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

Lido Protocol's May Data Soars

With a solid foundation, a robust ecosystem, and a trusted community, Lido Finance, the largest liquidity staking protocol, has become the market leader in LSD staking platforms, serving as a successful example within the DeFi ecosystem.

Lido Protocol's revenue comes from charging users a 10% staking reward as a fee, which is distributed to Lido DAO, node operators, and the insurance fund. After the launch of Lido V2, with users being able to easily swap stETH back to ETH, the staked data continues to rise, and the revenue in May increased by 22%, making it the fastest-growing DeFi protocol in terms of revenue.

In terms of TVL data, Lido has become the largest DeFi protocol with assets worth $12.7 billion, which is more than double the TVL of the 2nd ranked MakerDAO.

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

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

From the perspective of the ratio of LSD APR and the market value/TVL of the native token, Lido's data is generally not inferior to other competitors, belonging to the type with high security and stable returns, which is an important reason for its solid position.

Lido's main competitive advantages

Lido mainly benefits from its: 1) LSD's natural advantages; 2) continuous advantages gained from long-term stable operation.

First, stETH has a natural advantage, and its holders benefit from the token's deep liquidity, making it one of the preferred liquidity collateral choices for core users. The extensive integration of collateral in DeFi increases the use cases of the token. stETH can be used throughout the DeFi ecosystem, providing liquidity to exchange pools on Lido or other platforms, and can also be lent out on certain platforms. For mature capital seeking the optimal investment attribute combination, it is obviously more attractive than ordinary LSD, further enhancing the competitive advantage of Lido's staking derivatives.

Over the years, Lido has operated steadily, and the gap between it and its closest competitors (Rocker Pool, Frax) will continue to widen over time, squeezing the market space of other competitors and attracting more and more stakers to choose Lido.

Lido's commitment to decentralization

First, Lido is actively using DAO governance structure for operation. Lido's supporters can vote on proposed updates to the platform using the LDO token and participate in decisions about the overall development direction.

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

Furthermore, the Ethereum staking protocol upgrade of Lido supports a buffer pool, allowing stETH holders to quickly exit staking from Lido, achieving a key milestone in the Ethereum staking ecosystem of "onboarding staking" and "offboarding staking".

In addition, Lido is recruiting more Lido node operators to increase its underlying diversity. At the same time, Lido's execution layer client diversity has also been improving in the past two quarters. Lido has always insisted on operator and validator set diversification to reduce the risk of downtime or censorship while maintaining network performance and neutrality.

Lido's Dual Governance Mechanism Proposal

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

Considering the significant amount of staked ETH controlled by the protocol, Lido's core developers believe they must change the governance model of Lido DAO. They propose the "LDO+stETH" dual governance proposal to mitigate moral hazards (the amount of ETH staked by Lido has now reached 7.19 million ETH, over 1 million ETH higher than when the proposal was made). This proposal aims to address the delegation agency problem that arises in the current governance state, where LDO holders (agents) may act in their own interest, disregarding the interests of stETH holders (delegators).

Stakers are actually more concerned about the interests of the Ethereum network, and the interests of LDO holders do not necessarily align completely with them. In the worst-case scenario, LDO holders theoretically can act maliciously, siphoning off the staked ETH in the smart contract and abusing their control over the liquidity staking 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 another address. This means that although the DAO does not directly control the ETH supporting stETH, it can steal funds from users, destroy their stETH, and mint it elsewhere by modifying the code.

The goal of proposing a dual governance scheme is to better adjust the incentive mechanisms of both parties and prevent such incidents from happening. Under this scheme, LDO holders can still propose suggestions for protocol changes, but stETH holders also have the veto power to reject proposals considered to be "critical governance decisions". This is crucial for protecting the interests of stakers and preventing governance from being controlled or the protocol from becoming imbalanced.

Although the proposal has not been implemented yet, as the number of stETH continues to rise, the dual governance proposal will be discussed again.

Lido benefits from SEC regulation on CEX staking

Last week, the U.S. Securities and Exchange Commission (SEC) filed lawsuits against Binance and Coinbase. The charges against the two exchanges are different, but there is a common theme - the SEC is investigating the staking services provided by these CEXs to their U.S. users. While the SEC's complaint does not target Ethereum staking solutions, the agency has indicated its intention to investigate Ethereum staking.

In February of this year, as part of a settlement agreement with the SEC, Kraken was forced to terminate its Ethereum staking services for U.S. users. SEC Chairman Gensler stated, "This should be a wake-up call for everyone in the market." The SEC's scrutiny of staking on centralized exchanges will further benefit Lido in capturing a larger share of the ETH staking market.

Despite the withdrawal option being made available after the Shanghai upgrade, Lido still maintains its dominant position in Ethereum staking, with deposits increasing by over 900,000 ETH (15%) this month. Lido's market share has increased from 31.4% to 31.5% - a testament to the protocol's ability to translate past success into continued dominance in the future.

Risks associated with excessive growth in Lido staking

After overwhelmingly voting against self-imposed deposit limitations in June 2022, the Lido governance organization chose to continue disregarding the threat posed by its increasing staking dominance. On the surface, self-imposed deposit limitations do indeed go against the best interests of LDO token holders and harm Lido's profitability. However, not implementing self-imposed limitations also presents very real risks to the entire staking system.

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

Ethereum developers such as Danny Ryan have warned of the dangers of staking becoming "cartelized," pointing out that Lido can extract high profits compared to non-staking pool capital. A report by Bankless, a supporter of Ethereum, suggests that the Lido community should be concerned about the excessive growth of its staking share (centralization of staking), which could suppress future demand for Ethereum block space.

Currently, the platform's staking amount is approaching the first threshold, which is approximately 33.3% of ETH staked. In theory, reaching this threshold makes Ethereum more susceptible to manipulation by attackers. This would result in a downgrading of the core attributes that advocate for the value of Ethereum and provide greater power to potential attackers on the network. If Lido continues to grow at an uncontrolled rate, it will inevitably surpass these thresholds and pose systemic risks to the ecosystem. Therefore, the continued increase in staking share is a double-edged sword for Lido, as it still has a long way to go in terms of decentralization and mitigating system risks.