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Lido Liquid Staking: A Risk for Ethereum?

By The Fire Team
Overview of Lido Liquid Staking, including how much staked ETH is within the Lido System.

There’s no one thing crypto is about, but if web3 has any central purpose, it’s decentralization.

The thesis: No one party should control our financial and technological infrastructure. 

For web3, the most fundamental part of that is the layer 1 blockchain—of which the most popular (at least for smart contracts) is Ethereum. While Ethereum was founded to advance decentralization, there’s a risk the platform is centralizing because of liquid staking platform Lido

Lido ETH staking has as much as 73% market share in ETH liquid staking—and about 36% of all staked Ether. Could this be a centralization risk for Ethereum? If Lido becomes too powerful, it could gain control of the Ethereum network—and if it fails, it would wipe out many of web3’s biggest believers—the people who stake their assets to secure the network.

In this article, we’ll dive into Lido, liquid staking and the dangers of centralization it might pose. Ready to dive in? Let’s go! 

What is Liquid Staking? 

Before anything else, let’s explain liquid staking. We’ll start with staking: 

Proof of Stake is a consensus mechanism used by most blockchains (including Ethereum) to secure their network and validate transactions.

Here's a simple explanation of how it works:

  1. Staking coins: You participate by "staking" some of your coins. This means you lock up some of your coins in the network as a deposit.
  2. Creating blocks: The creator of the next block is chosen in a deterministic way, based on their wealth, also defined as 'stake'.
  3. Rewards: If you're chosen to validate a block of transactions, you get a staking reward of transaction fees or newly minted coins. If you try to validate fraudulent transactions, you lose some or all of your staked coins. This provides an incentive to validate transactions correctly.
  4. Security: The more coins you stake, the higher the chance you'll be chosen to validate transactions. This means someone who wanted to attack the network would need to own a majority of the staked Ethereum, which would be extremely expensive and counterproductive, as they would harm the value of their own investment. 

This sounds awesome, right? Take some ETH, stake it and earn more in Ethereum staking rewards!

But it’s not as easy as it sounds. To guarantee security, a number of caveats apply: 

  • You need to have at least 32 ETH ($57k) to earn Ethereum staking rewards. 
  • Your ETH is locked up as long as you’re staking. You can’t use it to trade, buy NFTs or do anything else. 
  • It’s technically difficult to maintain your own validator node, which can make staking ETH risky: If you make a mistake, you could lose all of your coins.

How does Lido staking work?

That’s why liquid staking platforms like Lido were invented. Liquid staking primarily solves two problems: 

  1. It removes the minimum to stake and earn staking rewards.
  2. It gives you liquid tokens you can trade with while earning rewards

Lido is basically a staking service: You stake your ETH with them and they maintain validator nodes, ensure uptime and get stETH (staked ETH) tokens in return. Because they pool so much ETH, they easily meet the 32 ETH minimum, which enables their users to stake any amount of ether, no matter how small.

Lido liquid staking transaction showing the exchange of ETH for stETH in a transaction simulation window using the Fire Chrome extension

Lido staking APR is usually lower than “solo staking” APR because Lido charges a fee.

These stETH tokens are usually the same price as Ethereum (within a few dollars) and can be traded on the public market. That way, you can earn Lido’s staking APY (4.3% in June 2023) without locking up your funds.

Whenever you want to claim your rewards, you can sign back into Lido, give back your stETH and withdraw your ETH + rewards.

As mentioned in the beginning, this formula has been successful: Besides having a giant market share in the liquid staking market, Lido has also expanded from ETH staking to offer

  • Lido Polygon (MATIC) staking
  • Lido Polkadot (DOT) staking
  • Lido Solana (SOL) staking
  • Lido Kusama (KSM) staking

Is Lido staking safe (for Ethereum)?

From content creators like Sassal from The Daily Gwei to Ethereum coders like Danny Ryan, many are alerting their audiences to the risks of Lido and other liquid staking protocols.

That’s not because their dApp is risky: Lido’s smart contracts are audited and Lido hasn’t had exploits, hacks or weaknesses. Lido has built a fantastic product people love to use. But because Lido interacts with the core of Ethereum security (staking), its success could become a problem to the network at large.

Staking and validating is essential to maintain the Ethereum blockchain’s security. If a liquid staking pool like Lido gains the majority of staked ETH, this creates multiple risks:

  • If a majority of staked ETH is in one staking pool, it creates a vulnerability to censorship.
  • The more transactions a single node operator validates (which scales with the amount of ETH they stake), the more centralized a blockchain is.

There are other considerations like governance and more technical issues. To read more about the detailed risks of LSDs (Liquid Staking Derivatives), we recommend reading Danny Ryan’s article.

That’s why Lido staking could be risky for the entire Ethereum blockchain. It’s important to note that Lido is run by a DAO (decentralized autonomous organization) and governed by holders of its LDO token. This presents an improvement, but doesn’t negate the risk.

But there are alternatives to the big player:

Lido vs. Rocket Pool

Sassal.eth or Anthony Sassano is one of the most outspoken critics of Lido’s dominance–and an equally outspoken enthusiast of Rocket Pool.

In a YouTube interview, he commends the Rocket Pool team for “sticking it out” since 2017, long before Ethereum moved to proof of stake. While the longevity is impressive, he also noted the commitment to decentralization with offerings like minipools, which allow anyone to start their own validator.

Rocket Pool is another liquid staking provider which functions much the same way as Lido. Staking on Rocket Pool is a similar experience, but also offers to help you run your own node—if you put in at least 8 ETH. This offers a much higher APR (Rocket Pool’s current APR for this service is 6.86% + RPL rewards. 

Rocket Pool transaction showing transaction simulation of exchange from ETH to rETH in the Fire Chrome extension

While they’re functionally similar, decentralization enthusiasts are now opting for Rocket Pool liquid staking instead of using Lido. The main reason for this is that Rocket Pool is smaller and doesn’t command the market share Lido does.

Staking with Rocket Pool or another provider like Stakewise attempts to decentralize the liquid staking market.

Note: Rocket Pool and Lido Risk

Before we wrap up, we want to note that both Lido and Rocket Pool have a token (LDO and RPL, respectively. Both are unlikely to offer a future airdrop. If you ever see announcements of a new Rocket Pool or Lido token, tread carefully. It’s likely one of these 3 common scams.

If you’re exploring Ethereum, check out Fire!

We’re a trusted chrome extension that simulates transactions before you sign any potentially malicious smart contract.
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To Summarize

In summary, Lido liquid staking, which has by far the biggest market share in ETH liquid staking, poses a potential risk of centralization for the Ethereum network.

Liquid staking allows users to earn staking rewards without the need for a minimum staking amount or locking up their funds. However, by consolidating a large portion of staked Ether, Lido could gain control over the Ethereum network.

While Lido is governed by a decentralized autonomous organization, the risk remains. While the Ethereum network is not under direct attack from Lido or other staking protocols, it’s worth monitoring the risks of having one dominant staking pool in the ecosystem. That way, we can ensure a successful, decentralized web3.