MAY 17, 2023 • 5 Min Read
Liquid Staking Derivatives (LSDs) enable users to swap ETH in return for a derivative token that represents staked ETH. LSDs let users bypass the frictions of staking ETH: (i) the technical know-how of running a validator, and (ii) the 32 ETH requirement (nearly $60,000 at today’s prices). The swapped ETH is then staked by the provider and the yield is passed on to the token holder (minus fees). To read more about how LSDs work, Pro Members can read our report from January of this year, The Future of ETH Liquid Staking.
Last month’s Ethereum Shapella upgrade enabled Ethereum validators to finally withdraw their staked ETH and reward.
This week, Lido’s v2 upgrade enabled in-protocol withdrawals at a 1:1 ratio for all ETH stakers on Lido.
This is very significant as Lido has a 76% market share of all liquid staked ETH. The ability to unstake from Lido creates a direct economic incentive for node operators to operate properly, as users are now free to abandon them at will. Lido v2 introduces a staking router that looks to leverage these incentives to further decentralize the protocol.
Currently, 46% of all Ethereum staked is staked with LSDs.
Without LSDs, centralized exchanges would likely control the majority of Ethereum staking, creating a centralized attack vector in the production of Ethereum’s block space. As a result, the decentralization of LSDs impacts the decentralization of Ethereum itself.
The LSD market is considered to be a “winner-take-all” market as liquidity and network effects work in tandem to create a positive feedback loop of growth. With Lido currently being in the strongest position (by a wide margin) to be that winner, the decentralization of Lido becomes important for the Ethereum ecosystem as a whole.
Currently, Lido has a set of 30 node operators who have been vetted by the Lido Node Operator Subgovernance Group (LNOSG), approved with a governance vote of LDO holders, and given the responsibility of acting as validators representing all ETH staked with Lido.
However, the LNOSG being the arbiters of who can and cannot be a node operator is not sustainable in the long term. In Lido’s own words: “Curation by peer-review-only will lead to a full-blown cartel in the long-term; a dystopian outcome for Ethereum that we absolutely must prevent.”
Lido’s Staking Router will orchestrate deposits and withdrawals to satisfy the DAO’s desired stake distribution, and allow DAO-set treasury staking rewards and stake allocation algorithms to control the validator distribution.
Distributed Validator Technology clusters will be introduced that group validators into independent committees who propose and attest to blocks together. These committees will enable the onboarding of “untrusted” Node Operators by pairing them with a majority of trusted Node Operators to reduce the risk of underperformance or misbehavior. Node Operator Scores will also be integrated for stake allocation. These parameters combine to enable permissionless node deployment, with operators having the freedom to set custom parameters, such as fees or collateral requirements.
Ultimately, Lido will be able to upgrade from a curated list of reputable node operators, to validator pool markets with pools acting as supply and stake acting as demand.
Lido’s validator set was bootstrapped in a centralized manner. While a governance vote did have to pass for validators to be accepted, the Lido team was the ultimate arbiter of which validators were eligible to be accepted by the DAO. While Lido’s Node Operator bootstrapping was moderately centralized, there really isn’t anything wrong with this. Most protocols need centralized elements as they build out their liquidity, incentive mechanisms and network effects.
What is important though is that these centralized points of failure become decentralized away as the network matures.
Lido has stated that its intent is to be “credibly neutral”. This stems from a 2020 blog post by Ethereum Inventor Vitalik Buterin about Credible Neutrality as a guiding principle. The purpose of credible neutrality is to create credible systems of rule that everybody can get behind, rather than having systems that give power to a select few.
For a protocol to be credibly neutral, it must:
– Not discriminate for or against any specific person or group of people
– Have transparent fairness for all parties
– Have all outputs directly correlated to inputs
Both free markets and decentralized blockchains have the tendencies of credible neutrality. Free markets foster an environment where competition and individual choice drives economic outcomes with impartiality. Decentralized blockchains align incentives and discourage malicious behavior, while ensuring security, decentralization, and stability.
The common denominator between the two is game theory. It is the foundation of Ethereum’s consensus model and Lido’s pool markets.
With the amount of ETH staked with Lido accelerating, Ethereum’s decentralization is betting on Lido’s Game Theory.
P.S. Send me a Twitter DM @cryptunez with who our next AMA should be! 😎
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