Success is great. We love it, want it, need it. But success can be its own problem.
Right now, the Lido DAO has reached a new milestone in their staking of Ethereum. They recently have come to represent 33% of all staked Ethereum, and are growing larger. Due to the nature of the Proof of Staking (PoS) consensus system Ethereum has adopted, their blockchain is at risk. Lido has the power to interfere with transactions, consensus, and the future of the blockchain, a power that is likely to increase as their share continues to grow.
What is the Lido Ethereum Liquid Staking Protocol?
From their own GitHub page, they are described as follows:
The Lido Ethereum Liquid Staking Protocol allows their users to earn staking rewards on the Beacon chain without locking Ether or maintaining staking infrastructure.
Users can deposit Ether to the Lido smart contract and receive stETH tokens in return. The smart contract then stakes tokens with the DAO-picked node operators. Users' deposited funds are pooled by the DAO, node operators never have direct access to the users' assets.
Unlike staked ether, the stETH token is free from the limitations associated with a lack of liquidity and can be transferred at any time. The stETH token balance corresponds to the amount of Ether that the holder could request to withdraw.
Individuals can hand over their small amounts of Ethereum to Lido as a custodian, which is able to collect large sums for staking. This was originally seen as an opportunity for average users to benefit from the adopted PoS system which was recently implemented. However, it has exposed a flaw, as a plurality of Ethereum has come under their control.
What is the Lido DAO?
Again, from their own GitHub, they are described as follows:
The Lido DAO is a Decentralized Autonomous Organization that manages the liquid staking protocol by deciding on key parameters (e.g., setting fees, assigning node operators and oracles, etc.) through the voting power of governance token (DPG) holders.
Also, the DAO will accumulate service fees and spend them on insurance, research, development, and protocol upgrades. Initial DAO members will take part in the threshold signature for Ethereum 2.0 by making BLS threshold signatures.
The Lido DAO is an Aragon organization. Since Aragon provides a full end-to-end framework to build DAOs, we use its standard tools. The protocol smart contracts extend AragonApp base contract and can be managed by the DAO.
DAOs are an implementation of organization built from a collection of smart contracts, typically requiring a token for voting purposes. They can help democratize business and financial interactions online, but have also been sources of difficulty as errors in logic allow for exploits, or criminal activity is hidden behind a veneer of openness and transparency.
It is not the purpose of this article to suggest misdeed, or ulterior motives, but it is important to explain that the governance of the Lido DAO is not well understood, out of the hands of the average participant, and has proven itself interested in short-term profit and not the long term health or growth of Ethereum.
The Vote
As Lido approached a plurality control of staked Ethereum, a vote was put forward to hardcap the holdings of Ethereum. This was a sensible and easy solution to the problem, as it would prevent the liquidity pool gaining enough power to negatively influence the blockchain, or consensus.
However, passing this vote would hinder the profits of the pool, requiring fees earned in Ethereum to be sold, or new deposits to be turned away.
A small number of holders with a significant portion of the Lido governance token voted against the cap, and chose unlimited growth. Some commentators expect for their plurality to reach 40% of staked Ethereum by the end of 2023.
No Solution in Sight
Unfortunately, there is no clear method to stop Lido from continuing on its course, not without creating major issues which threaten the blockchain. It is possible to block nodes, or even addresses, but this would undermine any idea of decentralization and freedom for Ethereum.
The underlying flaw is one found in most PoS implementations. The rich get richer. It effectively awards the largest holders, allowing them to increase their proportion over time. Though these were issues pointed to when Ethereum was moving away from Proof of Work, they did little to address them through controls or mechanisms of operation. They preferred to trust in the community.
My Final Thoughts
This is a developing story. No one can say whether Lido will harm or help the Ethereum blockchain. They can only point out the potential. It should not be the case. Cryptocurrency is built on principles of decentralization, or at least diversity among stake holders to help ensure the minimum health of the system. Now, it appears Ethereum must hope Lido acts appropriately, and does not fall victim to bad actors, or exploits. The power they wield is considerable, and the impact they could have is dire.
In all, it would be better if Lido, or anyone, was not in this position.
