Lido Voters Reject Limiting Growth In Key Move For Eth2

After four days of voting, Lido, the largest liquid staking protocol on the Ethereum network, appears poised to reject calls to limit its own growth.

Less than one half of one percent of the votes cast were in favor of Lido limiting its stake on Ethereum. Of the participants, those holding more than 99% of Lido’s governance tokens, LDO, voted for the protocol to not hold back on its growth.

Staking Service

The governance proposal, titled “Should Lido consider self-limiting?” was authored by Vasiliy Shapovalov, CTP at P2P, a non-custodial staking service for professional investors.

Posted on the protocol’s portal on June 24, a successful vote would have bound the protocol to “decreasing inbound stake flow in any shape, form or severity,” with the specifics to be determined in a second round of voting.

The vote will help determine how a key protocol in Ethereum’s proof-of-stake chain will continue developing. It also provides insights into decentralized governance dynamics, where crucial decisions are meant to be held up for debate among a broad community of stakeholder, though in practice it often ends up being a few large token holders who participate and call the shots.

Lido on Monday accounted for almost one-third of all staked Ether, according to data compiled on Dune Analytics. Ethereum is transitioning to the proof-of-stake consensus algorithm, which requires blockchain node operators to deposit cryptocurrency, instead of spending energy to confirm transactions.

Lido allows ETH holders to stake their cryptocurrency via the platform and earn staking rewards, while delegating the actual running of an Ethereum node to operators in the Lido ecosystem, of which there were 29 as of Tuesday.

Risk of an Attack

The concern is that Lido nodes may be able to coordinate. If this were the case, the higher the percentage of staked ETH they own, the higher the risk of an attack to the Ethereum network.

This is the second major governance proposal to attract serious debate in recent weeks aimed at limiting opportunities for bad actors to abuse the protocol’s dominant market share.

Prominent Ethereans have called on Lido to limit its growth. They include Ethereum founder Vitalik Buterin and Ethereum foundation researcher Danny Ryan, who caused a stir last month with a blog post titled “The Danger of LSD.”

The “LSD” in question are the liquid staking derivatives issued by Lido and similar protocols, such as Rocket Pool. Lido allows users to receive a derivative token called staked ETH, or stETH, in exchange for staking ETH with the platform. The advantage is that stETH can be used as if it were ETH on DeFi protocols.

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

Cartel Activities

Protocols like Lido are likely to become monopolies, Marco Di Maggio, a professor at Harvard Business School and former researcher at Terra Labs, wrote in a blog post in 2020.

“Network effects will emerge, where more usage around a particular liquid staking protocol increases liquidity and utility as collateral, which further drives adoption of that solution relative to its competitors,” he wrote. “As a result, we can expect that only a limited amount of liquid staking protocols can coexist in a meaningful way.”

Lido’s potential monopolization of staking comes with the risk that LDO holders “force cartel activities of censorship, multi-block [miner-extracted value], etc, or else the [validator] is removed from the set,” Ryan wrote.

‘I am against any limitations being put on LIDO for leading the liquid staking market.’

Benjicohen

In the protocol’s governance forum, Lido users pointed to what they say is a far scarier possibility, however: centralized exchanges, such as Coinbase and Kraken, stepping into the void left by a self-limiting Lido.

“I am against any limitations being put on LIDO for leading the liquid staking market,” wrote Benjicohen. “If u disagree consider how you’d feel when Coinbase or Kraken take over instead.”

Ryanberckmans argued self-limiting was a reversible decision. And, in any case, “the estimated worst-case scenario of a Coinbase derivative taking over as being extremely unlikely and also, if it happened, more like a relatively healthier duopoly,” they wrote.

Another user, Izzy, said that perspective was unreasonable.

Not a Solution

“Why give them the opportunity (and power) that comes with catching up at all?” they wrote. “Is the risk that’s introduced (and overall detriment to decentralization) worth it? The protocols that will catch up the fastest are ones that can leverage economies of scale.”

Cobie agreed that letting others play catch up — what he described as “altruism” — was not a solution. But Lido has changes to make before he would trust it with monopoly power.

“I could see how limiting growth prior to the ability for users to exit (for example) is not an unreasonable suggestion in the circumstances,” he wrote.

Misunderstanding

Adam Cochran, a partner at Cinneamhain Ventures, said such fears were based on a misunderstanding of what Lido is.

“The rhetoric surrounding this idea continues to come from adversarial stakeholders, individuals who do not understand Lido’s systems, and people who are misinterpreting the genuine concerns of some in the Ethereum community,” he wrote. “Lido arguably isn’t even a staking entity, but instead, a rewards incentive and protocol layer for staking entities to be able to provide staking as a standardized service.”

With the proposal seemingly destined to fail, attention will likely turn to another topic of debate: changing Lido’s governance structure to make it harder to abuse the protocol.

Wary of the same “cartelization” Ryan had warned of, 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.

Lido Community

And on Tuesday, Lido team members proposed a governance update on the protocol’s blog that would create an objection-only period at the end of any DAO vote. It would, they argued, prevent a hypothetical attack in which a malicious actor with 5% of LDO, the amount required for a quorum, creates a proposal without support from the Lido community and swings it in his or her favor right before the voting period ends.

“This is an important step for Lido DAO to harden its governance process and mitigate against protocol capture or damage,” the team wrote.