The domination of the Lido market and the decentralization of Ethereum post-Merge

After a successful third testnet merge, September 19 was recently proposed as a tentative target date for the Ethereum merge. Ethereum is set to move completely from proof-of-work (PoW), the original consensus mechanism used by the Bitcoin network, to the more energy-efficient proof-of-stake (PoS) used by younger networks like Solana and Cardano.

“The merger will not solve Ethereum’s downsizing problems alone. It’s just the beginning of a roadmap for future scalability upgrades, “he shared with Cointelegraph Jacob Blish, Lido’s commercial development manager.

Ether (ETH) staking on the Beacon Chain, the PoS network that mirrors Ethereum’s transactions, is expected to remain blocked for at least six months after the merger is complete. After the merger, staking liquid ETH tokens will start benefiting from transaction fees and maximum drawable value, meaning returns will increase.

There has been a lot of hype surrounding the merger. It’s the biggest event in the cryptocurrency industry in a long time, Rocket Pool founder Darren Langley told Cointelegraph, adding, “The lockout period is testing liquid staking protocols now, but that’s mainly due to macro and to centralized finance (CeFi) in progress. Drama. Once it explodes, liquid staking will explode. ”

Currently, ETH staking returns are gaining near a 4% annual percentage rate (APR), with just over 10% of the ETH supply being staking, according to StakingRewards.

The liquid staking service of the Lido

The launch of the Beacon Chain created a need in the ecosystem for a decentralized liquid staking solution that would compete with centralized exchanges (CEX) and could be used within decentralized finance (DeFi) for loans, lending and more. .

The staking service offered by Lido has gained popularity as the first protocol to implement a liquid staking derivative on Ethereum through the minting of the stETH token. Contrary to popular belief, stETH is not meant to be anchored to ETH. As Blish shared:

“Lido staking ETH is supported from 1 to 1 ETH but the exchange rate is not pegged. It can float and trade at a premium or discount as secondary market forces determine the price. This does not affect the underlying support of stETH.

The benefit of Lido’s first engine of launching a liquid staking product helped the protocol move forward with more DeFi integrations for stETH and other multichain products for Solana, Polygon, Polkadot and Kusama. The team recently announced that stETH will expand to Tier 2 solutions to promote their DeFi integrations.

Various staking protocol balances starting May 2022. Source: Twitter

The protocol has attracted liquidity to the Curve pool with incentives in the form of additional Lido Token Rewards (LDOs) and a referral program to further its growth strategy and consolidate itself as a temporary winner within the liquid staking space.

Compared to other protocols in the entire DeFi ecosystem, Lido stands out as the only product that has been able to compete and even outperform its centralized counterparts, such as the Binance ETH (BETH) token, in terms of total locked-in value.

Alternatives to liquid staking derivatives

New products tend to start with strong market leaders, but competition soon develops and innovation ensures new entrants that have the potential to capture market share. The network effect obtained by Lido in a short time made it difficult for its competitors to reach and conquer a substantial share of the market.

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Other liquid staking projects have small differences in terms of fees, product decentralization, and the characteristics of the tokens they offer, but the value proposition remains the same: enabling users to maximize capital efficiency and increase returns by protecting the network.

“The Ethereum ecosystem is built on trustless decentralization. That so much voting power in the hands of an organization is certainly against that ethics,” Jordan Tonani, head of institutions at Index Cooperative, told Cointelegraph, adding: “Having healthy competition between multiple liquid staking protocols is a better outcome, and shortly after the merger, a new set of liquid staking protocols will be supported to promote decentralization. ”

Rocket Pool accounts for over 1.5% of all Ethereum in staking, with 1,300 individual node operators in 84 geographic locations. For this reason, it could impact Lido’s market dominance and increase its relevance in the liquid staking space with new scaling solutions.

Stakehound, Stkr and Stakewise are some of the other projects looking to dent Lido’s market share, but are still lagging behind in terms of depth of liquidity and utility as collateral in DeFi.

It is worth pointing out that Rocket Pool’s permissionless approach appears at first glance to appear more decentralized, as opposed to Lido’s licensed approach, which was a compromise to ensure the reliability of node operators in the early stages of the protocol. The Lido team worked on onboarding without permission based on performance reputation to transition from the current model.

Monopoly or oligopoly, it must be decentralized

Considering the data, Lido currently has a monopoly on the immature market for liquid staking derivatives.

Lido, as a decentralized autonomous organization (DAO), opened the debate on its governance forum on whether stETH is limited to a fixed percentage of the entire ETH staked. Blish explained:

“We are aligned with Ethereum’s ethics of decentralization at the core. Governing the protocol through a DAO ensures that Lido does not pursue any action that could enter into conflict with our community and our values ​​”.

Additionally, a dual token governance proposal was recently approved that allows stETH holders to veto LDO token holder governance proposals that can harm stakers on the Ethereum network.

Similar to the liquid staking dilemma proposed above, Bitcoin (BTC) mining appears to exhibit centralized forces. The space has matured in a market where the three largest mining pools have over 50% of the network hash rate. And the top six mining pools account for more than 80% in the past three months, according to data from BTC.com.

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It is difficult to predict the changes we will experience after the merger and what implications it might have on liquid staking products. While liquid staking derivatives tend towards centralization, an optimistic medium-term evolution could result from other alternative products gaining ground and dividing the market into an oligopoly.

“Realistically, there will be many players in the ecosystem, but maintaining a strong level of decentralization is critical to Ethereum’s success, especially its credible neutrality,” said Langley. “The key to decentralization is lowering the barriers to entry, including lowering the collateral requirement and technical challenges “.

Some volatility is expected in the following month as the hype around the merger continues to grow around liquid staking products. The demand for these products has never been stronger. Further developments will demonstrate whether the space will be managed by one, few or many derivatives with liquid staking.