Unveiling the Rise of Lido: How it Consolidates Its Leading Position in the Ethereum Staking Market

Lido's Rise to Dominance in Ethereum Staking

Author: Ebunker

Lido protocol’s May data soared in all areas

With solid fundamentals, a strong ecosystem, and a reliable community, the largest liquidity staking protocol Lido Finance has become the highest market share LSD staking platform, serving as a successful example of the DeFi ecosystem.

Lido Protocol’s income comes from charging users a 10% staking reward as a fee, which is allocated to Lido DAO, node operators, and insurance funds. After the launch of Lido V2, due to users being able to flexibly exchange stETH for ETH, staking data continued to rise, and income in May surged by 22%, making it the fastest-growing DeFi protocol in terms of revenue.

From the TVL data, Lido has become the largest DeFi protocol, with an asset value of $12.7 billion, more than twice that of Makerdao, the second-largest.

Since the beginning of this year, Lido’s TVL has been rising and has benefited from the implementation of the Ethereum Shanghai upgrade. Since the launch of Lido V2, its TVL has risen by 15%.

As most of the liquidity on Lido is composed of ETH, the increase in TVL indicates that stakers have returned to the protocol to lock in more tokens. As shown in the graph above, the steady increase in active users on the Lido protocol last month also confirms this.

From the perspective of LSD APR and the ratio of the protocol’s native token market value to TVL, Lido’s data is not inferior to other competitors and belongs to the type with high security and stable profits, which is also an important reason for its stable position.

Lido’s main competitive advantages

Lido is mainly based on: 1) LSD’s natural advantages; 2) Long-term and stable operation to obtain continuous advantages.

Firstly, stETH has a natural advantage, and its holders benefit from the token’s deep liquidity, making it one of the preferred liquidity mortgage choices for core users. The integration of a wide range of collateral in DeFi has increased the use cases of the token. stETH can be used throughout the DeFi ecosystem, providing liquidity for exchange pools on Lido or other platforms, or lending it on certain platforms. It is obviously more attractive to mature capital seeking the best investment attribute combination than ordinary LSD, which further enhances Lido’s competitive advantage in staking derivatives.

Lido has been operating smoothly since its launch years ago, and the gap between it and its closest competitors (Rocker Pool, Frax) will continue to widen over time, while extracting profits and squeezing the market space of other competitors, making more and more stakers choose Lido.

Lido’s Decentralization Commitment

First, Lido is actively using a DAO governance structure for its operations. Lido supporters can use LDO tokens to vote on proposed updates to the platform and participate in decisions about the overall direction of the organization.

Second, the launch of Lido V2 also marks further progress on its decentralization roadmap. In the staking route of V2, anyone can develop an entry for new node operators, from independent validators to DAO organizations to distributed validator technology (DVT) clusters, to create a more diverse validator ecosystem together.

Furthermore, Lido’s Ethereum staking protocol upgrade supports a buffer pool, allowing stETH holders to quickly exit staking from Lido, achieving a key milestone for a truly “allow staking” + “exit staking” Ethereum staking ecosystem.

Additionally, Lido is recruiting more Lido node operators to increase its underlying diversity. At the same time, the diversity of Lido’s executive layer clients has also been improving over the past two quarters. Lido has been insisting on the diversity of operators and validators to reduce the risk of downtime or censorship, while maintaining network performance and neutrality.

Lido’s Dual Governance Mechanism Proposal

While maintaining decentralization, Lido is also looking for ways to reduce the risk of its own system, and the LDO+stETH dual governance proposal is a self-improvement attempt. The Lido ecosystem is currently governed by its protocol token LDO, which gives users the power to vote on activities, upgrades, and changes on the platform. The stETH maintains a 1:1 redemption ratio with ETH, representing the amount of ETH held by users who stake.

Considering the huge amount of ETH staked by the protocol, Lido’s core developers believe that they must change the governance model of Lido DAO and propose a “LDO+stETH” dual governance proposal to resist moral hazard (Lido’s staked ETH has now reached 7.19 million ETH, 1 million ETH higher than when the proposal was made). The proposal aims to address the delegation proxy issue that currently exists in the governance status, where LDO holders (agents) may act in their own interests and disregard the interests of stETH holders (principals).

What pledgers care more about is the benefit of the Ethereum network, and the interests of LDO holders are not completely aligned with them. In the worst case, LDO holders theoretically can behave maliciously, steal the ETH pledged in the smart contract, and abuse their control over liquidity pledge code. This is because Lido DAO has the ability to upgrade the stETH contract, enabling it to destroy stETH from any address and mint it to other addresses. This means that although the DAO does not directly control the ETH supporting stETH, it can steal funds from users by modifying the code, destroying their stETH and minting it elsewhere.

The goal of proposing a dual governance plan is to better adjust the incentive mechanisms of both parties and prevent such incidents from happening. Under this plan, LDO holders can still propose protocol changes, but stETH holders also have veto power and the right to reject proposals that are considered “key governance decisions.” This is crucial for protecting the interests of pledgers, preventing governance from being controlled or the protocol from being imbalanced.

Although the proposal has not yet been implemented, with the continuous increase in stETH quantity, the dual governance proposal will be discussed again.

Lido benefits from SEC regulation of CEX pledging

Last week, the US Securities and Exchange Commission sued Binance and Coinbase. The charges against these two exchanges are different, but there is a common theme-SEC is investigating the pledging services provided by these two CEXs to their US users. Although the SEC’s complaint is not directed at Ethereum pledging solutions, the agency has indicated that they are willing to investigate Ethereum pledging.

In February of this year, as part of a settlement agreement with the SEC, Kraken was forced to terminate its Ethereum pledging services for US users, and SEC Chairman Gensler claimed that “everyone should pay attention to this in the market.” The SEC’s investigation into the pledging of centralized exchanges will further benefit Lido in occupying a larger share of the ETH pledging market.

Despite the upgrade in Shanghai and the opening of withdrawals, Lido continues to dominate Ethereum staking, with over 900,000 ETH (15%) in deposits this month. Lido’s market share has increased from 31.4% to 31.5% – proving that the protocol has transformed past success into continued dominance in the future.

Risks of Overgrowth in Lido Staking

After overwhelmingly voting against self-restricting deposits in June 2022, Lido’s governance organization chose to ignore the threat posed by its ever-increasing stake. While self-restrictions may indeed go against the best interests of LDO token holders and harm Lido’s profitability, the risks posed to the entire staking ecosystem by not self-restricting are very real.

Recently, more and more Ethereum holders have begun to oppose Lido, with some arguing that the community should force corrective action if Lido refuses to self-restrict. While this sentiment is concerning, it is unlikely that we will see such controls implemented at the base layer, as this would involve a hard fork and could disrupt Ethereum’s fragile social consensus layer.

Ethereum developer Danny Ryan has warned of the dangers of staking “cartelization,” pointing out that Lido can extract high profits compared to non-staking pool capital. A report by Ethereum supporters Bankless notes that the Lido community should be concerned about overgrowth in its staking share (staking centralization), which could inhibit prospects for future demand for Ethereum block space.

The platform’s stake is now approaching the first threshold of approximately 33.3% of ETH stake. In theory, reaching this threshold makes Ethereum more vulnerable to manipulation by attackers. This would degrade core attributes of Ethereum’s value proposition and provide greater power to potential attackers over the chain. If Lido continues to grow at an uncontrolled rate, it will inevitably exceed these thresholds and pose systemic risks to the ecosystem. Therefore, the ongoing rise in stake is a double-edged sword for Lido, which still has a long way to go in terms of decentralization and systemic risk mitigation.