Bankless: Is Lido unstoppable?

Liquidity staking giants are getting bigger and more concerned.

Original title: "Is Lido Unstoppable?"

Written by: Ben Giove, bankless

** Compilation: Kate**

May is an important month for Lid*o. Withdrawals are live, and its ETH-denominated TVL hits an all-time high. *

The entire staking industry is in trouble after *Shapella, but Lido's alternatives are catching up? Or is Lido losing market dominance? Let's dig deeper. *

—Bankless Team

Despite market turmoil, ethereum staking deposits are climbing and the biggest players in the space are getting stronger.

Despite last month’s Shapella hard fork (a network upgrade that allows withdrawals from staking), ETH’s staking volume is still surging. Since then, over 2.9 million ETH has been staked or queued to be staked, a 15.9% increase from before Shapella.

Today, roughly 18% of the total ETH supply is in the staking and/or activation queue. Even now, this is well below the ~60% average for the largest PoS blockchains, suggesting more ETH will flow to validators in the future.

The staking supercycle is well underway.

Lido keeps winning

One of the main beneficiaries of this surge in staking is Liquid Staking Derivatives (LSDs). These tokens, which represent claims on the underlying collateralized ETH, have grown dramatically post-Shapella, as have their collective deposits.

LSD currently holds a total of 36.9% of stakes, up from 35.8% on Shapella.

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Source: DUNE

The largest LSD issuer is Lido, and the entity attracting the most notional pledges since Shapella. Lido itself has a 31.8% staked share of ETH. That’s almost three times the size of the second largest crypto staking entity, Coinbase.

Lido's growth has made its governance token, LDO, one of the best-performing tokens in the market, up 95% against the U.S. dollar and 22% against ETH year-to-date. This comes despite Lido’s recent implementation of withdrawals via V2, which launched on May 15th.

Since withdrawals went live, more than 444,000 ETH has been withdrawn from the protocol, with the vast majority (97%) belonging to bankrupt lender Celsius. This represented 7% of Lido's pre-v2 deposits.

In addition to allowing stETH holders to withdraw, V2 also introduced a second major change to the protocol in the form of a staking router. The staking router enables validators to create their own custom, isolated staking pools (called modules) in Lido. For example, a validator or a group of individual stakers can launch a module that utilizes Obol's Distributed Validator Technology (DVT) network or EigenLayer's restaking solution.

Modules not only have the potential to grow and diversify Lido's validator set, but due to their isolated nature, allow the protocol to experiment with new staking techniques at the margin while reducing overall risk. However, just like V1, all modules (and new validators) must be approved by Lido DAO governance before going live.

Lingering Questions

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Source: Dune

When it comes to decentralizing Lido, V2 is a step in the right direction. However, it still does not address one of the major risk factors facing the protocol, as LDO holders ultimately still control the validators.

Given the large amount of staking under their control, this could pose a significant risk to the health, decentralization, and trusted neutrality of Ethereum as a whole.

Now, not all staking is controlled by one guy in the basement. Today 30 entities are verified in the Lido V1 module. Of course, as a non-custodial, transparent protocol, Lido is a more acceptable option than black-box centralized exchanges. However, the ability of token holders to pick and choose who validates the protocol and how they validate it can have serious adverse effects.

For example, LDO holders could require all validators and new modules to run a relayer that reviews transactions for OFAC compliance. Now, it seems that these token holders do not want to do such a thing. But they may be pressured by the government to do so. Due to its highly institutionalized stakeholder base, Lido could be very vulnerable to this attack.

According to Arkham Intel, about 10.1% of LDO supply is held by seven venture capital funds, hedge funds, and market makers: Paradigm, Dragonfly, DeFiance, Jump, BitScale, Wintermute, and Brevan Digital Howard.

Now, 10.1% doesn't seem like that much. But considering that the only LidoDAO governance votes to achieve 10% of total voter participation were in the first two ballots in December 2020 (158 votes since then), history shows that it was enough to effect meaningful change. That number doesn't even count all the other institutional holders that might exist.

These entities must be registered with governments around the world. And if the pinch comes to shove, they end up at the mercy of the government. Given the growing hostility towards cryptocurrencies in jurisdictions such as the United States, this could pose a risk to Ethereum’s decentralization and trusted neutrality.

To its credit, the Lido community has acknowledged that LDO holders have too much power over the protocol and is taking steps to address this, such as through stETH governance.

At the same time, however, it is critical that the community drive staking diversification by increasing the ease of staking individually, and creating and growing permissionless, governance-minimized liquid staking solutions.