The dominance of the Lido market and the decentralization of Ethereum after the merger

After a third successful testnet merger, September 19 was recently proposed as a tentative target date for the Ethereum merger. Ethereum is on the verge of completely transitioning 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 alone will not solve Ethereum’s scaling issues. This is just the beginning of a roadmap to achieve future upgrades,” Jacob Blish, Head of Business Development at Lido, shared with Cointelegraph.

Staked Ether (ETH) on the Beacon Chain, the PoS network that mirrors Ethereum transactions, is expected to remain stuck for at least six months after the merger ends. After the merger, the staked ETH liquid tokens will start enjoying transaction fees and maximum extractable value, which means that the returns will increase.

There has been a lot of hype surrounding the merger. This is the biggest crypto event in a very long time, Rocket Pool founder Darren Langley told Cointelegraph, adding, “The lockdown period is now testing liquid staking protocols, but that is mostly due to macro conditions. and centralized finance (CeFi) in progress. drama. Once it explodes, the liquid staking will explode.

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

Lido Liquid Staking Service

The launch of the Beacon Chain created a need in the ecosystem for a decentralized liquid staking solution that would compete with centralized exchanges (CEX) and could be used in decentralized finance (DeFi) for lending, borrowing and more.

The staking service offered by Lido gained popularity as the first protocol to implement a derivative of liquid staking on Ethereum thanks to the minting of the stETH token. Contrary to popular belief, stETH is not meant to be pegged to ETH. As Blish shared:

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

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

Various staking protocol balances in May 2022. Source: Twitter

The protocol attracted liquidity to the Curve pool with incentives in the form of additional Lido Token (LDO) rewards and a referral program to continue its growth strategy and cement itself as a temporary winner in the space of liquid staking.

Compared to other protocols in the wider DeFi ecosystem, Lido stands out as the only product that was able to compete and even surpass its centralized counterparts, like the Binance ETH (BETH) token, in terms of total value locked.

Alternatives to Liquid Staking Derivatives

New products tend to start with strong market leaders, but soon competition grows and innovation secures new entries that have the potential to take market share. The network effect achieved by Lido in a short time has made it difficult for its competitors to catch up and grab a substantial share of the market.

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Other liquid staking projects have small differences in fees, product decentralization, and the features of the tokens they offer, but the value proposition remains the same: to enable users to maximize the efficiency of their capital and increase their performance while securing the network.

“The Ethereum ecosystem is built on decentralization without trust. Such voting power in the hands of a single organization certainly goes against that philosophy,” Jordan Tonani, head of institutions at Index Cooperative, told Cointelegraph, adding, “Having healthy competition between multiple liquid staking protocols is a better outcome, and soon after the merger, a new set of liquid staking protocols will be supported to promote decentralization.

Rocket Pool represents over 1.5% of all Ethereum staked, with 1,300 individual node operators spread across 84 geographic locations. For this reason, it could impact Lido’s market dominance and increase its relevance in the liquid staking space with new scaling solutions.

Stakehound, Stkr, and Stakewise are some of the other projects trying to squeeze Lido’s market share but still lag behind in terms of liquidity depth and usefulness as collateral in DeFi.

It’s worth pointing out that Rocket Pool’s permissionless approach appears to appear more decentralized at first glance, unlike Lido’s permissionless one, which was a trade-off in order to ensure the reliability of node operators in the early stages of the protocol. The Lido team has been working on performance reputation-based permissionless onboarding to transition from its current model.

Monopoly or oligopoly, it must be decentralized

Given the data, Lido currently holds a monopoly in the market for immature liquid staking derivatives.

Lido, as a Decentralized Autonomous Organization (DAO), has opened the discussion on its governance forum around limiting stETH to a fixed percentage of all staked ETH. Bliss explained:

“We are aligned with Ethereum’s decentralization philosophy at the core. Governing the protocol through a DAO ensures that Lido will not pursue any actions that may conflict with our community and our values.

In addition, a dual token governance proposal was recently passed that allows stETH holders to veto governance proposals from LDO token holders that may harm stakingrs on the Ethereum network.

Similar to the liquid staking dilemma proposed above, Bitcoin (BTC) mining appears to exhibit centralizing forces. The space has become a market where the three largest mining pools hold over 50% of the network hash rate. And, the top six mining pools account for more than 80% over the past three months, according to data from BTC.com.

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It is difficult to predict the changes we will experience after the merger and the implications this may have on liquid staking products. Even though liquid staking derivatives are trending towards centralization, an optimistic mid-term development could come from other alternative products gaining ground and splitting the market into an oligopoly.

“In reality, there will be many players in the ecosystem, but maintaining a strong level of decentralization is critical to the success of Ethereum – especially its credible neutrality,” Langley said, “The key to decentralization is to reduce barriers to entry, including lowering the warranty requirement and technical challenges.

Some volatility is expected over the next month as the hype surrounding the merger continues to build around liquid staking products. The demand for these products has never been stronger. Further developments will prove whether the space will be managed by one, a few or more liquid staking derivatives.