Exploring Lido Governance in Depth: Checks and Balances in Power Structure

Exploring Lido Governance: Power Structure Checks and Balances

Source: Stanford Blockchain Review

Author: Michael Li

Translation: Kxp, BlockBeats


A recent innovative governance proposal on Lido, a popular liquidity staking protocol, has largely gone unnoticed. The proposal’s core assertion is to support a “dual governance scheme,” where stETH holders in addition to LDO holders will be endowed with governance rights on the Lido protocol.

As we delve into the details of this proposal, we find that despite novel features such as DAOs having “self-executing smart-contracts” and “governance tokens on permissionless blockchains,” the core issue of governance ultimately boils down to the construction of effective mechanisms.

Just like the fine art of nation-building, DAOs also require a shared sense of purpose, cooperation, and a robust decision-making framework. These all involve dealing with complex power relations and balancing different interests in pursuit of common goals. In this article, we compare the dual governance scheme to the two-house structure of the United States Congress, analyze their common balancing methods, and discuss their unique differences.

Lido’s Dual Governance Proposal

Lido is a decentralized autonomous organization that provides liquidity staking solutions for Ethereum. The Lido ecosystem is currently governed by its protocol token LDO, which grants users the power to vote on activities, upgrades, and changes on the platform. Lido’s stETH derivative token maintains a 1:1 redemption ratio with ETH prices and represents the amount of ETH a user has staked.

Considering the massive amount of staked ETH that the protocol controls (6.17 million ETH, roughly $11.5 billion), Lido’s core developers believe they must change the governance model of the Lido DAO to guard against moral hazards.

Thus, the dual governance proposal aims to address the delegation-agent issue present in the current governance state, where LDO holders (agents) may act in their own interest rather than considering the interests of stETH holders (principals).

In this case, the stakers are more concerned with the interests of the Ethereum network, while the interests of LDO holders are not quite aligned. In the worst-case scenario, LDO holders could even launch a heist and steal the staked ETH in the smart contract, abusing their control over the liquidity staking code. This is because the Lido DAO has the ability to upgrade the stETH contract, enabling it to burn stETH from any address and mint it to another. This means that while the DAO does not directly control the ETH supporting stETH, it can steal funds from users by modifying the code, burning their stETH, and minting it elsewhere.

The dual governance scheme aims to better align the incentives of both parties and ensure that such events do not occur. Under this scheme, LDO holders can still propose changes to the protocol, but stakers also have veto power and the right to reject proposals deemed “critical governance decisions.” This is crucial for protecting stakers’ interests and preventing governance from being controlled or the protocol from becoming imbalanced.

The design of the dual governance mechanism aims to give active members of the stETH community time to react to controversial decisions. First, all important decisions are time-locked, giving the community the opportunity to express dissent via the Veto Escrow smart contract. If a small percentage of the community, such as 5%, disagrees, the governance mechanism enters a temporary veto voting state.

If most of the overall stETH supply joins the upgrade process, governance will transition into a veto negotiation state, allowing stakers to negotiate with governance. Successful negotiations will restore normal governance operations. However, if negotiations fail or most stETH supply joins the upgrade process, global settlement will be triggered, dissolving the protocol and returning ETH to stakers.

Veto Lift Voting is a mechanism that allows stETH holders to execute specific governance decisions when there is a dispute between LDO and stETH holders. When governance is in a veto negotiation state, stETH holders locked in Veto Escrow can initiate a vote with two possible outcomes: lift veto or not lift veto.

The vote will last for a fixed period of time, allowing either outcome to be chosen during the initial two-thirds of the time and only allowing not lifting veto during the final one-third of the time. Successful votes require a minimum quorum and more voting power supporting lifting the veto. If successful, the veto will be lifted, and the decision can be executed; otherwise, the decision will remain unexecutable. This two-stage mechanism will ensure fairness and prevent sudden overturning of decisions without the opportunity to react.

Bicameralism – Bicameral Legislature

The design of Lido’s dual governance scheme follows the principle of bicameralism, which refers to an authoritative legislative body consisting of two chambers or institutions.

The U.S. Congress is a typical example, consisting of the House of Representatives and the Senate. When designing the structure of Congress, the framers also faced the principal-agent problem, which is the problem between elected officials (agents) and citizens (principals). The design of the bicameral system aims to prevent the authority from being controlled by populist “mob rule” through the Senate, while also preventing the authority from being estranged from public opinion and detached from the general opinion of voters.

Of course, such a constitutional arrangement is both a deliberate design result and a historical inevitability, deeply rooted in the tug-of-war between real politics and populous and less populous states. However, the great compromise of 1787 ultimately allowed the representatives of the lower house to be allocated according to population, and the representatives of the upper house to be allocated according to equal states.

In the process of drafting the U.S. Constitution, the framers intentionally designed the membership and governance scope of the two houses, and integrated the principles of checks and balances to prevent the abuse of power and protect citizens’ freedom.

For example, the number of representatives in the House of Representatives is directly related to the population of each state, and representatives are elected every two years. In contrast, senators are appointed by state legislatures, serve six-year terms, and stagger their terms so that one-third of the senators are re-elected every two years. In addition, every state in the Senate has equal representation, with two senators per state, regardless of population.

The Constitution grants unique functions and powers to the House of Representatives and the Senate. The Senate has the power to approve treaties and presidential appointments, while the House of Representatives has the exclusive power to make fiscal bills (tax laws). Ultimately, the enactment of laws requires the approval of each legislative body.

Dual Governance and the Bicameral System

We can observe that there are many similarities between the dual governance mechanism and the bicameral system. From a higher level, they both alleviate the principal-agent problem through the coordination of interests, and limit the power of the governing body by introducing a balancing mechanism. Further research reveals that the bicameral system and the dual governance scheme have four main design features in common: 1) diversity of representation, 2) reasonable delay, 3) expertise, and 4) predictability.

1. Diversity of representation: In the US Congress, the Senate can limit the public’s crazy actions and balance the majority of the House. In Lido, dual governance expands the diversity of representation by combining the interests of stETH holders with those of LDO holders. Here, stETH holders serve as a safeguard to ensure that LDO whales do not control governance, thereby ensuring a more balanced decision-making process.

2. Reasonable delay: The bicameral system and dual governance scheme increase the complexity of governance processes. In Congress, it often requires negotiation of a bill between the two houses; in the case of Lido, the introduction of a time-locking mechanism reduces the likelihood of arbitrary changes, thus curbing the impulse of the ruling party to adopt quick solutions when dealing with complex issues. Of course, on the other hand, such a design may also lead to more stalemates, that is, situations where no bill can be passed.

3. Professionalism: Hamilton and Madison expressed the following views in Federalist No. 62:

“A group of people who are summoned from private activities by the majority of people, have a short tenure of office, and have no lasting motivation to use their free time in learning the laws, affairs, and comprehensive interests of the country, is difficult to avoid in exercising legislative duties. All kinds of important mistakes.” (Federalist No. 62).

On the contrary, senators are more conducive to accumulating professional knowledge and networking resources related to governance due to their longer terms of office. In fact, an important responsibility of the Senate is to review and improve affairs originating from the House of Representatives. Members of the House of Representatives are closer to voters and can more accurately represent public opinion. For Lido’s dual governance scheme, we can reasonably assume that LDO holders are better at deciding protocol parameters and maintenance, while stETH holders are more suitable for evaluating proposals from the perspective of Ethereum network security.

4. Stability and predictability: Madison also pointed out in Federalist No. 62: “Authority and individuals, like themselves, do not last if they are not truly respected; but neither does it truly deserve respect if there is no certain degree of order and stability.” The bicameral system restricts the fickleness of policymakers, and Lido’s dual governance improves the security of pledge providers, which is crucial for the development of the protocol.

Constitutional Engineering and DAO Design

The bicameral system is not exclusive to the United States; its historical roots can be traced back to ancient societies in Greece and Rome. The modern bicameral system originated in England and has been adopted in many other countries, although their specific designs differ.

Comparing the dual governance proposals for the US Congress and Lido is done at a micro level. From a broader perspective, designing a DAO is no different from designing a constitution. Essentially, they are institutional arrangements consisting of systems, processes, and policies designed to efficiently coordinate activities to achieve common goals. The study of constitutional engineering has a long history and can serve as an important reference for emerging DAO designs.

One of the perspectives for comparing constitutional structures is to evaluate veto gates and veto players. Veto gates refer to formal institutions that can block proposals in the legislative process, while veto players refer to any person or group capable of blocking proposals.

For example, the US presidential system and bicameral legislative institution have three veto gates: presidential veto power, the two houses, and the Supreme Court. However, the number of veto players depends on the ruling party’s position, and a party’s relative dominance can lead to one veto player controlling all three veto gates.

Lido’s dual governance proposal may be the first DAO to attempt to set veto gates in its institutional design. However, whether the proposal can successfully achieve its stated goals remains uncertain and will depend on the interaction between veto players. For example, whether stETH holders will act as a unified interest group remains to be seen. As Lido also provides liquidity staking on multiple other chains such as Polygon, Solana, and Avalanche, the inclusion (or exclusion) of non-ETH stakers in Lido DAO governance will further complicate the relationship between LDO holders and stakers.

Optimism Collective: Token House and Citizens’ House

After a detailed discussion of Lido’s dual governance approach, it is worth noting that other projects are also exploring innovative governance structures. One typical example is Optimism, an Optimistic Layer 2 Rollup on Ethereum that employs a unique bicameral method to meet the diverse needs of its community members.

Optimism Collective consists of two parts: Token House and Citizens’ House. Token House consists of OP token holders who vote on various governance proposals, while Citizens’ House is responsible for Retrospective Public Goods Funding (RetroPGF).

RetroPGF includes a series of experiments where Citizens’ House members allocate a portion of protocol profits or token reserves to projects that have made significant contributions to public goods based on specific criteria. The basic concept of RetroPGF is that retrospectively identifying and rewarding projects that have already proven their value is more effective than allocating funds based on potential future benefits.

In each round of RetroPGF, Citizens vote to allocate funds to deserving projects based on their contributions over a predetermined period of time. This approach establishes a strong incentive mechanism for community development of public goods that have a positive impact on Optimism Collective. This makes the ecosystem more accessible to build, learn, and connect, ultimately driving increased usage and demand for the blockspace.

The identity-based Citizen House membership system promotes diversity, prevents oligarchic politics, and encourages long-term commitment to Optimism Collective’s goal of supporting public goods. By separating membership identity from token holdings, Citizen House can maintain a more inclusive and balanced decision-making process, reducing the risk of manipulation and collusion. This approach ensures that public goods funding governance prioritizes the welfare and sustainable growth of the entire community, not just token value growth.

Conclusion – Checks and Balances in Power Structures

In his book “Post-Capitalist Society” (1993), Peter Drucker, the father of modern management theory, proposed a hypothesis for a self-governing community organization that would exist between the private and public sectors.

“Every developed country needs an autonomous, self-governing community organization department that provides people with the community services they need. Most importantly, it will establish community connections and revive civic consciousness. Historically, people’s fate has been closely linked to the communities they belong to. In the post-capitalist society and polity, individuals must take responsibility for their communities and actively contribute to their development and prosperity.”

The core innovation of blockchain lies in governance – a new mode of trust distribution. DAOs driven by blockchain have become the basis for many organic communities and undoubtedly have the potential to realize Drucker’s vision of nurturing “new citizen centers”. However, the road to achieving this goal is complex and challenging.

“Ambition must be made to counteract ambition.” – The Federalist No. 51

The spirit of checks and balances proposed by James Madison is not only an eternal political principle, but also a principle that any populous community organization should follow when balancing the interests of all parties. Therefore, it is encouraging to see organizations such as Lido DAO and Optimism Collective actively adopting more complex institutional arrangements in their governance processes.

In order to realize the vision of DAOs for new forms of social organization, and to get rid of the intervention of centralized institutions, innovation must be achieved not only at the technical level, but also at the institutional design level. In order to truly realize its potential, DAOs should be brave enough to explore the diverse fields of constitutional engineering and draw valuable experience from the rise and fall of past political structures.