Lido Proposes ‘Dual-Governance’ Scheme to Quell Ethereum Centralization Fears

LidoDualGovTokensProp

Wary of “cartelization”, core members of the Lido team have proposed changing the way the liquid staking protocol is governed. 

Proponents believe it would prevent validators from amassing undue power, if successful, and give holders of Lido’s staked ETH token (stETH) veto powers over proposed changes to the protocol. Lido currently accounts for almost 32% of ETH staked in Ethereum’s Beacon chain.  

When Ethereum completes its transition to a proof-of-stake consensus mechanism later this year, its security will be depend on users who stake their Ether to the network, allowing them to run block-producing nodes called validators while earning staking rewards.

Lido and similar protocols, such as Rocket Pool, allow users to simultaneously stake their Ether and access their locked liquidity using derivative tokens backed 1:1 by their staked ETH. These tokens, like stETH and rETH, can be used to earn yield in the wider DeFi ecosystem.

The protocol is governed by Lido DAO. In a worst-case scenario the DAO can be captured by a small number of bad actors, posing a risk to stETH holders and potentially the Ethereum network itself. 

“Because Lido decides which node operators to give the stake to, they can exert some pressure on making operators do what Lido wants,” Hasu, a strategic advisor at Lido, said in a Twitter Spaces event hosted last week to discuss and explain the proposed solution.

“The most extreme case would be, for example, to just stop making blocks in Ethereum, or to reorganize the chain, extract very bad MEV or censor particular users.” 

Hasu

Sam Kozin, a core developer at Lido, co-authored a solution dubbed “dual governance” that would allow holders of stETH to veto governance proposals approved by LDO holders. 

“We don’t think that these dual governance mechanics should apply to all decisions, it should only apply to decisions that potentially can harm stakers,” Kozin said on the Twitter Space. 

If stakers are upset with Lido governance, they can always withdraw their ETH and move to another liquid staking protocol, Kozin noted. But withdrawals will only be possible sometime after The Merge, and the dual governance proposal gives stakers a means of protecting themselves while they wait for the network to enable withdrawals, he added.

LDO Concerns

Some fretted online that it would, as one Twitter user put it, “make the LDO token nearly worthless.” 

Although the proposal will limit the power LDO holders have over the protocol, it will benefit them in the long-term, according to Hasu. 

“As you can see from literally the last two months of discussion, the need for the community and Ethereum developers to trust that Lido doesn’t do something that will harm Ethereum is clearly a huge problem for Lido,” he said. “If there was some way to prove that you don’t need to trust Lido, then Lido could safely scale to much bigger size on Ethereum.”  

Some commenters on the governance forum and Twitter raised concerns with a requirement that stETH holders lock stETH in escrow in order to trigger a veto. 

“Limiting scope is great but on a [principal-agent] problem side it seems more than likely that people with large LDO positions are the same ones with large stETH positions,” wrote 0xGioMedici. “And since value/function of LDO/stETH is somewhat dependent on the presence of this dormant stETH across DeFi world a possible veto situation where everyone is pulling their dormant stETH could end up hurting a lot more than it helps.” 

Locking stETH in escrow “could decrease the capital efficiency of stETH,” satBalwyn wrote in the governance forum, “while locked stETH can’t get extra rewards by being used in defi.”

Longer-term, Lido should “ossify” parts of its protocol – in other words, make them immutable and impossible to change, Kozin and Hasu argued. Doing so would further protect the protocol and, in turn, Ethereum by limiting opportunities for LDO holders to propose and approve changes that benefit them at the expense of stETH and ETH holders. 

“But we cannot do it right now because the specification of the base protocol, the ethereum protocol, is not yet settled, so we cannot preserve the code,” Kozin said.” 

Centralization Fears

Lido, and its dominant position in the Ethereum ecosystem, has been a point of discussion this year after its meteoric growth. 

In a blog post last month titled “The Dangers of LSD,” Ethereum Foundation researcher Danny Ryan argued that liquid staking derivatives like Lido and Rocket Pool could pose a systemic risk to the underlying blockchain. 

If any protocol were to stake a majority of the Ether in circulation, it would become vulnerable to censorship demands and other abuses of power blockchain technology was developed to circumvent, Ryan wrote.

Ryan’s post wasn’t the only hit Lido has taken recently. 

Liquidity Crunch

For most of its history, stETH traded at par with ETH. In the past month, however, stETH “de-pegged” from ETH, and on Monday was trading at 93 cents to every dollar of the latter. Although each stETH token can be redeemed for one ETH token after the merge, forced selling from large holders of stETH and lack of liquidity on Curve, a decentralized liquidity pool, pushed its price down on secondary markets, creating an opportunity for ETH bulls but fear that its falling price could cause collateral damage in the broader DeFi economy. 

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