Liquid Staking Platforms Like Lido Could Threaten Ethereum

A lead Ethereum devel­op­er has high­light­ed some of the risks that liq­uid stak­ing deriv­a­tives pose to the Ethereum ecosystem.

On June 1, Ethereum devel­op­er Dan­ny Ryan post­ed a recent arti­cle on liq­uid stak­ing deriv­a­tives (LSDs). Those above “crit­i­cal con­sen­sus thresh­olds” pose risks to the Ethereum pro­to­col, he noted.

“With with­drawals enabled, it’s time to reshuf­fle,” he said.

Are Liquid Staking Platforms a Danger to Ethereum?

Liq­uid stak­ing deriv­a­tives are pro­to­cols such as Lido that offer flex­i­ble ETH stak­ing. How­ev­er, their “decen­tral­ized” gov­er­nance is ques­tion­able and could lead to centralization.

Ryan stat­ed that LSD pro­to­cols are a “stra­tum for carteliza­tion” that induce sig­nif­i­cant risks to the Ethereum pro­to­col. Those allo­cat­ing cap­i­tal to these pro­to­cols should be aware of the risks asso­ci­at­ed, he added.

“LSD pro­to­cols should self-lim­it to avoid cen­tral­iza­tion and pro­to­col risk that can ulti­mate­ly destroy their product.”

In an extreme sce­nario, con­sen­sus can be exceed­ed with the stak­ing deriv­a­tive achiev­ing out­sized prof­its com­pared to non-pooled cap­i­tal. This could be due to coor­di­nat­ed MEV (max­i­mal extractable val­ue) extrac­tion, block-tim­ing manip­u­la­tion, and/or cen­sor­ship, he said.

“And in this sce­nario, staked cap­i­tal becomes dis­cour­aged from stak­ing else­where due to out­sized car­tel rewards, self-rein­forc­ing the cartel’s hold on staking.”

Fur­ther­more, decid­ing who can become a node oper­a­tor is anoth­er avenue for cartelization.

In the case of Lido, the LDO gov­er­nance token may be the decid­ing fac­tor, and this could threat­en Ethereum. This is because whales and VCs often manip­u­late DeFi governance.

“Thus the gov­er­nance token decid­ing NOs [node oper­a­tors] can become a self-rein­forc­ing carteliza­tion and abuse of the Ethereum pro­to­col,” Ryan noted.

He con­clud­ed with a rec­om­men­da­tion that Lido and sim­i­lar LSD prod­ucts self-lim­it for their own sake, and stak­ers should also have limits.

“Cap­i­tal allo­ca­tors should not allo­cate to LSD pro­to­cols exceed­ing 25% of total staked Ether due to the inher­ent and extreme risks associated.”

On May 22, Ethereum co-founder Vita­lik Buterin cau­tioned on the dan­gers of “over­load­ing” Ethereum’s con­sen­sus past its core func­tions. “We should instead pre­serve the chain’s min­i­mal­ism, sup­port uses of re-stak­ing that do not look like slip­pery slopes to extend­ing the role of Ethereum con­sen­sus,” he said.

ETH Staking Update

21.7 mil­lion ETH are cur­rent­ly staked, accord­ing to Nansen data. How­ev­er, Beaconcha.in reports a much low­er fig­ure of 19.1 million.

Lido has the lion’s share of this, which is why it is the biggest threat. Lido cur­rent­ly has 6.95 mil­lion ETH staked on the plat­form, val­ued at $12.6 bil­lion. This equates to around a third of the total amount of Ethereum staked.

With­drawals have slowed and are cur­rent­ly out­paced by deposits, accord­ing to Nansen data.