Ethereum’s Elephants; Lido, Part 2/2
With centralization being Ethereum’s current state, it is its main problem. This elephant has manifested itself in different ways. In part 1, we started by talking about the layers, and how the emergence of layer 2 led to a pivot away from centralization.
In this second and final part, we will look at the elephant in the room; Lido. The issue of Lido’s dominant share in Ethereum staking, 31.76% as of December 2023, is another concern to all stakeholders involved. Lido’s offering made this possible. Lido Finance removes the 32 ETH requirement to staking Ethereum by letting users deposit any amount and receive stETH in return. This stETH token reflects your staked ETH and any earned rewards, all while remaining liquid for use in other DeFi applications. Lido takes care of running the validator nodes necessary for staking.
Lido’s share in the network has made some things obvious
- This concentration of staking power within one entity could potentially influence protocol decisions.
- It also raises security risks. Since Lido acts as an intermediary, delegators don’t directly control their staked ETH, which is locked in Lido’s smart contracts. If these contracts were hacked or suffered a critical bug, Lido’s staked ETH, representing a significant portion of the network’s total stake, could be stolen or manipulated. This could erode trust in the network, negatively impact staking rewards, and potentially compromise Ethereum’s security if the attacker gained undue influence over validator behavior.
Ethereum is aware of these risks and is already taking steps to mitigate them. Ethereum has unveiled its plans, it notes that its current staking system can be seen as a two-tiered system with node operators and delegators. Lido and RocketPool are examples of staking pools that create this system. However, this system has drawbacks:
- Centralization risk: The way node operators are chosen in these pools is not decentralized.
- Needless Burden: Verifying transactions puts a strain on the network. The network could be more efficient if delegators didn’t need to sign off so often.
Now Ethereum is focusing on how delegators who can’t run nodes themselves can still contribute to the network’s security. Ideally, users would be able to choose which validators they support and participate in securing the network in a simpler way than running a full node. This would make the system more decentralized. Additionally, the network should require fewer signatures from validators each time a block is added, making it easier for everyone to participate in securing the network. Decentralization would be made much easier by everyone being able to run a validating node.
Just as Ethereum has shown, it’s crucial to diversify staking across multiple validators and consider alternative staking options to mitigate concentration risk. Here are the steps to solving Elephant Lido.
1. Encouraging Staking Diversification:
- Promoting awareness: Educating users about the importance of diversifying their staking across multiple validators to spread the influence and reduce Lido’s dominance.
- Supporting alternative staking options: Fostering the development and adoption of decentralized staking services and non-custodial staking solutions to offer users more choices.
- Implementing protocol-level incentives: Exploring mechanisms within the Ethereum protocol itself that incentivize stake distribution across validators, potentially through rewards or fee structures.
2. Enhancing Lido’s Transparency and Governance:
- Improving disclosure: Encouraging Lido to be more transparent about its governance processes, investment decisions, and potential conflicts of interest.
- Strengthening community engagement: Promoting active participation of Lido users and the broader Ethereum community in decision-making to ensure Lido’s actions align with community interests.
- Exploring alternative governance models: Considering alternative governance structures for Lido that could further decentralize decision-making and reduce the concentration of power within the organization.
3. Addressing Regulatory Uncertainties:
- Clarity on staking regulations: Seeking clear regulatory frameworks for staking services to provide certainty for Lido and encourage responsible growth without stifling innovation.
- Collaboration with regulators: Engaging in constructive dialogue with regulators to address concerns and ensure Lido operates in compliance with relevant regulations.
- Exploring self-regulatory mechanisms: Investigating potential self-regulatory frameworks within the staking industry to establish best practices and mitigate risks.
It’s important to remember that these are just some potential approaches, and the optimal solution will likely involve a combination of strategies. Addressing this elephant effectively will require ongoing collaboration between Lido, the Ethereum community, regulatory bodies, and other stakeholders. Ultimately, the goal is to create a staking landscape that is diverse, transparent, and accountable, ensuring the long-term health and decentralization of the Ethereum network.
