Post-Merge, If Lido Becomes Dominant, What Does That Mean for Ethereum? - Ep. 372

Ryan Berckmans, Ethereum investor and community member, and Alexandre Bergeron, Bitcoin investor, discuss Lido’s dominance as a liquid staking provider, whether that issue can be resolved, and how it could be a centralizing force for Ethereum.

Show highlights:

what stETH is, what the uses cases are for stETH, and why it is important
how Lido had a first-mover advantage and how that kicked off network effects
whether the liquid staking derivatives system is one of a “winner-take-all”
how much of the staked ETH will be turned into a liquid staking derivative
how Lido might have a huge MEV opportunity after the Merge
what the proposer-builder separation is
whether Lido’s dominance will increase over time
whether other competitors have been competitive with Lido
why Lido is a natural monopoly because of the incentives and MEV opportunities
what the implication of Lido’s monopoly is for Ethereum’s censorship resistance
whether Lido is effectively a single entity despite having multiple node operators
whether there could be a long waiting period for becoming a validator after the Merge
how Lido is moving its staking derivatives to other chains
how Lido’s new dual-governance proposal works, why it might be useful to decentralize Lido and whether it reduces the power of LDO token holders
how Lido’s centralization is the biggest threat to Ethereum in the long term and what are the possible solutions
why Ryan believes the value of ETH comes from its credible neutrality and whether Lido’s centralization may jeopardize that
whether finding solutions around MEV opportunities is a good way to reduce Lido’s monopoly
whether Lido’s competitors could form an alliance and build a tokenized basket of their staking derivatives to compete with Lido
whether Lido could airdrop the LDO token to all ETH holders to decentralize its governance token

Episode Transcript

Laura Shin:

Hi, everyone. Welcome to Unchained. Your no hype resource for all things crypto. I’m your host Laura Shin, author of the Cryptopians. I started covering crypto seven years ago and as a senior editor at Forbes was the first mainstream media reporter to cover cryptocurrency full time. This is the July 12, 2022 episode of Unchained.

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Today’s topic is the dominance of Lido. Here to discuss are Ryan Berckmans, Ethereum investor and community member and Alex Bergeron, bitcoin investor. Welcome, Ryan and Alex.

Ryan Berckmans:

Thanks for having me Laura.

Alex Bergeron:

Hi, Laura. Thanks for having us.

Laura Shin:

Last week I did a show, which was the first in a two-part series on staked ETH or stETH and Lido and since there are actually a couple big issues regarding Lido and liquid staking derivatives, I felt that this should be broken into two different shows. Last week’s show, the one with Hasu and Tarun Chitra focused more on stETH itself and the role it has played in recent crisis in crypto involving Celsius and Three Arrows Capital. This week, we’ll look more at the role that Lido and liquid staking derivates could have on Ethereum itself.

One last note is that for various reasons, we’re recording this almost two weeks before this episode runs, so if there’s any recent news development that we are for whatever reason not mentioning, that is why. All right. So, Ryan, let’s start with you just so we can get all the listeners up to speed and make sure everyone has a basic understanding. Can you explain what staked ETH is and what Lido is and why they’ve become popular.

Ryan Berckmans:
Perfect. So, staked ether is the idea that now that Ethereum is switching to proof of stake, everyone wants to get in on the staking game. You take your ether, you lock it up in the ETH2 beacon chain deposit contract, and then the network pays you rewards to participate in the validating of the chain. However, when you lock up your ether, it then becomes immobile, unproductive, inaccessible.

And so, Lido’s staked ether token is a liquid staking derivative that aims to let you eat your cake and have it too where you can participate in the staking process while retaining a fungible tokenized representation of your staked ether that you’re then free to use in DeFi for any number of wonderful things, especially borrowing against it and earning yield on it.

Laura Shin:
Interestingly, Lido accounts for about 32 percent of all staked ether at the moment and amongst the liquid staking derivative providers, it actually accounts for 90 percent of that. So, it’s quite dominant if we look at even some of the other more centralized entities that offer staking. For instance, Kraken is the next highest in there at 8.5 percent, which is quite a bit lower than that 32 percent.

And what also separates Lido apart is that its non-custodial and more decentralized than something like a Kraken or a Binance. So, in general, what are some of the…you gave some examples of how people can use their staked ETH or what it is that they can do with that. And so, why is it that you think that this has really taken off, and Alex, you can also weigh in on this.

Alexandre Bergeron:

I think two main aspects are at play here. Obviously, Lido is the first one to launch, and Ryan, correct me if I’m wrong, but I believe Lido was the first one to launch a staked ETH implementation full scale and this sort of first runner advantage has allowed them to grasp quite a bit of momentum from the get go. They have very competent team. They’ve managed to allow a whole bunch of DeFi integration, which has allowed them to gain an edge in the ecosystem versus some of the other competitors.

But the main aspect driving all of this is the incentive for network effect within the staked ETH. The staked Ethereum, staked derivative model, whereas it benefits all of the users of a staking derivative to have as much liquidity as possible. And so, you’re seeing this right now at play interestingly in the Curve stETH to ETH pool where there’s been a bit of a, some call it a depeg, and people will argue whether or not it should be a peg or not, but you’re seeing a little bit of liquidity and balance between ETH and staked ETH in this pool.

The reason why it benefits people to all converge into a single staking derivative interface or implementation is to bolster that liquidity and try to correct those imbalances and try to allow for a solution that enables people to get in and out of that system as they please because we all know that although it is possible for people to get out of their staked ETH position via the Curve pool, they would have to wait up until the merge and some more time for the actual staked ether to be able to be withdrawn from Lido, and I think those two aspects have made it so that Lido is really shown itself to be probably the most credible implementation and certainly their association with a lot of very influential funds and venture capital firms has certainly bolstered their case in that regard as well.

Ryan Berckmans:

I think Alex is absolutely right. Lido had a first mover advantage that because of their strength and their timing combined with the relative lack of strength and late timing from the most credible competitors has created a situation where the expected high degree of natural network effects in any liquid staking derivative system have really flowered in Lido’s case and they’re in a situation where they not only have a first mover advantage but in an arena that has just extraordinarily winner take all kind of rich get richer effects.

I think that an oligopoly model where there are say four, five, or six good staking derivatives that each have a good slice of market share is probably the most diverse free market we can hope for in the liquid staking derivative industry. However, because of Lido’s early traction, that oligopoly is something that we’re really going to have to struggle to work towards because they have such an early lead to Alex’s point.

Laura Shin:

Alex mentioned the investors. You know, there are a lot of super credible names on here. Andreessen Horowitz, Paradigm, Alameda. There’s also another one Three Arrows Capital, which you know, obviously recent events have kind of shown that their approach to all this maybe wasn’t one where they were managing for a risk. But anyway, what I did want to also address here is that it seems like you guys are implying, and from what I’ve read I would guess the same thing, that over time this huge lead that staked ether and Lido have already will basically grow.

I mean it just feels like over time as after the Merge happens and we really have staking as like a real part of the Ethereum ecosystem that we’ll just have more and more people who will not only want a stake but that also get some liquidity from the ether that they’ve staked, and it almost feels like you can’t really think of too many reasons why someone wouldn’t do that. And so, if you were to make a projection, how much of ether staked in Ethereum would you imagine eventually gets turned into some kind of liquid staking derivative, and you know, with Lido at 90 percent market share, do you think that it would kind of continue to be that dominant in that space?

Ryan Berckmans:

I’d say so. In other chains with mature staking economies, such as Solana we see something like I think two-thirds total supply staked. I think there’s every reason to believe that Ethereum’s total staked ether could meet or exceed that, especially given the additional real yield from our substantial transaction fees.

And so, as the amount of staked ether grows and the incentive to tokenize that staked ether will grow alongside of it as the liquid staking derivatives become more trusted, more useful, more well integrated into all manner of products, I think we’re going to see to the point of the Seminole article written by Hasu, a Lido advisor as you know, and Giorgio’s last year, they had predicted that an overwhelming super majority of staked ether would become staked with liquid staking derivatives and that’s a view with which I substantially agree.

Alex Bergeron:
I just wanted to chip in on this because I mean it’s funny you talk about this article because it actually most likely is what tipped me into this whole sort of dynamic initially, and people might wonder why you’re having me on this podcast and why this bitcoin guy might know a bit or two about this entire thing.

So, if you go on my Twitter account, you’ll notice back in July of 2021, I posted a thread about this entire dynamic and I laid it out in a very public way in a bit of a bombastic and some might call trollish way, but I feel like I was one of the very first people to air out sort of a bit of this dirty laundry that I think was familiar to more engineers or protocol workers in the Ethereum community.

I can only imagine it was not well known by many Ethereum people because if you go look at that tweet, I think I’ve had over two million impressions on that tweet to this day. It was extremely popular. And one of the things that’s very important to point out and one of the main concerns about Lido’s ability to gain further and further share is that post Merge, one, the staking yield becomes probably the common denominator in terms of a user choosing worth to allocate its stake.

Post Merge is when some of the most interesting aspects of MEV come into play. MEV is a whole other topic. I’m sure probably you’ve had people talk about MEV on your show. Something that is very important to know and to understand is that when a staking implementation and staking validator has access to such a large share of staking on Ethereum, they are able to gain an outside share of the MEV opportunity compared to smaller ones. That is just because of variants, but also of specialization.

MEV is sort of a…I recently sort of compared it to a digital equivalent of mining specialization in terms of chip efficiency, in terms of operational efficiency. Like, where validators like miners are able to allocate resources to MEV in a way that enables them to, you know, develop new sort of MEV scheme and new ways to exploit that, and all of these things are…the game play for MEV just opens up to a whole new world when the Merge comes around.

Lido’s ability to bolster their resources and target, you know, they have quite a bit of a tight-knit affiliation with Flashbots. Obviously, they’re investors. Some of them are very well acquainted I think with MEV. And so, it gives them that much more of an advantage in terms of using that MEV to convert it into higher staking yield, which will allow them to attract even more users compared to an alternative solution.

Ryan Berckmans:

I substantially agree with that. There is a very important initiative within the Ethereum community to standardize what we call proposer builder separation where the folks who run the large computers with fancy algorithms to discover the MEV opportunities will become a niche cottage industry and they will bid in real time in an open marketplace to win the right to capture the MEV in any validators block. Be that a Lido validator in a large Lido cartel or in an individual homestaker.

And so, on the one hand, we’re hopeful that proposer builder separation will level the playing field and reduce some of those economies as scale around potential cartel type activity from for example the Lido validator set. However, to Alex’s point, there are certain kinds of MEV which are only possible when you control multiple side-by-side blocks in the validator.

As we’re building the blockchain, we have these proof of stake slots that represents each next block being built and there are some kinds of MEV which are unlocked when you know the person you’re buying the MEV opportunity from controls both of those adjacent slots. So, you can do what’s called kind of cross slotter, cross blocker, cross ePAC MEV. And so, I think Alex is right that the large size of the Lido note operator set does pose a potential for greater returns, like truly greater economies of scale in the size of those node operators, especially if they lean into some of those cross slot MEV opportunities.

Laura Shin:

Yeah. So, essentially the point here is that because Lido already has this first mover advantage but then on top of that that has led it to have these network effects that give it kind of prime partnerships, especially in the area of things like MEV research amongst other things. This is not the only advantage. But that will then attract more users to it because the users will want to be part of a pool that has that MEV advantage because it’s just going to make it a better opportunity for them.

There’s many reasons actually why Lido has become dominant, and I just wanted to ask if you had any opinion on why it is that some of the other competitors who are sort of similar, you know, some of these decentralized liquid staking derivatives providers such as Rocket Pool or Staker STKR. Do you think any of those could ever come close to its market share or at least begin to compete in any real way or do you feel like this competition is essentially over?

Ryan Berckmans:

I’m not nihilistic about the landscape. I don’t think the competition is over. I do think that Lido has now established a lead that is going to take years to erode if we are successful. And so, if we look at someone like Rocket Pool to zoom in on them, today Rocket Pool has at least two kind of head winds that may prevent them from competing as effectively with Lido as all of us would like. Actually, three. Three different head winds.

So, the first is that Lido at this point has superior DeFi integrations. More DeFi integrations, all of the things equal, that’s going to drive more yield, more trust, more confidence, more of that gravity well effect around the derivative. That’s the first headwind.

The next head wind is that Rocket Pool sort of straight up charges a slightly higher fee than Lido, which is something I’d like to see them revisit. You know, the fee represents yield that’s not in the pocket of the end users and I think in a hyper-competitive landscape where Lido already has an edge, I think charging lower fees is something that every competitor should consider.

The third headwind is that Rocket Pool is actually a multi-sided market. So, technically every liquid staking derivative is a multi-sided market because Lido has to recruit and support and vet and maintain relationships with node operators. These are professional operations that run these computers and custody the validator keys, which is sort of their most important job, so they don’t get slashed and extorted. Whereas Rocket Pool relies on a growing grassroots and hopefully someday professional community of node operators that run sort of half the staked ether.

So, in Lido, you have professional node operators at a marketplace of derivative customers. In Rocket Pool, you have a much more decentralized group of node operators who run the validators and then the other half is the staking derivative customers, and while that offers the possibility or even the realization of greater decentralization in Rocket Pool versus Lido, in practice, the challenge they’re having is they’re having trouble growing the side of the market of people who want to run Rocket Pool nodes.

One of the reasons for that is if you run a Rocket Pool node, you’re actually required to belong the RPL token. So, it’s not enough that you can just stake ether and say hey, I want to be…I love Ethereum. I’m going to stake ether. I’m going to stake on Rocket Pool. You also additionally have to love the RPL token, and I think that’s created some friction for them.

And so, to kind of zoom out from Rocket Pool, there’s a laundry list of important business line items as to why Rocket Pool is not directly competitive with Lido today, and I think if we look at some of the other competitors we would find similar line items around community endorsement, decentralization, DeFi integrations.

What’s happened is Lido has just sort of run the table on these line items. They’ve executed at such a high level and masterfully and with such a strong team and great relationships that it’s not simply the winner take all network effects of the liquid staking derivative that’s caused Lido’s success. It’s also that the other competitors just unfortunately have not done as good a job as Lido and that sort of give and take has created the landscape that we see today.

Alex Bergeron:

Yeah. It’s important to point out also that Lido is so far ahead that they are actually able to look forward, and by that I mean, they are already actively working towards implementing their staking derivatives solution on other chains and that becomes very interesting because it’s another aspect that allows them to compound their lead by allowing in the future cross chain MEV opportunities for validators that are able to gain majority stakes or not even majority stakes but significant enough stake across different…whether it’s Solana or…I’m not sure Cosmos is one. I don’t think so. They have a different model grade.

But anyway, this lead that they’ve built allows them to deploy further capital into development and pushing new initiatives that…it’s very unlikely for me that another competitor would come around. I think like Ryan said, if it is the case it’ll take a couple of years.

But ultimately for me, regardless of who’s the winner in this staking derivatives game, I tend to be of the opinion that it is a sort of natural monopoly because of the incentive of staking derivatives, because of the MEV opportunity and the way that although there is a somewhat elegant solution that Ryan highlighted with the proposer builder separation, the concern and it’s a concern that’s been shared with Hasu and some of the folks at Flashbots, is there’s a very real sort of dystopian alternative reality there and to me very likely reality where the leading staking validator, whether it’s Lido or someone else that comes around in the future, will simply choose to do away with that protocol and virtually integrate the whole supply chain of MEV.

And because they have such a large advantage in terms of the stake and the resources, they’re able to effectively build their own blocks and have the capacity to just relay them to themselves basically. So, you have a scenario where there’s effectively a single block builder in Ethereum and obviously you can imagine the challenges that this implies in terms of centers of resistance, in terms of even just user experience for people that are participating in DeFi and stuff like that.

Laura Shin:

Well, but wait, I have a question because since they have different node operators within that, is that really the case or are you saying that since they’re kind of unified by the LDO token that that’s how they become one entity? I thought that the node operators, it’s like 21 right now or something, so they’re kind of separate entities and they’re like geographically and jurisdictionally diverse, and they use different software clients. So, is it that you’re saying they’re sort of like one entity because they’re all unified by this token?

Alex Bergeron:

I would say so at that moment, and I think it’s an important point that you bring up. They are effectively single entity at the moment because it is a permissioned system for someone to be able to become a validator in Lido. And so, the LDO token owners have the ability to decide who gets to validate blocks on the Lido staking implementation. And so, it’s a wide list from one day to another. An operator can be booted off the list. Another can be added.

But because it works in such a permissioned way at the moment, you expect everyone to be aligned, and you know, it’s a one-party sort of rule where there’s not too much…I don’t expect there to be too much divergence in terms of what rules are going to be broken. There’s going to be a lot of interesting crossroads that are coming up for Lido in terms of what extent they want to exploit MEV. There’s a lot of very perverse MEV tactics out there.

How much do they want to frontrun users and it’s a very difficult problem because the incentive financially is to exploit the MEV opportunity to its maximum because if you don’t do it yourself, someone else is going to do it and you’re already unfortunately seeing this. I mean, you already sort of see the incentive play out, the financial incentive play out in the recent vote that was proposed where I think Ryan was a major advocate for Lido to sort of at least temporarily sort of self-limit their growth to allow other players to catch up and make it this oligopoly that he refers to earlier.

It turns out that the Lido DL vote was overwhelmingly in favor of continuing the pace of growth as it is and not self-limit. Perhaps a proposal was not adequate or was not something that the Lido token holders would consider. Maybe there’s something else that’s going to come up. But yeah, it really is a tough sort of push and pull game between financial incentives and sort of more altruistic motive of trying to do good for the Ethereum community.

Ryan Berckmans:

I substantially agree with that and to add some color there, I think it’s mostly correct to suggest that the Lido DAO and their node operators are typically likely to act as a single unit politically, operationally sort of against or in concert with the Ethereum community. Just to expand on some of the incentives there, just sort of a grab bag of some of the internal incentives, the Lido DAO token, the LDO, is famously closely held. I saw a stat recently that I think the top hundred LDO holders control like 94 percent of the token, just as one of the stats there. That’s a startling stat.

Another incentive that I think is very much at play is that because today we’re at something at about 15 percent total supply staked, plus or minus a couple percent, we recently expect this to grow to 70 percent, 80 percent in the coming years. This is about to hit a hockey stick after the merge once withdraws are enabled, once proof of stake shows itself to have reduced risk.

And this means that Lido’s ability to cut off new or existing operators from the promise of the future hyper growth, the hyper growth that everybody expects, is a very significant carrot and stick situation because as well as the operators have done so far, you know, it’s really only one fifth of the business that’s to come if not more, if they’re share of total staked ETH grows.

And so, that is a significant powerful force that the DAO has over node operators. But there’s also sort of a force that pushes back on that, which is that today it’s not possible for the holder of a staking withdrawal key to force the exit of a validator, and to my knowledge, although that’s something the community is interested to explore…so if you had a non-custodial staking solution, I have my withdrawal keys. That’s my property, and then, I pay an operator to run my validators for me, I can’t force them to offboard my validators by signing something in my withdrawal keys.

I have to sort of trust them to offboard my validators when I ask, or in certain situations they can actually provide pre signed validator exit transactions, so that I can hold these signed transactions in my custody, and if I’m sort of done with them, I can broadcast them myself and exit the validators myself. Now I’m not sure if Lido has a practice today of requiring their node operators to provide pre signed exit transactions that would somehow be held in custody by the DAO. How that would work is kind of a TBD.

But today, to my knowledge, Lido DAO relies on the node operators to exit the validators upon request. As well, even if they did retain those transactions to offboard the validators, there’s still going to be an offboarding period where the validators are in the exit cue, which could range from sort of hours to weeks depending on congestion and during that time, a malicious node operator that was interested to kind of go nuclear or even defect could actually cause their validators to become slashed.

You know, they could potentially sell those slashing rights to North Korea to get a side channel pay out. So, there are attack vectors here for a node operator that was fed up with Lido and wanted to defect. And so, I think in terms of the internal power balance between Lido and their node operators, on the one hand, node operators want to behave because they want future growth. They want to participate in this giant upswing of staking activity.

On the other hand, the existing node operators do have some degree of power over Lido because Lido cannot force them out of the system today. So, that all being said, I substantially agree with Alex that they operate as mostly a single political and operational entity, and you know, when that entity has 21 node operators and 94 percent of the token held by the top hundred wallets, I think that starts to look like sort of the opposite outcome that we were hoping to achieve when we spent years investing in client diversity and true decentralization.

Laura Shin:

Yeah. So, in a moment, we’re going to talk about how this might worsen after the Merge and just in the post-Merge environment but first a quick word from the sponsors who make the show possible.

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Back to my conversation with Ryan and Alex. So, we were just talking about how that you guys all feel that Lido’s dominance will only increase over time. One other factor that I just wanted to raise because I saw SureSat’s article about this and some people in the Ethereum community did not like the source of this, but I still think that this is a good point. After the Merge, I guess the protocol will only allow four new validators to be activated per epic, which is every 6.4 minutes and because there’s going to be a lot more ETH available to be staked post-Merge, people are expecting that there will probably be a long waiting list or like a long que for new stakers to become validators, which would therefore give Lido more of an advantage because again, they’re going to have a larger set of active validators that will attract more users who will want to try to get in on that. So, that’s just like an additional factor that might worsen all this and accelerate it.

So, let’s talk a little bit about this part about the LDO token. Given that the ownership is quite centralized, do you feel that there are kind of ways to mitigate that? Do you see that there are any proposals to decentralize that further or do you think really the ways to go right now are more about just minimizing the market share that Lido has or what do you think are some of the potential solutions here?

Ryan Berckmans:

There’s a new proposal on the table for a novel governance mechanism. I think they’re calling it dual governance and that’s where they hope to give the holders of the actual stETH tokens, the yield bearing liquid staking derivative, the right to veto certain governance proposals, maybe all governance proposals. Pardon me. I think that’s a fantastic novel governance mechanism.

In a way, Lido’s efforts to decentralize itself is interesting because on the one hand, they’re doing a legitimate great job at attempting to grow their decentralization. It’s a terrific team. They’ve got a great mission. On the other hand, the more work they can do to convince the community that their monopoly is benevolent, benign, the more likely that monopoly becomes entrenched and we lose out on the opportunity for an oligopoly because it is path dependent. Where we end up is a function of how we get there.

And so, I think this dual governance proposal is quite novel, but to me, it doesn’t give them a pass on the concept of becoming a super majority monopoly.

Laura Shin:

Can you just describe the dual governance proposal a little bit more for people who are unfamiliar with it?

Ryan Berckmans:

Absolutely. So, in traditional on chain governance, you have sort of one token, one vote. People can propose governance proposals through the system. The governance proposals are actually executable programs that modify the system. So, you’ll propose a proposal that says here’s the English description of what this does and here’s the program associated with it and often a community of experts will check that, and in the Lido system, you have this ultra-concentrated governance where it’s really a relatively centralized group of insiders that have the ability to kind of rock the vote on any given proposal.

Lido acknowledges this and they’re working to grow towards greater decentralization and to achieve that goal, they’ve proposed this novel mechanism where although one LDO token will still give them one vote, they’re proposing that the stETH token holders who are kind of the users, the end users of this product, will get a veto. So, the analogy here would be, you know, if there’s a McDonald’s shareholder meeting and they’re voting on something, you know, one share of McDonald’s is one vote.

Well, what if everyone who spent money at McDonald’s in the last year had the ability to veto those shareholder resolutions, you know, pro rata with the amount of money they spent at McDonald’s in the last year. That’s sort of the dual governance idea, that the users get veto power. And so, we’ll have to see how it works out in practice, but I’m certainly encouraged that that’s something they’re looking at.

Laura Shin:

Alex, do you have an opinion on this dual governance proposal?

Alex Bergeron:

I do. I think it’s ironic, and no offense Ryan, but I think it’s ironic to call it novel because ultimately for me I find it to be very redundant in the sense that it effectively just turns Ethereum into a DPoS system. This really proof of stake system because when you think about what is the Lido token there to achieve, well, one of the main things really…probably the main thing it achieves is that it decides on the list of validators that are to be part of the Lido protocol, right.

And so, if you effectively give the stakers the ability to decide who the validators are and who should be assigned stake by their ability to veto the LDO token holders who were the ones originally responsible for achieving this, then from my point of view, yes, you’ve effectively devolved into distributed proof of stake, which is perhaps workable, but certainly, I think far removed from the promises of Ethereum’s proof of stake implementation.

In terms of the Lido token itself, there is another proposal that exists that’s been got for by Lido itself actually. It’s not a concrete proposal actually. They published a roadmap to decentralization where they outlined a few steps that they wanted to achieve to further intermediate the ownership of the Lido token with the ability to make changes to the protocol. The end goal really for them is to effectively bake into the Lido protocol a sort of layered protocol on top that allows validators to be selected almost on a programmatic basis.

It is a bit of a reputation system where there’s some liveness properties that are evaluated whether it’s the ability for the validator to remain online and so on and so forth. And so, they are trying to design a system where they are hoping to remove the responsibility from LDO token holders to have access to write and edit the validator list.

I think it’s an interesting proposal, but to me, it’s again a debated incentive because if you remove from the Lido token holders ability to decide on the governance effectively of the Lido protocol and its validator list and so on and so forth, and the same goes for the dual governance proposal that Ryan talks about, then what is the reason for the Lido token to exist if there’s no governance to be had.

I think it’s entirely valuable outlook to try to minimize governance as much as possible but when you try to make it to the point where there’s no governance necessary at all, then you find yourself with a token that just extracts value from the protocol and its end users, the stakers, to provide a very sort of obscure and not very clear to me exactly what value is being provided at that point.

Ryan Berckmans:

I substantially agree that even in the case where the node operators are picked in a semi-automatic fashion, it’s still a gameable system and in the case where the stETH holders have veto power, well they can vote no, can they also vote yes and how much organized political activity would it take for the stETH holders to actually hold the Lido insiders in check. I just think there’s so many potential issues here over the medium and long term that it transitions a huge chunk of Ethereum staking from the model we want, which is can’t be evil to the model we’re trying to move away from, which is don’t be evil. You know, please don’t be evil.

I think to Alex’s point, it’s very problematic. I think perhaps an interesting question is among all the forces that are growing Lido, making Lido more dominant, what are the opposing forces. Like what are the reasons we could come up with that Lido won’t earn 70 percent, you know, run 70 percent of stake three years from now. So, yeah, I’d be happy to chat about those.

Laura Shin:
Yeah. Do you have thoughts on that because when I was doing research for this show, I felt like everything I was seeing was pointing the other way?

Ryan Berckmans:

I wish I had a silver bullet. I wish I could say here’s this one thing that’s going to happen that will create a feedback loop. I think that’s not the case. I think that this is going to be a long sort of battle for potentially the soul of Ethereum, which sounds like a little melodramatic, but I don’t believe it is.

I’ve been in this space for many years, and I think Lido centralization is probably the biggest issue ever to pop up ever in my whole tenure. Perhaps the biggest community issue since the DAO fork. There was a time where programmatic proof of work was sort of a contentious fork that ended up getting shot down and that was a very divisive issue.

You know, in a way, the threat that Lido presents is almost as if programmatic proof of work had been successful and gone south. Like, that’s sort of the issue that’s baking here. This is a very, very potentially destructive issue over the long term. You know, that’s sort of the view of Danny Ryan from the Ethereum Foundation who summarized Lido as, if I’m paraphrasing correctly, he said a stratum for cartelization. Like this is a place for centralized activity to take root and grow and strengthen itself and erode our credible neutrality.

And so, what are some of the factors pushing back against that. How do we avoid that? Well, I think unfortunately the number one thing is just education. We need to sort of get the word out there, thanks Laura, to let folks know that if you’re a whale, if you’re a professional custodian, if you’re allocating that size into staked ether, you should think twice before putting all your money in Lido because you are not only potentially explicitly putting your money at risk in a single system that has a set of node operators, but you know, ultimately sort of a single governance token. In some ways a single community point of failure.

But you may also be making Ethereum literally less valuable when you allocate into Lido because the value of Ethereum is a function of its credible neutrality. That’s really what separates us from other layers, the fact that someday the world’s governments will be able…I think today, but the world’s governments some years from now will come to believe that they can use Ethereum as a neutral, level playing field. A place where they can come and transact with each other and enter into bilateral fair agreements between nations, and Ethereum offers a promise of being this global public utility that keeps governments honest about their commitments in a way that has never before been possible, and that’s only possible because we’re a highly decentralized public chain.

Laura Shin:

If things go the way we’re discussing in the show, then maybe they feel that maybe they could go to Lido and pressure Lido to do certain things to get their way.

Ryan Berckmans:
I think if we end up in a scenario three years from now where 85 percent of all ether is staked, which is potentially realistic, and 55 percent of its staked with Lido, which is potentially realistic, some would even say the current default outcome, I see governments looking at Ethereum and saying well, you know, yeah, Solana is running a data center. Yeah, Solana requires these big beefy computers that you could never run at home. Yes, Solana doesn’t have client diversity, but Ethereum has been captured by this single entity that runs almost all their staking. So, maybe it’s six of one, right. I think the more dominance Lido has, the more Ethereum starts looking like some of its competitors at the highest level, and I think that’s something that should concern all ether holders that trying to grow the premium of our token based on the neutrality of our chain.

Laura Shin:

Yeah. Just to kind of play out or really spell out where this could go, you know, right now Ethereum does not have on chain governance. Obviously, there is the Foundation. It appears that they do a lot of the governance via forums and proposals and just sort of talking about things on the internet, but like you would essentially have this kind of other entity, which would be, I mean, you could just broadly say the Lido community but since we’re talking about the LDO token holders, essentially it would be those 100 entities that make up 94 percent of the token holders.

So, they would effectively perhaps in some way bring some kind of on chain governance to Ethereum even if it were this sort of minimal governance style. And so, move it from the wider community to those token holders. Is that fair?

Ryan Berckmans:

I think that’s absolutely right Laura. When we look at the prospect of the stETH token holders getting veto power over Lido, then we ask the question does that substantially alter this governance landscape? I think there’s a rich set of viewpoints on that topic, and you know, one viewpoint put forth by Danny Ryan is that Ethereum should be governed by its users and when you give existing users veto power over an important part of the system, that’s going to effect, in my view, who the future users become. So, even if stETH users get a veto over Lido governance proposal, if the stETH users are in practice today’s whales, today’s funds, today’s operators, maybe the world’s governments look at that and they say I’m not sure that we’re going to put our eggs in the basket of LDO insiders and stETH whales deciding the fate of this chain.

Laura Shin:

One other thing that I wanted to say too about how you were saying you felt that one of the ways out of this would be for people to recognize that putting their money into Lido would be putting Ethereum at risk, etcetera, to me frankly that’s sort of the tragedy of the common situation or like climate change kind of situation because you’re going to have the people who are more self-interested who will be like oh, well, it kind of hurts me to not be with the market leader, so why should I take the hit for the greater good of Ethereum.

And so, you’re going to get this kind of dynamic where some people will be freeloaders. They’ll be like I’m just a small staker. I’m going to be part of Lido even if it’s bad for Ethereum and I’m going to reap the benefits of all these advantages that we discussed earlier. So, you know, I feel like if the incentives aren’t aligned for people individually then I’m really not sure how things are going to veer away from Lido’s continued dominance. This is my opinion.

Ryan Berckmans:

I totally agree with that. Alex, go ahead.

Alex Bergeron:

I personally absolutely agree, and you know, Laura and I have been talking about incentives this entire chat and I can’t decide if incentives are less of altruistic motives and things like that. Personally, I would say that if there is an escape, a way out of this, it’s likely to be technical because the crux of the issue here, and we’ve talked about it, but I still feel like it’s been a little underplayed, is MEV.

If you are able to find solutions that remove MEV opportunities from stakers, validators slash miners, then you significantly sort of are able to bring back a certain balance to the validating staking field where as long as a lead staker that has significant share of the staking market isn’t able to gain an outsized share of the MEV opportunity then it’s likely that you’re going to get much more of perhaps an oligopoly model like Ryan suggested earlier where the margins are a lot smaller and there’s a lot more competition between the validators and the staking protocols.

I know that it’s a very intensely debated subject. It feels like this is absolutely not the way that Ethereum is going in terms of protocol design. Quite to the contrary, they’re very much enabling MEV and the capture of MEV, but there are ways for application developers to design their applications to I think remove these kinds of opportunities or at least diminish them as much as possible, and there are further more complex protocol work that involves the encryption of transaction and stuff like that that could potentially…you know, the entire problem with MEV is that everything is public.

So, are you able to make transactions private in a way that allow people to not be able to front run them in such a way? I would think personally that this is where a bit more effort should be put in. There’s a guy on Twitter that claims to be the first guy to have identified MEV back in 2014 called PMC Goohan I believe, and he’s been very vocal in the Ethereum forums and conversations about MEV boost, which is Flashbots’ most recent implementation and the proposal builder separation proposal about are we doing the right thing in terms of enabling this capture of MEV.

There’s a very decent argument that yes absolutely you want to democratize this access to the MEV, but on the other hand, if you choose to go there, there might not be a going back. And so, technically I think technical work perhaps is the way out for Ethereum as far as Lido is concerned but I think it’s worth pointing out that we’ve talked a lot about social, political concerns and potential failure modes and what not but there’s also a very real technical concern there where you can sort of see Ethereum piling in more complexity at the technical level.

You’ve got a stack now that sits where it’s proof of stake, staking derivatives, governance, LDO governance, and now perhaps protocol to decentralize the governance that sit on top. All of these layers are technical designs that aren’t…obviously they’re being worked on by, at least as far as Ethereum is concerned, probably their brightest minds.

So, you would hope they’re building something that’s secure, but when you’re piling in complexity like that, the concern is not only incentives and social failures, it’s if something breaks along the way, you could end up with a very unfortunate, perhaps catastrophic, situation where who knows what’s going to happen from that point on. Ethereum is a bit of a precedent in that regard. I guess my point is technology presents itself perhaps as a solution but also perhaps as the downfall of Ethereum in that regard.

Laura Shin:

I can’t remember if you mentioned this, but I think in Osmosis they do have that where…or at least I think they’re introducing it later this year, threshold encryption, which prevents people from being able do frontrunning because the transactions are private. So, it’s not like that doesn’t exist. I do think that’s a really interesting point.

Before we go, I do also want to discuss a couple of other proposals that I saw that Ryan had proposed earlier which would be one was that Lido’s competitors form an alliance, and Ryan said that what they could do is build a tokenized basket of their staking derivatives then agree that this basket token would be Lido’s primary competitor in a duopoly. What do you think of that idea?

Alex Bergeron:

I hadn’t seen the details of that. I made the point earlier that you’re already seeing the stake Ethereum derivative kind of very wobbly. You know, you’ve had this event with 3AC where it seems like they lost quite a bit of money making that bet. They had to withdraw a lot from the Curve pool and then now there’s an imbalance. It’s trying to come back to the parody if you will. It’s a game that is very liable, very vulnerable to financial speculation and therefore all sorts of traps.

To be honest, perhaps if you’d asked me three or four months ago, I would have said that sounds like it might be a decent idea to try but given this state of the house of cards that have fallen in the recent weeks, I wouldn’t bet too much on financial construction at this very moment. I’d have to see it more fleshed out in proposal to really commit to an answer.

Ryan Berckmans:

Yeah. I think Alex is right that the prospect of it being a silver bullet is potentially slim. The idea of a basket of derivatives is, to Laura’s point, if we have a long tail of Lido competitors where the most successful Lido competitor is something like about one seventh the size, well, what if they just agreed that they were going to compete under a new ticker and join forces and that would give them the opportunity to sort of punch above the individual weight of any one of them and it would also sort of provide the public good that they could invite new derivatives to join them to sort of grow their own importance. And I think in practice, this could be a very effective tool for combating Lido dominance or at least pursuing a duopoly, but I think there are sort of two practical challenges that have effectively turned it into a non-starter in reality.

So, the first challenge is that when you have a basket of derivatives, there’s some governance around that basket. What are the weights? What are the percentages in the basket? Is it 30 percent Rocket Pool? Who controls that? So, you’re adding another layer of governance on top of the existing governance communities in the underlying derivatives. So, that’s kind of a layer cake of governance and that presents both technical and sort of political risk and raises the question of like who gets these governance tokens.

And then, even if you pass the governance challenge and you say all right, we found a working model, a huge problem with the basket model is that the people that you need to be in the basket the most are the ones who have the least incentive to join it. So, look at Rocket Pool, the number two liquid staking derivative. Why would they join a basket? They’re already the number two derivative. You’re asking them to join forces with the other derivatives who are nipping at their heels. It’s not clear why they would rather do that than just focus on their own success.

So, I think for those two reasons, the competitive reason and the governance reason, it makes a basket impractical, but if we could wave a magic wand, I think it would be an effective way to compete with Lido, and to that point, I share Alex’s concerns about MEV and I think it’s going to be a very significant problem moving forward yet I also have the view that we have to sort of maybe crawl before we can walk and run, and I think in this case what crawling really looks like is the community needs to ensure that when a whale, professional or private, is open to the idea of not being in Lido, they say oh yeah, I’m on the market for a staking derivative, that they have good options. We need to ensure that at a basic level, the Lido competitors are competitive.

And I’m going to pick on Rocket Pool here for a moment. As long as you need to belong the RPL token to participate in the mini pool process, it’s always going to be challenging to grow that side of the market, to even keep up with Lido never mind close the gap with Lido. As long as RPL charges a nominally higher fee than Lido, you’re also losing on the basic fee comparison. And so, you just got to ask yourself why would someone who’s open to the idea of not using Lido pick a competitor?

So, for me I would say that the highest priority of the community if I could suggest something is to ensure that the Lido alternatives are actually competitive for whales allocating.

Laura Shin:

So, we’re kind of running out of time but I did want to actually just mention one other option that Ryan had floated also, and Ryan you could elaborate on this and then Alex can respond, but it was that you said, and you even called this an extreme option, but you said that Lido token holders could Airdrop a vast majority of the LDO token supply to ETH holders, and then, you said that would effectively enshrine stETH but it might help mitigate the potential downside of Lido governance by a small elite. I don’t know if you have more to add.

Ryan Berckmans:

Yeah. I mean, I suppose I think I’d love to see that. Lido has generated a lot of wealth for its early insiders, and I think a lot of folks would agree that they’re on track to do quite well into the future. You know, there’s a few problems with Lido. One problem is sort of the big problem of just having a monopoly derivative but there are sort of two other problems that are unrelated and potentially independently solvable.

The first problem in my view is that Lido does business with other chains. If you’re going to have a single staking platform via the monopoly derivative on your chain, maybe you want them to only do your chain and be sort of loyalist towards your chain. I think that’s not an unreasonable request. So, I think Lido committing to shutting down their business and other chains, it’s not something I expect them to do but I think it’s something that would be a reasonable ask from the community.

And then, that kind of third problem is how closely the LDO token is held. You know, when you have that to my knowledge, the top hundred wallets holding 94 percent of the token, I mean, it’s just a little silly. Very centralized. And so, maybe we can solve that problem by Airdropping the LDO token to not even stETH holders but maybe ether holders pro rata and just say hey, we’re going to double this token supply of LDO. We’re going to Airdrop one token for every one token that already exists. We’re going to give all these tokens to everybody in the community. I think that would be a shrewd move by Lido that would increase…actually, I kind of hope they don’t do it because I think it would be so clever that it would get a lot of people interested in their success and I think it would help to solidify their dominance. So, I guess it’s six of one. On the one hand, it would decentralize their governance token. On the other hand, it would probably endear them to a very large audience.

Laura Shin:

Alex, do you have any thoughts?

Alex Bergeron:
Only one word, incentives. I personally don’t…I would be very surprised if they were to do that and I would also put it in very hyperbolic way but perhaps they’d be Airdropping tokens to themselves because I mean, certainly the concentration of ETH is not as skewed as Lido is but when you put into the same boat Paradigm, a16z, Alameda, you get quite a lot like Ethereum. Is it all the same players just colluding but in a much more transparent way? To me it feels like that at times but certainly I wouldn’t go as far as saying that Ibiza’s supply distribution is as centralized as Lido but yeah, perhaps.

Laura Shin:

Yeah. I see my editorial assistant commented that because users usually sell the airdrop that the only real outcome would be that the LDO token holders would get wrecked. So, it’s not in their incentive to do so. Anyway, this has been an incredibly fascinating discussion. I really appreciate that you guys did this. I just found it super fascinating. Hopefully, it gives a lot of people food for thought. Where can people learn more about each of you and your work?

Ryan Berckmans:

I’m on Twitter at RyanBerckmans.

Alex Bergeron:
I am on Twitter, solely on Twitter at BRGEAlex4. BRGEAlex4.

Laura Shin:

Awesome. Well, it’s been a pleasure having you both on Unchained.

Alex Bergeron:

Thanks a lot.

Ryan Berckmans:

Thanks so much. Good to meet you, Alex.

Alex Bergeron:

Good to meet you Ryan as well.

Laura Shin:

Thanks so much for joining us today. To learn more about Ryan, Alex, and these issues with Lido and Ethereum centralization, check out the show notes for this episode. Unchained is produced by me Laura Shin with help from Anthony Yoon, Matt Pilchard, Juan Aranovich, Pam Majumdar, Shashank and CLK Transcription. Thanks for listening.

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