechanism that can be activated in the event of a Lido proposal that might negatively affect stETH holders.

The model suggests that LDO holders would need to lock in their LDO to obtain governance power. If LDO voters support a proposal that is subsequently vetoed by stETH holders, the staked LDO would be slashed. This mechanism is designed to harmonize the interests of LDO and stETH holders. However, it could potentially lead to a governance stalemate, with stETH holders exploiting their veto power.

Mitigating Potential Governance Gridlock

To deter the misuse of veto power, one proposition is to impose a significant timelock rather than immediate slashing. If stETH holders fail to rectify the vetoed situation, the timelock would be lifted. Under these circumstances, the stETH that vetoed the proposal would also be seized.

There are numerous variations of how this dual governance model could be implemented. The complexities of such a model are beyond this discussion's purview. For instance, the proposed slashing mechanism for vetoed transactions might discourage regular community members from partaking in governance. It should be noted that the community has not yet determined a definitive solution.

Implications for DeFi Protocols

An important consideration is that a significant portion of stETH is utilized in DeFi protocols, and may not be readily available for voting, thereby limiting its governance power. According to Nansen data, 21.2% of LDO holders also hold one or more of stETH, astETH, crvstETH, and wstETH.

Since this subset of LDO holders owns approximately 33% of the total LDO supply, it will be intriguing to observe how this impacts potential vetoable decisions. It could be argued that what benefits Lido (and by extension LDO) is also beneficial for Ethereum (and thus ETH), and that holders of both should consider this when participating in Lido governance. However, a potential situation could arise where the value and potential upside of LDO holdings surpass that of ETH, incentivizing holders to protect their dominant portfolio component (LDO) potentially at the expense of Ethereum.

The Future of the Dual-Governance System

Ultimately, the development of a well-conceived dual governance system that aligns the interests of LDO holders with stETH will be crucial, especially if Lido sustains its market-leading position. If Lido can establish a dual governance system that the market perceives as safe, it could further solidify its leading position. In such a scenario, it will be imperative that Lido remains secure and satisfactorily decentralized to resist censorship.

Lido DAO

Lido is configured such that a Decentralized Autonomous Organization (DAO) is equipped with the ability to enable withdrawals from Lido addresses. The Lido DAO was founded in 2020 with the initial aim of smoothing out the User Experience of the ETH staking process. 

Lido validators custody private keys.

The Lido DAO holds withdrawal keys. 

• Validators are required to manually trigger exits from staking contracts

• When the owner of funds is not the validator

• The validator can hold funds that they do not own, funds being staked,  by just not triggering the exit

This ETH research post re: 0x03 Withdrawal Credentials gives further insight into the potential solutions/workarounds to validators holding owners' funds hostage. 

Lido is distinguished from its competitor Rocketpool, which is permissionless, in that the constituent members of the Lido DOA are professional organizations requiring vetting.