Lido dominance and decentralization of Ethereum after the merger

After a successful third testnet merger, September 19th was recently proposed as an initial target date for the Ethereum merger. Ethereum is set to make the full transition 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 resolve Ethereum’s expansion concerns on its own. It is just the beginning of a roadmap for achieving future expansion upgrades,” Jacob Bleich, Head of Business Development at Lido, shared with Cointelegraph.

Ether (ETH) on the Beacon chain, the PoS network that reflects Ethereum transactions, is expected to remain closed for at least six months after the merger is complete. After the merger, the liquid ETH stacked tokens will start to benefit from transaction fees and the maximum extractable value, which means higher returns.

There was a lot of hype around the merger. Rocket Pool founder Darren Langley told Cointelegraph that it was the biggest single event in cryptocurrency for a very long time, adding: “The shutdown is testing the protocols for liquid staking now but this is mainly due to macro conditions and ongoing centralized funding (CeFi) drama. It explodes, the liquid antifreeze will explode.”

Currently, ETH returns are earning approximately 4% annual percentage rate (APR), with just over 10% of ETH supply, according to StakingRewards.

Lido’s Liquid Staking

The launch of the Beacon Chain has created a need in the ecosystem for a decentralized liquid storage solution that competes with centralized exchanges (CEX) and can be used for Decentralized Finance (DeFi) for lending, borrowing, and more.

Lido’s staking service gained popularity as the first protocol to implement liquid staking derivatives on Ethereum by minting stETH. Contrary to popular belief, stETH is not meant to be associated with ETH. As Blish shared:

“The ETH stack issued by Lido is backed by 1 to 1 ETH but the exchange rate is not pegged. It can fluctuate and trade at a premium or at a discount as secondary market forces dictate the price. This does not affect the underlying support of stETH.”

Lido’s first feature with the launch of its liquid staking product helped the protocol move forward with more DeFi integrations for stETH as well as other multi-chain products for Solana, Polygon, Polkadot, and Kusama. The team recently announced that stETH will expand to Layer 2 solutions to enhance DeFi integration.

Various staking protocol balances as of May 2022. Source: Twitter

The protocol attracted liquidity to the Curve pool with incentives in the form of additional Lido token (LDO) bonuses and a referral program to further its growth strategy and establish itself as a temporary winner in the liquid storage space.

When compared to other protocols in the DeFi ecosystem as a whole, Lido stands out as the only product that has been able to compete and even surpass its centralized peers, such as the Binance ETH token (BETH), in terms of total locked value.

Alternatives to Liquid Staking Derivatives

New products tend to start with strong market leaders, but soon competition develops and innovation ensures a new entry has the potential to gain market share. The network effect that Lido achieved in a short period of time made it difficult for its competitors to catch up and grab a large market share.

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Other liquid staking projects have slight differences in fees, product decentralization, and token features that they offer, but the value proposition remains the same: to enable users to maximize capital efficiency and maximize their returns while securing the network.

“The Ethereum ecosystem is built on unreliable decentralization. So much voting power in the hands of a single organization definitely goes against that ethos,” Jordan Tonani, Head of Enterprises at Index Cooperative, Jordan Tonane, told Cointelegraph. Multi-fluid staking is a better outcome, and soon after the merger, a new set of liquid staking protocols will be supported to enhance decentralization. ”

The Rocket Pool represents over 1.5% of all Ethereum stack, with 1,300 individual node operators across 84 geographic locations. For this reason, this could affect Lido’s market dominance and increase its importance in the liquid storage space with new metering solutions.

Stakehound, Stkr, and Stakewise are some of the other projects that are trying to make an impact on Lido’s market share but still lag in terms of depth of liquidity and utility as a collateral in DeFi.

It should be noted that Rocket Pool’s unauthorized approach appears to be more decentralized at first glance, as opposed to what Lido authorized, which was a trade-off to ensure the reliability of node operators in the early stages of the protocol. The Lido team is working on setup without permission based on performance reputation to switch from their current model.

Monopoly or oligopoly, it should be decentralized

Looking at the data, Lido currently has a monopoly on the immature liquid staking derivatives market.

Lido, as a Decentralized Autonomous Organization (DAO), has opened the discussion on its own governance forum on stETH which is limited to a fixed percentage of all ETH. Bleach explained:

“We agree with the ethos of Ethereum’s decentralization at its core. Regulating the protocol through the DAO ensures that Lido will not follow any actions that could conflict with our community and our values.”

Also, a two-token governance proposal was recently passed that would allow stETH holders to veto governance proposals made by LDO token holders that could harm miners on the Ethereum network.

Similar to the liquid staking dilemma suggested above, Bitcoin (BTC) mining appears to be showing central forces. The space has matured into a market where the three largest mining pools have more than 50% of the network hash rate. The six largest mining pools accounted for more than 80% in the past three months, according to data from BTC.com.

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It’s hard to predict what changes we’ll see after the merger and what effects it might have on liquid staking. Although liquid staking derivatives are moving towards centralization, optimistic development in the medium term may come from other alternative products gaining ground and market segmentation into oligopoly.

“Realistically, there will be many players in the ecosystem, but maintaining a strong level of decentralization is critical to the success of Ethereum — particularly its trusted neutrality,” Langley said. Guarantee requirements and technical challenges.

Some volatility is expected in the following month as the consolidation hype around liquid staking products continues. The demand for these products has never been stronger. Further developments will establish whether the space will be operated by one, a few, or many liquid derivative products.