Lido Q4 2023 Updates

By Michael @ CryptoEQ | CryptoEQ | 4 Dec 2023

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This article delves into the evolving landscape of Ethereum staking, highlighting the significant transition to a proof-of-stake (PoS) model and the central role of validators in this ecosystem. It discusses the complexities and responsibilities of node operators and validators, differentiating between their functions. The focus then shifts to Lido's dominant position in decentralized finance (DeFi), examining its influence in Ethereum staking and the broader implications of its stake share surpassing critical consensus thresholds. The piece also explores potential solutions and innovations, including the GOOSE Module and Distributed Validator Technology (DVT), emphasizing Lido's strategic approaches and their impact on the Ethereum network.

ETH Staking

Ethereum's transition to a proof-of-stake (PoS) consensus mechanism has redefined the roles and responsibilities of participants within its network. In this PoS model, validators are central figures who not only run full nodes but also stake a significant amount of Ethereum (32 ETH) in the Beacon Chain. Their primary responsibilities include proposing new blocks when chosen or attesting to the validity of proposed blocks. Validators are rewarded for their contributions to the network's stability and security. Still, they also face penalties, including financial repercussions and the risk of being removed from the network for poor performance or malicious actions.

A common point of confusion in this ecosystem is the distinction between node operators and validators. Node operators are individuals who manage servers and run Ethereum client software to validate blocks and track the chain. Running a full node does not necessitate a 32 ETH stake. In contrast, validators, in addition to requiring a full node to track the chain, must deposit 32 ETH to activate a unique validator key pair. This key pair is essential for signing block proposals and attestations. Large stakers often activate multiple validators to stake their ETH effectively, but since a single node operator can manage multiple validator key pairs, the total number of validators provides limited insight into the network's decentralization.

Ethereum's architecture does not inherently support stake delegation to node operators. This means that direct, in-protocol staking requires both the effort of maintaining a node and the immobilization of 32 ETH. To address this gap, platforms like Lido have emerged, offering infrastructure through smart contracts to facilitate stake delegation.

Lido Dominance as of Q4 2023

Lido stands as a towering figure in the DeFi landscape, not only in terms of Total Value Locked (TVL) but also in the amount of Ethereum deposited. This prominence can be attributed to several factors, chief among them being its early entry into the market and its pioneering efforts in Liquid Staking Token (LST) solutions. Lido's first-mover advantage has been a significant contributor to its current market position. 

lido dominance nov 2023 Source

Additionally, the platform is recognized for its user-friendly and efficient staking process, which appeals to a broad user base. The process for users is straightforward: they connect with their Web3 wallet, deposit Ethereum (ETH), and, in return, receive Lido's liquid staking token, stETH. This mechanism allows users to enjoy the benefits of Ethereum staking rewards while having their assets unlocked and liquid. The versatility of stETH extends to its usability across various DeFi protocols, enhancing its appeal.

Lido offers two versions of its liquid staking token: stETH and wstETH. stETH is a rebasing token that automatically adjusts balances to reflect daily staking rewards. On the other hand, wstETH is a wrapped version of stETH, characterized as a non-rebasing, reward-bearing token. Lido's dominance in the LST market is notable, with a market share that accounts for 32% of all staked ETH.

Lido has significantly streamlined the staking process, removing many of its complexities and limitations. In return for these services, Lido charges a fee distributed between node operators and the Lido DAO, amounting to a 10% share of the rewards. 

In summary, Lido's early start, user-centric approach, innovative token offerings, and commitment to transparency have solidified its status as a leading entity in the DeFi space. Its comprehensive data dashboards and the utility of its staking tokens in the wider DeFi ecosystem further reinforce its position as a major player in the realm of Ethereum staking and decentralized finance.

LSTs table Source

Issues with >33% Stake Share

Lido's prominent role in Ethereum staking has become a topic of significant discussion, especially as it now controls 32% of all staked ETH. This level of concentration nears Ethereum's critical consensus thresholds, raising concerns about the potential for unilateral influence over the network. While Lido's stake is distributed among various third-party node operators, Lido governance still has the power to curate this list, which adds another layer of complexity to the issue.

In Ethereum's PoS system, certain thresholds of control carry specific risks:

  • Owning more than 33% of the stake could allow an entity to temporarily inhibit Ethereum's finality. Although the blockchain's inactivity leak would eventually penalize the attacker enough for the chain to finalize again, this represents a significant disruption.
  • With over 50% control, an entity could censor transactions and perform short-term chain reorganizations, known as a 51% attack. This level of control would enable harmful MEV extraction and other detrimental activities.
  • At more than 67% control, an entity could finalize its preferred chain, disregarding other stakers' votes. They could even revert finalized blocks, although they would face slashing penalties for this.

Lido has been criticized for approaching these thresholds without self-imposing limits on its growth, a precaution taken by several of its competitors. However, there is a belief within Lido that liquid staking is a market where the dominant player takes most, if not all, leading to aggressive growth strategies to outpace potential centralized competitors like exchanges.

The liquid staking market is divided into two categories: those with and without permissionless node operator participation. Lido, for example, employs trusted, permissioned professionals as node operators, while Rocket Pool allows anyone to become a node operator, requiring a bond and insurance in RPL tokens. This difference presents a principal-agent problem for Lido, as their node operators could potentially slash delegated stake without risking their own capital. Nevertheless, Lido's centralized model has advantages in early scaling, allowing unlimited minting of stETH based on demand.

Conversely, Rocket Pool faces scaling challenges due to its permissionless and safety-centric model. Its growth is constrained by the availability of node operator capital, often leading to a full deposit pool and a halt in new rETH minting. This limitation reflects the inherent scaling difficulties of a permissionless system.

Lido's scale also brings competitive advantages like compounding daily rewards into new validators and managing rare high MEV lottery blocks. Furthermore, Lido gained a temporary advantage when Ethereum enabled withdrawals and the demand for staking increased, leading to a prolonged validator activation queue. This situation favored Lido as other projects had a significant portion of their stake in the activation queue, diluting their LST rewards compared to stETH.

In summary, Lido's growth is largely due to the centralization trade-offs it embraced, particularly its use of permissioned node operators. While this approach has been justified as a means to prevent market capture by more centralized entities, it also benefits from the scale's centralizing forces. However, the widespread adoption of stETH, despite its individual rationality and utility, poses collective risks to Ethereum's foundational values of being permissionless, censorship-resistant, and a neutral platform for applications. This situation epitomizes a 'tragedy of the commons,' where individual incentives conflict with the broader health and ethos of the Ethereum ecosystem.

Counterpoints to > 33% Threshold

Even if Lido were to exceed the 33% threshold, orchestrating an attack to disrupt Ethereum’s finality would require collusion among its ~35 distinct node operators, a complex and risky endeavor. Additionally, such an attack would be detrimental to Lido itself due to Ethereum's inactivity leak penalties. It's important to note that Lido does not have direct control over the validator keys, as they are distributed among the node operators. 

While theoretical attack vectors exist, a more pressing issue is Lido's governance structure, which currently lacks maturity. Presently, Lido governance wields considerable power, including the ability to update smart contracts, control stETH minting, manage node withdrawal addresses, select node operators, and oversee a substantial treasury. Decisions within this governance framework are determined by LDO token holder votes, where the token supply is highly concentrated among a few venture capitalists and individuals, effectively centralizing control over Lido's governance.

The primary concern surrounding Lido thus centers on the concentration of power within its evolving governance layer, rather than a specific attack vector triggered by surpassing the 33% stake mark. Although there are plans to mitigate this issue, such as introducing dual governance to allow stETH holders to veto LDO-driven governance proposals, these measures are not yet operational. This situation underscores the complexity and nuances of governance and power dynamics within the Ethereum staking ecosystem, particularly in the context of rapidly expanding platforms like Lido.

Potential Solutions

Introducing the GOOSE Module

Lido's innovative governance trajectory introduces GOOSE (Guided Open Objective Setting Exercise). This module embodies the decentralized spirit, setting short to long-term goals in a manner that is both decentralized and adaptable. The inherent challenge for many protocols lies in fostering robust governance participation. Traditional managerial systems, despite their efficiency, often don't resonate with the core tenets of decentralization that are integral to the crypto universe. Lido's GOOSE aims to bridge this gap.

Designed as a potential precursor to a broader framework, GOOSE encourages participation from both Lido's community and the larger Ethereum ecosystem. This inclusive approach allows for the submission of goals aligned with the DAO's overarching mission, vision, and ethos—often referred to colloquially as "vibes." To ensure relevance and adaptability, these goals are subject to annual evaluations. This iterative process guarantees that protocol contributors always have a pertinent point of reference whilst retaining autonomy over the ideation and execution phases.

An integral component of the GOOSE proposal centers on incentivizing user-driven proposals. Recognizing the efforts of those whose ideas align with the "Vibes" reference matrix, Lido envisages compensating these innovative contributors. The broader implications of this model are multifold: it promises a more streamlined governance decision-making process, ensures optimal resource allocation by aligning goals with funding, and beckons superior talent to the ecosystem by offering incentives.

Distributed Validator Technology (DVT)

Recently, the governance token holders of Lido DAO (LDO) have chosen to embrace new validators through Obol and SSV networks. This decision underscores a pivotal shift towards Distributed Validator Technology (DVT), a forward-thinking innovation aimed at decentralizing validator node operations. DVT distributes a single validator's responsibilities across multiple operators to enhance the staking operations' resilience, reducing risks linked to technical mishaps or unforeseen downtimes.

Throughout 2022, Lido's team has diligently tested and integrated DVT solutions, particularly from Obol and SSV projects. This year, these efforts have accelerated, leading to significant advancements in DVT. Obol, for example, initiated multiple distributed validators on the Ethereum mainnet in April 2023, while SSV launched its mainnet DVT network in September 2023.

However, the recent snapshot vote's approval doesn't directly merge distributed validators with Lido's existing node operator set. Instead, it introduces a distinct "staking module" for these validators, made possible by the Lido V2 upgrade implemented in May 2023. This upgrade, also enabling staked ETH withdrawals, introduced the "staking router," facilitating the integration of diverse validator types, including distributed validators, into customizable pools.

From an analytical standpoint, Lido's adoption of DVT reflects a commitment to enhancing its validator set's robustness and decentralization. The phased implementation indicates Lido's cautious approach to new technologies. 

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Michael @ CryptoEQ
Michael @ CryptoEQ

I am a Co-Founder and Lead Analyst at CryptoEQ. Gain the market insights you need to grow your cryptocurrency portfolio. Our team's supportive and interactive approach helps you refine your crypto investing and trading strategies.


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