Bankless - 191 - Danny Ryan's Case Against Lido

Episode Date: October 9, 2023

Danny Ryan is a coordinator at the Ethereum Foundation. He’s been on Bankless many times before. Usually, we’re talking about the Ethereum roadmap and what’s coming next. This time we’re talking about something different…a risk to Ethereum that Danny sees. A little over a year ago, Danny wrote a blog post titled “The Risk of LSDs”... discussing the various risk vectors that a dominant LSD presents to Ethereum…even naming Lido specifically in the process.  ------ ✨ DEBRIEF | Ryan & David unpacking the episode: https://www.bankless.com/debrief-danny-ryan  ------ A lot of people have decided that liquid staking with Lido is the place to do it. At the time of recording Lido has over 30% of all staked Ether. Does this present a systemic risk to Ethereum? We did an episode called, “In Defense of Lido” with researcher Hasu who argued that Lido does not pose a systemic risk to Ethereum. In fact, Lido’s dominance is better than many other alternatives. We left that conversation half-finished when we published it in August 2023.  In today’s episode, we cover part two of that debate with Ethereum researcher and guest Danny Ryan who argues the opposite. Lido is a systemic risk to Ethereum and what to do about it. We believe our role as podcasters for issues like this is to voice both sides of the argument in long-form conversations and healthy debate. It is exactly the kind of thing you don’t get on Twitter. That’s why we’ve given voice to both sides of this issue.  We think there are good actors who care about this ecosystem at Lido and in the broader Ethereum community and we’re sure this episode won’t be the last word on this subject. ----- 🏹 Airdrop Hunter is HERE, join your first HUNT today https://bankless.cc/JoinYourFirstHUNT  ------ 📣 a16z Startup School | Apply Before Oct. 20th https://bankless.cc/a16z-startup-school  ------ BANKLESS SPONSOR TOOLS: 🐙KRAKEN | MOST-TRUSTED CRYPTO EXCHANGE ⁠https://k.xyz/bankless-pod-q2  ⁠ 🦊METAMASK PORTFOLIO | MANAGE YOUR WEB3 EVERYTHING ⁠https://bankless.cc/MetaMask  ⚖️ ARBITRUM | SCALING ETHEREUM ⁠https://bankless.cc/Arbitrum 🗣️TOKU | CRYPTO EMPLOYMENT SOLUTION https://bankless.cc/Toku  🦄UNISWAP | ON-CHAIN MARKETPLACE ⁠https://bankless.cc/uniswap  🔗 CELO | CEL2 COMING SOON https://bankless.cc/Celo  ------ TIMESTAMPS 0:00 Intro 7:41 Is Lido a Threat to Ethereum 8:57  Blog Post Thinking Change? 19:30 Uniswap 21:20 Theoretical Main Risks 25:45 God Mode  27:20 Practical Main Risks 34:00 Hasu Counter-Arguments  38:25 Permissionless Validator Set Mitigation 42:30 Veto Power Mitigation Argument 46:55 How Likely is the Lido Risk? 51:26 Client Team Positioning  55:00 How Special is the Lido Case?  57:45 One LST Inevitability   1:02:30 Solutions  1:06:55 Profit Maximization  1:09:00 Action Steps For Ethereum Decentralization  1:11:53 Can Ethereum Devs Do Something?  1:20:10 Hasu Questions Answered by Danny  1:22:45 Magnitude of the Lido Threat 1:24:20 How Can Lido Fix This?  1:25:59 Stick & Carrot for Lido 1:26:27 Silverlining of Lido Threat 1:29:05 Next Conversations  1:32:16 Closing & Disclaimers   ----- RESOURCES Danny Ryan https://twitter.com/dannyryan   Danny Ryan Blog Post https://notes.ethereum.org/@djrtwo/risks-of-lsd   Hasu’s Bankless Interview https://youtu.be/IfuUdIblfrY   ----- Not financial or tax advice. See our investment disclosures here: https://www.bankless.com/disclosures 

Danny, I can guarantee there are going to be a lot of folks who are designers of the Lido Protocol and participants in their community who listen to this podcast. I think many of them listen to our episode with Hasu as well. What would you say to them? What would you like to see Lido do? How can they fix this? Welcome to Bankless, where we explore the frontier of internet money and internet finance. This is how to get started, how to get better, how to front run the opportunity. This is Ryan Sean Adams, and I'm here with David Hoffman, and we are here.

to help you become more bankless. Where should you stake your ether? A lot of people have decided that liquid staking with Lido is actually the best place to do it. And at the time of recording, the staking protocol Lido has over 30% of all staked ether on Ethereum. The question today, does this present a systemic risk to Ethereum? So we did an episode called In Defense of Lido with crypto researcher Hasu, who argued that no, Lido does not pose systemic risk to Ethereum. In fact, he argued, Lido's dominance is better than many other alternatives that are out there. And David and I both felt we left that conversation half finished when we published it in August. So here's part two of that debate, this time with Ethereum researcher and guest Danny Ryan, who argues the opposite that Lido is a systemic risk to Ethereum and he has some ideas on what to do about it. Now, before we get into this episode, a special note, both Dave and I believe our role as podcasters for issues like this that are somewhat contentious is to voice both sides of the argument in the form of long-form conversations and

healthy debate. And this is the type of thing you don't often get on social media. You certainly don't see this type of conversation on Twitter. And that's why we've given voice to both sides of this issue. We think there are good actors who care about this ecosystem on the light of side and in the broader Ethereum community. And I'm sure this episode absolutely won't be the last word on the subject, right, David? Certainly not. And this is very different from the warring tribes that I think most people in the world of crypto Twitter are used to. Ethereum fundamentally is a place for multiple groups of people to come together and exist in the same space. And I think this is just an emphasis, a disagreement on a specific vision for Ethereum or what Ethereum is.

I think the Lido cohort or a little bit more of the people who are willing to succumb to the market and fall in line with the market and work with market forces. And then there's the other side of the Starryi I Dreamer side of things, which wants to preserve our values to the best of our ability and think that we can and attempt to overcome market forces. At least that's how I interpret this dynamic. So some big questions that we ask in this episode to parse out these two perspectives. Is Lido a threat to Ethereum?

That is, of course, the big question. Are LSTs liquid staking tokens making Ethereum centralized? Is this about Lido specifically or about LSTs generally? Is a single dominant staking service provider inevitable? or can we maintain a plurality? What is the risk level to Ethereum? Yellow, orange, red, like, how can we measure these things? And how do we solve this problem? Are there things that we can drown in the protocol to solve this problem? Where is the role of other LST protocols? And lastly, why Danny is still optimistic about the future of Ethereum. But first, before we get to this episode,

we disclose. Bankless holds small investments in Lido and Rocket Pool, and both David and I have angel investments in some smaller staking startups. We, of course, are very very, bullish Ethereum and believe very much in the decentralization of this network. We are long-term investors. We're not journalists. We don't do paid content. There's always a link to our disclosures in the show notes. All right, guys, we're going to get right to the conversation with Danny Ryan. But before we do, we want to thank the sponsors that made this episode possible, including our recommended crypto exchange for 2023. That's Cracken. Go create an account. Cracken Pro has easily become the best crypto trading platform in the industry.

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He's been on bankless many times before, and usually we're talking about the Ethereum roadmap. We're like, hey, Danny, when are we shipping that thing? How's it going? Winmerge. Or it's like, congratulations, Danny. just ship that thing. How do you feel? But this time, we're talking about something different. We're talking about a risk to Ethereum that Danny sees. So a little over a year ago, Danny wrote a post called The Risk of LSDs. We'll call them in today's episode LSTs.

LSD stands for liquid staking derivative. We've kind of gone through a name change, a rebrand in crypto, calling these liquid staking tokens, so LSTs. And it discussed the various risk factors that a dominant LST presents to Ethereum. And Danny even named Lido specifically in the process of going through that blog post. And I think this is a response to an episode that we've recorded all the way back in August with Haseu on the question of, is Lido a threat to Ethereum? And Haseu's answer was, no, not really. It's kind of an overstated threat. And I think Danny is taking the other side of that argument here today.

Danny, welcome to Bankless. How are you doing? Great. Thanks for having me. All right, here's the question. Is Lido a threat to Ethereum, Danny? So we're going to over here to talk about Lido. I'll talk about things in the abstract, but also about Lido. Yes, I mean, anything that stands to take over that much amount of stake, that much amount of mind share, that much amount of kind of systemic nature of the protocol, is a risk to the protocol. I mean, that's just plain and simple.

Lido is that thing today. It's an instantiation of something that's aiming to gobble up, you know, all of steak teeth, and quite a cavalier nature. in which they're, I don't know, a bit flippant about the risks at play here. So, yes, Lido's a systemic risk to Ethereum. Usually things that exist in the app layer stay in the app layer, but there's a handful of protocols out there that span Ethereum's app layer with its own protocol layer. Lido being one of them. This is why eigenlayer and restaking has caught the attention of many EF folk as well. Some things go down into the protocol.

Some things in the app layer go into the protocol. And this is kind of why Lido is the topic of concern. is when we talk about ETH stake, we're talking about the nature of the Ethereum protocol. Danny, you wrote that piece, The Risk of LSDs, LSTs about a year ago. Has your thinking evolved since then, or is there any kind of adaptation or evolution in your thought about the way that something like Alito or Lido itself has anything changed? Yeah. So first of all, I'm very proud of the coining of the LSD term.

I'm very sad. I agree with you. It's sad that we can't use it. You made that up, Danny? No, but I understand the evolution. I believe I made that. LSD. I think that's my biggest contribution to a deal to date.

But I understand the transition to T. You know, some of them, maybe you could call derivatives. Some of them are tokens in other ways. The blanket terms, nice. Anyway, I don't think anything is deeply changed. My views have become more nuanced as I understand that and other things that they've played out. I'll say this.

You know, Lido, as it attempts to surpass a third, it seems to surpass half and wants to gobble up pretty much all of Ethan existence, at least as some in the light of community want to see, it's a risk to Ethereum's credible neutrality at a minimum, and at a maximum creates systemic risks due to technical risks, regulatory risks, governance risks, all sorts of things, systemic risk to the protocol, things that could cause quite huge disasters, things that as an Ethereum community, as a theorem protocol, probably could recover from, but it's best not to go there. Donkrod had a tweet the other day.

I think he captured some things better than I have been able to. I'm just going to read it because I think it's very, very worth reading. In relation to, you know, the protocol failing and this thing being, you know, just the way incentives work, he says, the centralization does not work like this. No economic incentives will automatically guarantee our values, such as immutability or censorship resistance. The values of the Ethereum community do this. Our technology, as well as the incentives built into our systems, are a tool for this purpose. you believe that crypto values are simply individual profit maximization, you have missed the

plot or in the wrong place. Ethereum survived and thrived because people have values, and it will die if people forget about them. Yes, we do try to build our systems to be robust as possible to get the incentives aligned with our values as much as we can, but perfect alignment is ultimately impossible for the simple reason that centralized systems are more efficient than decentralized ones. And implicit in there is that this system, the Lido system, has many components of centralization, and at the limit can be a more efficient system layered on top of the decentralized system that it is today. And really only people, their values, their understanding of risks, not just of tomorrow, but in the many-year time horizon,

in their capital allocation, can protect us from, you know, a system that is inherently decentralized to become centralized. I mean, you see this not only in Ethereum staking with LSTs, you see this in mining systems where you have many, like, mining pools sitting right on these key thresholds, you know, sometimes surpassing it, all of a sudden you have like two mining pools in Bitcoin that are 55%. You know, it's really only like the people that allocate their mining power in those systems protecting the decentralization of the system. Because yes, like if you have a hundred percent pool in a mining system, you're going to make more money. Potentially, if you don't think about the second order impacts of what's going on

here. So I want to ask a question here. So I think you're making the case and we'll probably return to that theme that so much of what protects Ethereum actually and what keeps it decentralized and what keeps it corruption resistance is actually what we call on bank list kind of the layer zero, which is the social layer. And one point I'd make for everyone out there who says, well, that's kind of weak. Actually, that's how all coordination, human coordination systems are protected. If you look at law, let's say, right, the underpinnings of society, how is that enforced? Yes, there's a court system. But ultimately, if you look at kind of constitutional law, I mean, it's up to the people and the social norms of the day to hold politicians and lawmakers accountable for the

protections that we find within our constitution. And if the people forget that in the U.S. at the layer zero, that we won't get things like a peaceful transition of power from one president to the next. So at the end of the day, the layer zero is all that secures everything, all of the structures that we rely on for legal governance as well. I think you're making that case. I agree. It's interesting you bring up like kind of the government analogies here. like something that I've been thinking about a lot is like the importance of disjoint and disentangled sets across kind of the Ethereum stack and the Ethereum community. And this is deep analogues to like maybe like the US system of government. You have like different parts of government. You have

checks and balances. And actually like when they erode, say when the executive branch is actually kind of taking over like legislation in certain ways, it fucks up the incentives and it fucks up the system of checks and balances. And I do believe that like Ethereum is healthier when you have disentangled and disjoint sets. And I'll make them more concrete. So, like, maybe you have the user base of Ethereum, which right now is kind of equivalent to the Ethereum community, but you could imagine the user base being massive.

And then they have, like, maybe a core Ethereum community who, like, is more into, like, the values and things like that. And in the future, we hope that there's probably, like, far more users than there are Ethereum community. The Ethereum community is probably roughly equivalent to, like, ETH holders, right? Maybe you have a disjoint set there eventually, but maybe not. like that probably stays pretty tight.

But then you have ETH holders and you have ETH stake capital, right? And the ratio between those two and keeping a like disjoint set or at least a super set of eth holders in relation to ETH capital, all of a sudden keeps the ETH holders as a more check on the ETH state capital. If you have those converge and you have, you know, 100% of all ETH is staked, now you don't have this like disjoint set of ETH holders that are actually keeping their eye on, you know, is the validator set healthy? is the consensus doing what it needs to do?

Because all of a sudden, you've got kind of cartelized thinking. You don't have a rational independent actor. Similarly, if you take ETH State Capital, you take any of the subsets that are protocols or pools or any of the other things, you know, if you converge that, the staked capital all of a sudden becomes one thing underneath it, then you no longer have the disentangled set.

You never have that, like, natural kind of competition and check on power. And so what Lido aims to do, is essentially like take eith stake capital and unify it with what the Lido protocol is. And now you no longer have like a disentanglement of that. That's an argument for having many pools, many protocols, many individual stakers. Also, there's an argument there that the incentive structure of staking shouldn't converge such that, you know, 80 plus percent of all eth is staked.

In the event that it is, then again, you have that like unified set across the social layer zero instead of like a disjoint set that has like their eye on checks and balances. And so not only should we be thinking about, like, how do we prevent and how do we, from both a technical and social standpoint of Lido and other protocol capturing all stakes capital, but we probably don't want staking to capture all of these. And so thinking about the incentives at play, the relationship of MEV, MEP capture, MV burn and stuff into incentivizing the amount of stake that is staked is something we should be thinking about, too. I think what I'm hearing from you, Danny, is an advocation for pluralism, which I would say

is a pretty deep core principle of Ethereum. We enjoy having many different groups, many different tribes, many different apps, many different protocols exist cooperatively in the same space. I would say that's a pretty deep core of what powers Ethereum. Right. Yeah, I mean, we see that as a core tenant of how client development is done, you know, because that is a, like, very core part of how the protocol is governed. And if you just had one client, like, say, like Bitcoin Core, then Bitcoin Core becomes

becomes there is no difference between what they say and what the protocol is. And so instead, we have like these disjoint sets. We get to kind of checks and balances naturally in the social structures. Yeah, it's not just pluralism. It's also the idea of checks and balances, which is very important, right? So you can have power accrue to one particular group necessarily over another and one group can kind of, you know, check another group. Yeah, and I think about this a lot in relation to staking recently and I plan on writing a piece about it. But as I think about it, it's also something that I've thought and realized is very important. in the app layer as well, right? Like if you only have one stable coin and it's a massive amount of

the Ethereum economy, it becomes like a major systemic risk, right? So like if it's all USC, that's probably a big problem. Even if it's all USDA, you know, that powers the Ethereum stable coin economy. It's probably a problem. You know, instead we want like all sorts of like Eurocoins. We want Asian coins, we want all sorts of stuff so that we have like this like natural, maybe not anti-fragility, but at least resilience in the system so that it's not systemically placed upon like one single protocol, whatever their governance is, whatever their smart contract risk, et cetera. And I think what we're also advocating for is some semblance of decentralization in the properties that makes up Ethereum, right? If we have a diffuse set of LST tokens rather

than one central one, well, then this is a check on the ability of corruption to be able to find a foothold in the Ethereum system because of one LSC gets corrupted. Well, that's fine. There's like seven others that we could also engage with. But I think, Danny, I want to open up the conversation of us to like, well, not all of these systems are as corruptible. Like Uniswap has 80 to 85% of Dex volume trading on Ethereum. I would call that a monopoly. But how like corruptible is Uniswap? I would say not all that corruptible. And there's not really any kind of downstream consequences. Certainly. So the actual technical details of like what is at risk is relevant to the discussion of what we are trying to create checks and balances around. Yeah, I think uniswap's actually like a done,

it's probably one of the best instantiations of what I hoped was going to happen on top of Ethereum. You know, like small modular components that do one thing and do one thing well and are not generally changeable or upgradable. I mean, even the upgrade path for uniswap has always been, we'll make something better and people use it if it's better, rather than like we're going to go in and mess with it. I would say the way that they've done things, the way that it brings risks, in being a monopoly to Ethereum are far reduced. But still, there is super amount of risk there. You know, if you find a un-swap bug tomorrow, like, we're fucked.

Fortunately, it's isolating the app layer, and you started at the beginning in how Lido and other things like that become entangled with the consensus layer, become much, much riskier in terms of the impact to Ethereum. And so maybe your implication there is Lido and other things can do things over time. to make themselves less systemically risky, and they should. Absolutely. But I think that the entanglement with the consensus layer and the kind of the inherent incentives around security

and things there don't really allow for what I think to be, you know, safe monopolies that can dominate 50 plus percent of state capital. Yeah. I want to define the risks here of a dominant LST around Ethereum. I know that there are thresholds, one-third, one-half, two-thirds of what someone can do if they have that much stake. I want to know, is that the risk that you are concerned about? Or are there other risks? What are the risks that we can define here? Those thresholds are certainly very important in how it's worth thinking about these.

I think that there are risks beyond just like thinking about those. And they compound in the way the rest of the ecosystem kind of falls around them. But I guess traditionally just what can happen at one third. At one third, essentially an entity can hold the chain's finality at hostage. Right. So any single actor, any single protocol that exceeds that. that, you know, if they want to halt finality, whether it be for some sort of ransom, or whether it be because there's some thing that they're trying to prevent to get economic validity so they

can have some other type of gain for some time period, they can do that. At 50%, you can now begin to manipulate the fork choice. So the fork choice is, you know, we think about a blockchain, you know, a sequence of transactions and we get to kind of the final state of what's going on at the head of the chain. But really, like, what a block chain is is a block tree. So it can have potentially many paths and forks. And the fork choice is, like, given a block tree, what is the actual canonical chain that we all agree on? It's a block chain in history, but a block tree as you get to the present, right? So if you look at any head of the tree, it defines a chain, right? And so if we all agree on the same head, we agree on a chain. But potentially, the head could swap from A to B.

under certain economic or potential network latency conditions. And so what's really nice about the purpose-stake protocol is on some time frame, approximately like 12 minutes, we get finalized chunks of the chain where we'll never revert, and so it doesn't really matter if there were branches before them. But beyond that, there is chance for what we call reorgs, or if you have a high enough economic actor, potential manipulation of the view. And practically what that means is a transaction that got into the chain is no longer, in the chain. Maybe something's reverted, something's changed. Essentially, like my view of reality

could change. So instead of me sending you coins, you know, the chain could be reorg and I'm now sending Ryan coins. Point being is if I exceed those 50% thresholds, I can now manipulate that. So we could make it such that a couple of blocks come in. People think that with high confidence, those will eventually be finalized, but then they're reorged. And they're changed. And with a 50% attacker, they can kind of manipulate, at least within like the 10-minute time horizon, what is going on. Another thing that they can do is censor. So that 50% attacker could take a small amount of the stake or, you know, even 20% and say, you know, I don't want to include your blocks, you know.

Maybe they're doing that because they're maximizing MUV. You know, the incentives might be such that it's actually the profitable thing to do is to not include those 20% of blocks. Or maybe some jurisdiction has said don't include blocks of the, a certain type. And now they only have to knock on one protocol or one organization's door, because at that 50% threshold, you can essentially censor. If you censor more than a third, then you're not going to finalize. So if you don't have that two-thirds threshold, but you can do quite a bit of damage at that point, which leads into two-thirds. At two-thirds,

you can halt finality if you feel like it. You can reorg on that 10-minute time horizon. You can censor with impunity, and you can finalize, even if you're censoring. So if I only had like 50% and I wanted to censor like 49%. It's going to be painful because people are going to lose money because of the non-finality stretch. But at two-thirds, now I can kind of do it with impunity. At two-thirds, basically, don't you control every lever that Ethereum has? Like, you are Ethereum?

Yeah, without social intervention, you're in God mode. Right. Yeah. Okay. How much God mode? It's like, could I just take money from David's Etherass at two-thirds? Yeah, that's an important nuance. So you don't get God mode over cryptography, right?

So I can manipulate the chain. I can decide what's included in the chain. I can potentially reorganize the chain such that, like, what you thought was included is no longer included. But I can't actually forge a signature. I cannot forge a signature that David never signed, unless, of course, I hack into his computer and steal a shit. That's a different attack factor. Right. That's another one that maybe should keep us up at night.

Photography. Storing your keys is hard. So that's an important nuance, especially in the sense. when you have a strong running node culture and stuff, if you have, say, a chain where you're essentially just listening to the consensus set, and they tell you what the result of executing the blockchain is, and no one's executing the blockchain on their own. There's not like a strong culture of users.

There's not like a ton of independent providers and things like that. Then you can actually just like make arbitrary state changes. So that's an important thing is that many people actually run the protocol independent of Ethereum. And not just like home hobbyists, but like there's tons of services and analytics and exchanges and all sorts of stuff that essentially become like policemen of preventing invalid state transitions. Okay. So these were all of the theoretical risks, I would say, the possible technical risks.

But what about maybe the ones that you're more concerned about more specifically, like the actual practical risks? Like if I'm Lido and I want to attack Ethereum, what am I going to do and what keeps you up at night? Yeah. The thing that keeps me up at night is certainly like one third becomes kind of this critical milestone of like, wow, shit. Like we're going to let it happen. aren't we? 50% plus actually some of these like reorg, multi-block MEP, all this kind of stuff,

like in a system like Lido or others where you certainly have disjoint node operators, but you have kind of this like unified economic incentive, then I think it becomes actually very much a reality that they could flip a switch and they're starting to do some of these like malicious short-term reorg, censorship, etc. to optimize essentially their gains. And whether that's dictated by, say, the Dow, which is a governance vote, which I think people have shown is, you know, heavily weighted towards a few whaled, if not BCs, saying you must do so as the node operator set, or if it's just, you know, the node operator set's supposed to be optimizing their returns, right? And at above 50%, all of a sudden, optimizing your return becomes potentially

doing malicious things. And then if you're part of the node operator subset that is optimizing their returns, all of a sudden they're making more money than the node operator subset that isn't, then all of a sudden, you know, finitionally you're kicking out operators that aren't as good, you know, and good becomes malicious at that point. So I certainly like, above that 50% above that two-thirds threshold, like I do think that the economic incentives because you essentially have created like a stratum for a cartel at that point would push them to do in many potential ways this played out, things that I think people would consider as malicious against the security of the chain. Another thing is, you just begin to have fewer doors to knock on, right? In this, like,

global, decentralized, like, unstoppable system, you now have, like, a coordination layer over a validator set that becomes very small, right? And it becomes very targetable and attackable. And people cite the Lido governance vote on self-limiting to one-third. I think this was kicked off maybe after I wrote that piece and some other discussion about a year ago, and it was rejected. And I think people, when they look at that, they go, oh, I mean, it was three votes that did this. And all of a sudden, if I'm a regulator, I got three doors to knock on if I want censorship or if I want other things like that. And like, sure, there's probably multi-jurisiction going on there that maybe it potentially helps. There's also a lot of USVCs that are entangled in it.

So, like, it's really like these technical concerns with like a very reduced set that you need to knock on the door. instead of like coercing the global set of Ethereum, you know, you're now coercing a handful of Dow governance token holders. And so it's really that kind of like where the social component of Lido or something like it becomes entangled with the consensus, like it just makes it super way more fragile. So Danny, just to make sure I'm understanding this, like to summarize, under one third, we're kind of okay. But the closer we creep to one third, the worse it gets. one-third, they can effectively, one entity, let's assume it's not Lido, because that brings in other discussions, I think we want to get in there, but one entity, maybe a Lido-like entity, could delay finality. And for you, that's a, oh, shit, we're going to let this happen, right? It's kind of a failure

of our immune system to kind of stop this. Probably unlikely that they would do that, though. Because it's not, like, immediately obvious exactly how you reap the benefit from that. It's not, like, necessarily, like, incentive-compatible, unless, like, you were, We're delaying the outcome of an on-chain lottery, and that helped something. You know, like, you can think of scenarios in which, like, that becomes profitable and potentially valuable to do, but it's not like the most obvious place to attack. Right. And that's interesting because we could very well tip over, you know, one-third, and then

people will look at that and nothing will have happened, right? So maybe all of the naysayers will be called Chicken Littles because, hey, Danny, we're over a third, and nothing bad happens. See, we told you it'd be okay. but then you start to get really worried when we go over 50%. And because that brings a whole new set of powers to the entity that controls 50%, the ability to censor and maybe the ability to reorg. So to me, that's like skimming off the top.

So that introduces this kind of corruption type of vector where whoever has that control can kind of cheat users skim off the top a little bit. And then essentially, Ethereum no longer becomes a censorship-resistant protocol. potentially, right? If you have, again, three doors to knock on. So that 50% threshold is pretty critical because that's what happens after that. That's what could potentially happen after that.

Is that right? You know, there's censorship in the way of like, you know, are some boogeyman transactions making on the chain? There's also censorship in like the, oh, you know what? If these two operators, which are like bound in this same kind of payout set, if we actually just censor this block in between us,

we're going to make way more MV. we'll do that. So maybe it's less, it can be these like, yeah, knock on the door, jurisdiction says, like, you must censor these types of transactions. But it could also be like, you know, we'll do that because that was profitable. Well, we'll do that because that was profitable. And that begins to kind of break down the integrity of the chain. Right, right.

We get kind of like Robin Hood type front running types of situations, right, where maybe our corporate overlords reap the benefits first or something like this. And then at two-thirds, it's just all bets are off. I mean, this is no longer the Ethereum can't pervay any. semblance of being a credible neutral infrastructure, right? It's very deeply controlled at that point, is what you'd say. That is what I believe, yes. Okay, so I think I want to throughout this conversation, since we've had a conversation with Hasu and he was kind of saying, hey, these concerns are actually overplayed. I want to inject some of his voices as sort of a counter to this throughout this episode,

if I can, because I think some people who are maybe listening to this or on Team Lido are sort of sympathetic to those arguments might say, okay, guys, you just set up a strong. raw man and now you're beating it up. Okay, like, good job. Another bankless podcast. So I want to attempt to try to steal man this as we go. And so one thing I can hear the voice of Hasu saying is, but Danny, we're not talking about one entity here. And we're not actually talking about three votes. Okay. What we're talking about is a network of 29 independent node operators that have their own utility functions. That's exactly what he would say, utility functions, by the way, which means they have their own incentives and their own different skin in

the game. And so if the Lido governance apparatus actually did something, then this confederation of node operators would defect. They would no longer be part of the Lido network and they would go do something else. So that is a check-in balance on this. So the idea that, no, this is not actually one-third or 50% or two-thirds. This is actually 29 independent. entities here. What would you say to that? With aspirations to being permissionless, too. Yeah, yeah. Something like Lido becomes like a shroudum for Cardinalization. Like these entities, within the context of Lido, have a unified incentive, right? It's not like, I make my money for my M.E.V. You make your, you know, and that kind of stuff. It's all of the money gets channeled

to one place and we split it. And so, for one, within the context of operating as a Lido operator, you do have unified incentives. Yes, you might live in, you might live in, you. Taiwan and this other entity is in Australia. And so like we have and I'm a security company. So I have like second order things about this and this and that. So like, yes, we do have outside of the Lido context, disentangled incentives. But Lido either decides who those operators are explicitly through governance vote, which it does today, or it does in a permissionless way. And if it does in a permissionless way, it must be around profit maximization. That's the only way that you can decide if an operator, is good or bad in a permissionless way is, do you make enough money in relation to how much money other people are making? And so in the former, we have a governance vote, so we had the three-person problem. In the latter, we have the problem where once a subset of that operator set defects

and starts doing things like reorgs and stuff, they become much more profitable than the others in the set. So from a strictly objective standpoint, we now have a striation between people that are making more money and less money, and an objective thing is going to have to kick them out. And there's probably blurry things in between where you have like semi-governance or you have semi-objective optimization. But in either of them, you fail to have kind of like the ability to totally not have the kind of cartelized behavior. And so, yes, these operators could leave,

but it doesn't necessarily change the amount of capital that's allocated to LIDO. Right. So if five operators leave, you know, five of 29% of the capital doesn't leave Lido. Similarly, right now, you have this kind of interesting behavior where, like, the operator set, you can't forcefully exit operators. You can't forcefully exit state today. But Lido has kind of this like committee that holds pre-signed exits so they can't essentially do that. So we don't need to go down that path. But in many ways in which this plays out, I don't see how you can eliminate the tendency towards cartelized behavior. Okay. So there's some cartelize behavior. Let me ask you about maybe some other mitigators that someone like Hossu might bring up at this point. Because, you know, some people

people would say, okay, Lido has actually listened to the layer zero, right? And haven't done everything that the layer zero wanted, including kind of like caps, but they are implementing some decentralization mechanisms. One of them is more permissionless validator set. Now, my understanding is that's not live today, but a bit more like a rocket pool where it's not gate kept to these 29 different node operators. Anybody can join. Does that mitigate this in any way to you, Danny? No, because those are going to have to meet performance metrics. There's no way that they're going to allow a permissionless operator set that can't reach profitability goals. And so, again, we have this, like, if I have 100 permissionless operators that come in,

and they don't join in on cartelized behavior, assuming that a certain amount of the operator set has defected and now are doing things like reorgs and malicious MEV capture, if the 100 permissionless operators don't do so, then they're not going to hit the numbers, and they're going to be seen as not good enough for the set and they're going to be kicked out. Unless they don't care about profitability, but in a permissionless operator set, I don't see how you can't not care about profitability.

So, I mean, if they're willing to say, like, yeah, you can run Vito validators as long as you're bonded and you don't have to make any money or, like, meet Lido standards of APR, then sure, but I don't think that that's a reality that they're attempting to construct. Why is having a set of validators that's find by profitability a bad thing if we're talking about ETH stake.

So it could be a good thing, especially if you're below a third, even if you're below a half, but once you go above those thresholds and you have the ability for the operator set to do things that are what I might claim and many would claim are malicious, but extra profitable. Now, once that validator set defects and starts doing, you know, multi-block MEP, malicious reorg, things like that, then they're going to look more profitable than the set that we might call honest, is honest. So now you have a disparity if you're using an objective profitability function between essentially the cartel, the people that have aligned not only their incentives for their actions in relation to the incentives and the rest of the set. Are you saying that if everyone was under the one-third threshold, then optimizing for profitability is fine. but what that might lead to is that if the culture and the values of what our staking system is, is defined by profit maximization. Once we have the powers of being past a third, past a half, past two thirds, well, then what turns in, what was a competition in the marketplace turns into, well, now that I've been a profit maxi, I've always been a profit maxi.

I was a profit maxi when I had only 20%, but now I have 60%. And so now I will be a profit maxi by extracting other means that includes the powers that I have. as a result of being a large, that's what you mean? Yes, that is. But even sub one-third, if you move into a profit maximization regime where you're trying to use an objective profitability function, it incentivizes those 29 operators to converge, right? Because multi-block MEP is more profitable than single-block MV. So even if you have 20% of the network

and you're split amongst 20 operators, you know, the incentive still becomes to essentially try to be one operator, right? And that's not necessarily what happens in the current regime. It's not necessarily what happens tomorrow, but it's certainly like the tendency towards the incentives of unifying the profits there. Another thing I've heard from the community who are more proponents of Lido's strategy is this idea that we're talking about one single entity in kind of three votes, right? This token weighting governance that I think you're most worried about, Danny.

Well, we can find some ways to give some of this power back to Lido token holders. And sorry, I don't mean the Lido token. Yeah, yeah, the Stake's Eiff itself. And basically, the way this was described is staked-eth users would have the ability to vote just to veto things, essentially, in light of governance. So they wouldn't have necessarily the power to push proposals through, but they would have the power to stop really bad proposals, and this veto power would be injected. Does that help mitigate the situation in any way? Some, some. Yeah, I mean, there are gadgets that can and should be layered into any sort of LSD system like this to make them safer.

You know, so maybe the boogeyman jurisdiction that knocks on three doors and says you now censor, you know, X, Y, Z transactions, maybe if the stake teeth holders are actually, like, proliferated across the world, they reject such a veto. And they reject such a thing. And so I do agree that layers and predictions, but I don't agree that, especially in the kind of these more economic attacks with malicious M.E.V. Reorgs, et cetera, I don't really believe that stake deeth holders' incentives are disjoint enough from Lido's incentives. Like, they're kind of. kind of just unified in the sense. And I think that relying on state thief holders to be a fallback on that when like they're optimizing their APR, presumably, is not like, I don't really see that that follows. This is a wild idea and certainly not something that's been proposed from anyone in the Lido community to my knowledge. But what if Lido also gave just regular ETH holders some sort of veto power as well? Would that mitigate things? I'm not saying anybody on the Lido side would be willing, but we're talking about, you know, a good acting protocol and what they might do to mitigate and restore the balance of power. Yeah, and that goes back to like kind of the disjoint social sets.

That would probably help. But if Lido wants essentially all ETH to be staked ETH, and we wants all staked capital to be Lido state capital and wants all ETH to be staked ETH, now we no longer have disjoint sets and we've kind of converged the incentives here in a way that's probably degenerate to actually protecting. Part of your concern is that they're unwilling to do any of that, right? Yeah, yeah. And part of my concern is that in a high MEV regime, in the current, you know, there's two things there. As Lido all of Staked Eath and is Stakedith, all of Eith. And I think both of those things we should attempt to hold as not true so that we have these disjoint sets, so we have checks and balances. And so Lido's really like, you know, they or the capital

allocators towards it are going to decide if they've become over these critical thresholds inside of Staked ETH, but I do think that there's work actually, for better or for worse, there's work to do on the protocol to ensure that not all ETH becomes staked ETH, not the LIDO stake token becomes a staked capital in the system, because, again, it's important to have these disjoint stats. And that's a complex problem. You know, there's some potentially re-architecting of incentives, which is not something that we like to do. There's probably the notion that the system really needs to become MEV aware and capture that to avoid certain centralization concerns if the state capital is limited.

And there's a lot of complexities there. We have a lot of work to be. But I do agree with your notion that ETH holders, the ETH community, and at large the Ethereum user base, can and should be a check on balances. And whether that's integrated into the LIDO protocol to help make sure their protocol is a subset of Staked ETH is safer, great. But also keeping those set disjoint so that layer zero continues to operate in a safe and healthy way is very important.

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divert from the track that we are on, from the path that we are on? Or is this like, oh, this might happen one day, so we should be cautious, but otherwise we're fine. Like, where are we on this thought experiment to crash course with reality spectrum? It seems like the Lido Mindshare is quite cavalier and disingenuous about the risks and wants to gobble up all of state capital. Lido has, since I wrote that piece over a year ago, fluctuated at, you know, 30 to 32 and a half percent or whatever, maybe even 33 percent, close to that one-third threshold. I saw a graph. I think that kind of with like some of the collapse of shit last year with three arrows and stuff, like it coincided with me writing my piece and like the Lido steak went down. I don't think it had anything to do with my piece. But since it's really kind of fluctuated, I saw a really good graph the other day. I can't remember it came from. I actually came from Masari. Someone forwarded it to me of Lido's share. And it's really, it stayed in that below a third and it's kind of bounced off of it. And I wonder if that's kind of the immune system of the ecosystem coming into play or if it's just happenstance because of other capital allocators.

I don't know. It'd be interesting for somebody to do a dig there. But this is real. This is real. There's a reason that people in the East Staker community say no one above 22%. And it's so, obviously like the protocol can't, the protocol doesn't know anything

about this. The protocol can't say you're the same entity as that and anyone can replicate themselves and restake in a different environment. So the proto doesn't know anything about it. But they want the social handshake and the social norms to be, you know, more in that 22% threshold so that we're not constantly worried about it, right? If Lido's, sure, Lido like can't do these VAB things that they're at 32%, but we're constantly on alarm, right? And it's a huge constant threat

until capital becomes reallocated. And so, like, it becomes very valuable for us to not always have to be yelling about this thing in the event that, you know, say Lido goes sub 28, sub 25. we become in a much more comfortable regime. And, you know, this is a bit different than, say, like, the choice of, say, the consensus layer client. We used to have prism at, like, 70, 75% of the network. And, you know, the social structures came through. You know, the layer zero came through and reallocated that because it was a major, like,

risk to the network. You know, we have all of these, like, incredible client teams. And instead of it being on plus two thirds on one client, now it's, you know, there's still room to fix, but we're, you know, we're like 45. percent, 38%, 20-something percent. So we don't at least have like these critical critical thresholds being hit with the consensular client teams. So point being is like we've seen these social layer zero step up and fix things before. This is a bit more complicated because it has a lot of like financial monetary incentives entangled. And so this like seeing seeing meaningful movement here

probably doesn't just mean like I reallocate my capital to some like protocol that I see benevolent. I reallocate my capital to like another protocol that's very profitable, you know, and a good product. Because Lido is profitable. Lido is a good product. Lido is easy to use. Like there's a reason people like this thing. And so like we need better alternatives. You know, it's not just a simple like I'm going to be altruistic and take like a, I don't know, 10% hit on my APR or something. Like I need to have reasonable alternatives. And so it is exciting to see emergent protocols that are attempting to chip away at this, but we really need good protocols and good products out there so that people can, you know, make what is a good decision

for the different protocol is also, you know, a good financial decision for themselves. And so some of those numbers for bankless listeners that Danny was quoting between 30 and 32, that's the percent of market share of all staked ETH that Lido has right now. So as you can see, pretty close to that one third threshold, one percent away. And kind of hasn't quite gotten over that, dangerously close to that 1%. Of course, every percent up gets you closer to 50 percent as well. I mean, I guess one side comment, and I'm sure we'll get

into this a little bit later about the mitigators, is it strikes me that the difference between client teams and something like Lido is almost the difference between like public sector and private sector. I mean, the client teams didn't really have much of a profit motive, or at least not the same type of profit motive. I very much saw the prisms

of the world and the other client teams is basically like public goods types of products without this large corporate profit motive. But Lido very much has that. Almost in kind of the traditional economy, it operates more like a corporation that's going to eat up as much as possible. And that's certainly one thing Hasu said that I think all listeners should pay attention to is Lido and, you know, Hasu and advocates are not making the case that they should stop at any number. They're not making the case that they should stop at 30 percent or 40 percent or 50 percent. They're actually saying, no, we want to get to like

as high as possible, maybe 70 percent, even. and actually it wouldn't be so bad if we did. So that's kind of what's coming from the other side of this argument, I would say. And I think you're right. The way that client teams are positioned is they can think much more about the health of the network, independent of a profit motive. Like, yes, I think there's a reason that a lot of them do this beyond just they want to build Ethereum, like, you know, whether it be it bolsters up their security business or maybe

they want to get into the staking business. It's kind of like these second order things for why they might be making. a client, whereas Lido is essentially looking for profit. That said, they should be thinking about the second order impacts of what's going on here. In the event that Lido becomes 70% of the network, you know, enables the ability to do malicious reorgs and MEPB, you know, creates a more fragile Ethereum. In my view, they're going to devalue this system. The thing that they rely upon, Ethereum, the thing that they're building upon to reap those profits, they're going to wreck. And in doing so, they're going to destroy themselves.

And in that event, I will say again, like, the nice thing about bringing the crypto-economic asset in protocol with staking rather than extra protocol in mining is that layer zero can coordinate and can fix and patch in the event of disaster. But it's a mess. You don't want to go there. And in such a mess, I don't think I don't like I don't want to go there either if they take a second to think about it. I'm sure they're probably about it. Right. This is the whole kind of tragedy of the Commons moloch trap issue. I think the classic example of like a moloch trap is there's 10 fishermen around a lake and if they all fish at 100% capacity, then they're collectively drained the lake and then no one can fish anything. And so if they all self-cap at 70% of their capacity to fish the lake, then they can all have this lake and fish forever. But then if they all agree to self-cap, well, it increases the incentive for just one fisherman to defect and they get to fish at 100% while everyone. else self-caps. And so my question, Danny, too, is we focus on Lido so much in this conversation and broadly in this conversation just because they are the ones just one percent away from crossing

that big threshold. But to what degree is this a Lido conversation or is this just a natural market forces? Like if we strip out Lido, re-roll the dice of Ethereum and play it forward again, it would just be another LST protocol, right? Like, how special is Lido here versus just fighting Moloch? Yeah. It's hard to say exactly. how things would play out depending on initial conditions. One, like, if, you know, myself and others had the foresight of kind of the impact of some of these things, potentially some of the design of the system might be different, or there would be a lot more awareness around capital allocators from the get-go.

I think capital allocators are learning. I actually was talking to some people that know people on, like, traditional Wall Street, that are, like, very aware of the one-third threshold. I was like, really? And conscious about how they're thinking about capital in relation to it. And so Lido was the first mover. And Lido was very good and very good product that came out the gate. And so when I say, I don't know exactly how this would play out, say if we had five Lido's at the beginning,

I don't know for certain if we'd have this singular entity that was sitting at this one third threshold. I think that they would make a claim that it was the natural outcome. But I believe that there could have been a much more healthy competition distribution at the outset. And so I do think that having this conversation, I do think that being aware of the risks, And I do think that layer zero stepping up and understanding, you know, the risks today and the second order long-tail risk of capital allocation in such a regime would be valuable in any regime, regardless of Lido or maybe it was, you know, Coinbase could easily be the boogeyman here. And I know that Lido says, if we weren't here, Coinbase would be a third of all capital,

and, you know, it'd be much worse. And that's probably true. Lido's good at certain thresholds. Like, these protocols are good. Like, it's important to have many different protocols, many different allocations across jurisdictions, across smart contract risks, such that Ethereum is more resilient, you know? And so, hat off to you. I'm glad he exists, Lido. Just fucking tone it down.

The Hazu argument is that market forces just point towards the inevitable future of one dominant LST. And I kind of agree with that. Like, eventually, in the fullness of time, there will probably just be one LST because this is where market forces point towards. And so my kind of strategy is like, well, eventually there will be one. And so it's about having the graceful path to get there rather than not allowing that future to exist at all. How do you feel about that? Yeah, I think this comes down to layer zero. Like, if we're willing to kind of layer a centralized system on top of a decentralized system and make it as good as we can, then, you know what?

We probably shouldn't have built the beacon chain and we should just have like a consortium where, like, Vitalik and a handful of people picked a bunch of operators, honestly. You know, I think that the Ethereum community has pretty intense values of decentralization. I think that capital allocators can potentially think about tail risks. We think about them a lot. You should think about them too. And that we can have a healthy ecosystem. I also think that there can be much more competition in what LSTs provide, right? Like, WIDO has certain structures on how they handle like entries and exits and the queue

in relation to profitability and whether they rebase or not and what jurisdictions they're involved in and which operators they're using and what other structures they're using and what other strategies they're using. Like there's all sorts of like potential competition points here and potential differentiation points that we just like quite simply haven't seen because we had this mega first mover and we had kind of like a lax response to it in terms of like the competition here. Like two years ago or year and a half ago, you know, I wish some startup minded folks were like, oh, let's compete. And I guess we had some of that and we're seeing them come online, but we just haven't seen enough of it. Danny, but it is your contention that

having Lido at like above 30% is better than having say a centralized exchange above 30% not to pick any one centralized exchange. So that is a better scenario. So let's move the conversation into how we solve this, right? And there are maybe various mechanisms we can use. I know part of your post, maybe part of this episode is an appeal to the layer zero. And certainly we could talk about that a little bit. Maybe there are some in-prudical designs that we could talk about as well. One question I have for you, though, is the selfish profit maximization kind of mechanism that we might be able to use. So if an individual is staking with Lido, what are the risks versus not staking with Lido? My understanding of the protocol is if there are a group of validators that are all staking together,

the risks have increased as a result of that. If all of the validators together go offline, there's kind of a penalty that may be. Maybe you can describe that gets really amplified, that slashing risk. Maybe that's a reason. What are the selfish mechanisms to not stake with any provider that has the bulk of all ETH inside of it? So in general, there's anti-correlation incentives. So, you know, if an entity is slashed and scales with the amount with which they're slashed up to, you know, if one-third is slashed at the same time, they lose 100% of their capital. similarly with offline, the more that is offline at the same time, the more that you stand

to lose during that period, especially in a period of non-finality. And sorry, just to drill into why this is a thing, this is because any group of people that all get slashed all at the same time, it's assumed that they are doing very similar homogenous things that would be considered the opposite of decentralization. That's the mechanism, right? Right. Well, to make a network fault to finalize two conflicting histories, you have to have a minimum of one-third contradict themselves. And so when they contradict themselves by signing, you know,

two different histories, that becomes a slashable offense. And so if one-third does that within the same period of time, the protocol assumes that it was an attempt to create a network fault, to create two conflicting finalized histories, and they're punished to the maximum extent. You know, if one percent of the network does it at the same time, it's not assumed to be an attack. and you're scaled, you know, 1% times 3, you'd lose 3% of capital in doing so. That said, I will point out, the disjoint node operator set does protect against a lot of these disqualation incentives. Like in the event that, you know, one operator does something silly and they're not actually

attacking the network and double signs, you know, you're not necessarily going to lose a ton of capital because it ends up being 1 30th of Lido Capital that would do so. that said, if there's actually a coordinated attack and you're above certain key thresholds and Lido goes mega malicious and so do these operators, that would be potentially like highly slashable. That's due to the like intense nature of the kind of finality incentives, that's probably not like the biggest risk on your capital in being with Lido. I'd say the biggest risk on your capital and being in Lido is one, you're accepting smart contract risk. So you're accepting like this additional layer of coordination risk on top of the Ethereum protocol. Additionally, you're accepting

governance risk, you know, so it's just a handful of entities that could potentially steal rug all of the capital. That said, you can mitigate that with, you know, governance things over time, hopefully. And ultimately, you know, for better for worse, it's second order impacts in the event that you're staking with, you know, you're a major capital allocator and you're going to push the needle of Lido over a third, you're now beginning to devalue the system of Ethereum that you're relying upon. That is the longer term profit maximalization, I guess, angle, right? There's multiple forms of profit maximization. There's like short-term profit maximization, which is like maybe the, you know, the one month to two-year, three-year type timeframe. And then there's like the 10-year profit

maximalization outlook. And I think your argument is that if you have one operator or one entity that controls a large majority of the stake, the value of ETH will simply be lower over a 10-year time horizon because the reason ether is what it is today is because the network has some perceived decentralization and credible neutrality. That is why applications buy block space. And if that, to the extent that erodes, that essentially erodes, that essentially erodes. the value of ETH. So if you are a 10 plus year horizon profit maximizer, then you should care about the systemic risks here and you should essentially, you know, delegate to, or not delegate, but stake with a, you know, solo stake or stake with someone who has lower market share. Would you

also make that case or did I kind of overdo that profit maximization case? No, certainly. And because ultimately like by allocating capital and kind of degrading Ethereum's consensus, we degrade the guarantees of Ethereum. You know, we degrade the credible neutrality. We layer like a governance layer on top that can be captured and increase the chances of, you know, the consensus not doing what it's supposed to do, not doing what it's designed to do.

You know, every crypto-economic consensus, every consensus mechanism classically, too, it breaks at certain key thresholds. Like it loses its guarantees beyond, you know, X, Y, Z happening. And so pushing a consensus beyond its limits means that you can break it. It means that it can be broken.

I want to get into the action steps for how we can actually preserve Ethereum decentralization when it comes to East Stake. Because I know this is a very big Moloch problem, but I want to do more than just like screaming into the wind about, like, hey, let's value decentralization more. There's a bunch of different players here that are relevant. There are individual stakers who choose to use LSTs to stake their ETH. There are Lido competitors here, like Rocket Pool or other LST startups. There's also solo stakers, people who stake at home. and they have their own staking machine. Who's got the biggest role to play here?

And what action steps would you have for each one of these? So solaceakers in terms of the capital being allocated, probably aren't going to move the needle in terms of these key thresholds. But they're incredibly important to the resilience of Ethereum, right? In the event that there's a disaster and, you know, Lido essentially, you know, the community soft forks Lido out or something like that, then who's carrying the network on their backs? Who is still building blocks?

How does the consensus continue to move forward? solo stakers first and foremost. They're like the primary resilience of Ethereum, even if they're a small percentages in the network. Beyond that, capital allocators, like there are people allocating massive amounts of capital towards Ethereum products and other things like that. And I think them being aware of the systemic risks of allocating towards, you know, a protocol like Lido at those key thresholds is very, very important. And it was, again, like I got wind of some more traditional kind of Wall Street folks, like being intimately aware of the one-third threshold. And that's actually like kind of promising.

It's kind of interesting. I wouldn't have expected that. You know, it's innovators building out new products and innovative products and being aggressive, you know, like trying to eat Lido's lunch. Like I've seen very few instances of this, you know, like incentives, direct incentives to leave Lido and do something else. I think Diva is like the only thing, the only protocol that I've seen to do that. I think they launched that like a week and a half ago. I don't know the actual details are not endorsing Diva. I'm just saying someone finally is doing it.

I've been yelling into the wind about that for a while. And ultimately, you know, I think there's a lot of, like, education to do it for the Ethereum community, ethos, etheaters, ethters, et cetera, to, like, understand the risks here, which, you know, it's valuable for me to be on this podcast to talk about so. And for better for worse, we're not done. The Beacon Chain needs to be some work. And there needs to be some pretty deep kind of, like, economic research and other things going on to make proposals to ensure that Ethereum sustainable on not only, like, 5, 10, but 100-year-time horizon.

What sort of things can Ethereum protocol devs do to sort of stop this, right? Because- Yeah, once the devs do something. Well, I can kind of hear the voice of Hasu a little bit, right? And he's basically saying, okay, you guys are being starry-eyed dreamers again, right? Capital will consolidate. There will be network effects around LSTs. You guys can talk about it on the layer zero. Maybe that'll work for a while.

But the values get diffused over time. And will our kids care about this as much as we do, or, you know, this is a multi-generation network that we're trying to create. So ultimately, don't we have to bake our values into the actual protocol design itself in order to enshrine them for multiple generations and not be so reliant on the layer zero to enforce these? Of course, to a certain extent, the layer zero always has to enforce these, but can we offload as? Yeah, as much as we possibly can.

Okay, so how do we do that? Are there any solutions there? I read a recent Vitalik post about, you know, what to enshrine or what not to enshrine, and he put together the tantalizing question of what it would be like to actually enshrine LSTs inside of the protocol. Do you think that's an answer? Tell us what lovers we have on the protocol design side. Right. So certainly could go down the path of figuring out how to enshrine LSTs. Essentially, like, I want to stake, I want it liquid, and I want it defungeable with others. It's kind of a hard economic problem and like how things become entangled there. What do you do if things aren't necessarily profitable over here, but these are profitable and we're attempting to make them

fungible. There are some, like, proto designs there. You know, Donkrod had a post somewhat recently, I think Fatalek linked out to it, about like, you know, just an exploration of what that might look like. Additionally, you know, I think it's very critical that not all ETH becomes staked, because, again, like, the disentanglement of various sets helps the layer zero be resilient. And so, like, in the event that only 30% of ETH is incentivized to be staked and there's 70% of ETH that is not, then even in a regime in which, say, we have some sort of, like, malicious actor that tries to gobble up all of ETH staked and starts to do malicious things. We have checks and balances.

That are incentive compatible, right? And so, like, targeted economic stake rate, I think is very important. There are disparities between staking at home and staking with a large provider because of kind of, like, the chunkiness, the word people like to use, of MEP, you know, essentially a lot of the MEP comes in very few blocks. And so if you're a large provider, you get to kind of like average that out quite a bit, whereas if you're a small provider, you end up being much lower than the average, a smaller staker.

And so like the protocol becoming MEPA aware through things like essentially like you become MV aware and then you either like distribute it evenly or you burn it. So that's kind of the MUV burn protocols. I think those are very important. I think those are very hard. I think that Justin is very optimistic about the designs that exist today. I think there are a handful of people that are still banging their heads against it because they want to see to make sure these are actually incentive compatible in the long run.

And probably just some more fundamental research on what's going on in Lido, what's going on in LSCs, what are the actual incentives here? And I think something that's kind of interesting is, I can't read the exact figure, but I think it's like maybe only 30, maybe 40 percent of Stakedith, the Lido Stakeith token, is actually used in DFI and like essentially redeployed. and used because of liquid, which implies like 60 plus percent is maybe there for another reason. Why are they there? You know, and it's probably much more around like ease of use.

You know, it was like simple. Like you can buy it on a market. You know, it's all like, you know, capturing actually some of those other things and figuring out, you know, if it's actually ease of use, then staking or, you know, joining pools that aren't lighter. Like that only then becomes as easy as possible. that needs to become as simple as possible. And so there's probably some gains to do around making, staking not so scary and making it easier or maybe reducing the 32E threshold and all sorts of other things like that.

So there's a lot of work to do. Yeah, I guess my take on this high-level hearing about this from the solution side is there's really three things that really can be done. And two of these are short to medium term. And then one is the longer term. And the two short-to-medium term are education, right, and awareness and pushing back on the layer zero. part of your message today is basically that.

Real quick. Importantly, the system's imperfect. The system will probably be always imperfect, but the system can be better. And we need to make sure that we have the education now so that we don't enter into irrecoverable and healthy equilibriums that even when we have the better tech, the better research, and the better refinements of the protocol, you know, can't get ourselves back out of. Right. So it's like it's very critical. We have a very strong layers here right now to like hold our values super true.

as we write the ship. Yeah, definitely. I mean, the price of freedom is ever present vigilance, right? And so is the price of decentralization. So we don't get a lot of shots at this, certainly. So the layers here is important. So are competitors, by the way, which this is kind of a general call to competitors to, you know, enter and start building market share and provide better U.S. and try to leapfrog Lido and, you know, others in some way to distribute that. But really, I think the long-term solution here, Danny, at least to me, has to come to some kind of protocol level design, right? Because it seems like the forces that you're resisting are the same forces that the public sector has had to resist in other forms of human coordination, right? So anti-monopoly

laws when the corporations start to take over and, you know, push back against the government. So we have antitrust types of legislations. And sometimes, you know, the government has to come and break up companies and that sort of thing. They've had to intervene with the private markets and do something, essentially. Like, can the devs do something? Like, can the public sector do something? And the extent that we're able to embed this in our social protocols, like our legal system, we're able to kind of push back against this cartelization and this kind of mollock trap. So it seems to me that's got to be the long-term solution, that we do something to tweak the protocol, and I'm not sure exactly what that is. But is that your inclination to? Is that what

you ultimately think? Or do you think it's just too thorny a problem to actually solve in the protocol? LSTs in the protocol, does that solve it? You know, can we just do that? I'm not 100% sure. I don't have the answer. I know that there are answers and I know we must get there. And that's going to be like a huge component of the conversation of the design landscape over the next couple of years. I will say that, you know, there's going to be the combination of attempting to make the incentives of staking such that they do not converge towards a single LST. And there's also the design direction of ensuring that all of ETH does not become staked ETH, such that if it is inevitable, that a single entity takes all of staked eath, that there's still an immune system. You know, there's still,

if 70% of ETH is not staked Eth, then we now have 70% of capital that is against the staked capital doing malicious things, right? And so like that still relies on layer zero, but ensures that there's more incentive compatibility across that layer zero rather than just ideology. And so it's a combination of many of these things that I think have to come to fruition. There's a couple of perspectives I want to bring to the table brought to me by Hazu. He threw a number of of questions at me, and I'll read out two of them. One of them is, when the institutions come, where do you think that money is going to go? Not where you hope it will go, but realistically, where do you think it will go? And another question is, would you admit that Lido has decentralized

the network so far? You can choose to respond to either one of those, but I kind of think the gist is, and the gist I've gotten from Lido is, like, hey, we're the lesser of two evils. Like, it could have been worse. It could have been Binance. It could have been Coinbase. And they're also saying, and also, guys, we're improving. And we're, yeah. And we're, yeah. Respond to the vibe. Great.

I said earlier in the podcast, it's a good thing that Lido exists. It's a good thing that there's competition between Lido, centralized exchanges, you know, and other things. And Lido under certain thresholds is a boon to the network. That's a good thing. Like, it is a very good product. It's proven itself to be well developed, pretty secure. You know, I don't like the governance of it. I don't like token distribution on top of it.

But in certain healthy doses, certain doses is healthy. So where does capital are going to go from institutional capital? We shall see. Some of it's going to go to Coinbase. Some is going to go to consortium LST. Some of it's going to go to LITO. Some of it's going to go to institutions attempting to start their own, like, sort of like staking ETF or whatever.

And you know what? There's going to be a proliferation of many of these things. And it's best to have a proliferation of many of these things. Ideally, it's not all coming from the U.S. too, right? Like when people say institution, they're like, you know, you're essentially thinking about, like, trad-fi Wall Street. But, you know, hopefully this is multi-jurisdictional capital because this is a multi-jurisdictional, you know, machine that is very valuable for the entire world. So I'm sure, I know, I know like the honest answer is supposed to be, well, it's going to go to like

Coinbase and they'll manage the capital and then all of a sudden we have like another threat on our hands. But I don't think it's so obvious that it's just going to go all into one place. And if there are new vehicles that are well run and have different risk profiles from Lido and take some of that share, even if some of them are centralized players. Everything in its own orb is centralized to some extent. That's a good thing. So we shall see. And if we have another boogeyman in a few years that we have to talk about and fight, so be it.

Danny, you're a pretty calm, collected guy. I'd say I'm pretty sure you do yoga, so I don't really see you getting stressed. But if you had to illustrate the magnitude of the alarm bells or the color of the siren or just how severe we should be really connected. considering this problem to be, can you eliminate that subject? Yeah, what's the threat level? So layer zero is very strong today. And we can rely on layer zero for a lot of things today.

If layer zero lets us succeed one third today, it's pretty fucking disappointing. If it exceeds 50%, we failed. So we're at maybe yellow? You know, there's red, orange, yellow, blue, and green, right? I'm not feeling green from this conversation. I'm not feeling blue from this conversation. I'm feeling yellow and you're maybe saying... And we're right next door to orange.

No, we're orange. We're orange. Oh, uh-oh. Any Ryan says, but again, yeah, like, if red is, like, I feel like red is, is red an alert or like, it's a disaster? Red is like...

Like, red's like the earth blew up or something. We are under attack, right? Yeah, we're under attack. We need to everyone all hands on deck moment. Yeah. Yeah, I don't know. I mean, it's hard. Depends on how you frame attacks.

Sure. I know that some, like to say that it is an attack. Attacks don't come in all of the forms that we always think of them. Economic attacks are like probably the most real attacks in crypto. So maybe it is. Danny, I can guarantee there are going to be a lot of folks who are designers of the Lido Protocol and participants in their community who listen in this podcast.

I think many of them listened to our episode with Hasu as well. What would you say to them? What would you like to see Lido do? How can they fix this? Self-limiting while we're in this interim of trying to better understand and make sure that the protocol is safe on many-decade time horizon is probably a good thing. I do think that the talek had a very interesting, kind of offhand. proposal like a year ago. That's like maybe it should be a social norm that fees on this type of

protocol just go up until they're absurd as you approach key thresholds like one-third so they become naturally kind of rate-limiting or fucking super profitable because they're that good, I guess. So both of those I think are really interesting design directions. I do think that being Ethereum aligned while Ethereum is carry valuable, very important, becoming the backbone of many good things, but is also still has work to do. I think being aligned is making sure that, you know, your protocols stay in key thresholds under key thresholds. And so I think that's kind of the big thing. Other than that, like to the designers of the lighter protocol, like, you'll do a good job. You all have a good product, like respect. What's in it for them, Danny, to do this, to become better

Ethereum aligned. Is there a carrot? Is there a stick? Yeah, I mean, the carrot is, you know, Ethereum becoming the backbone of like global coordination and finance. And you're not wrecking it between now and then? How about the stick? The stick is, you know, you destroy the credible neutrality of Ethereum and you're going to destroy your product. As we end this, Danny, one question I have for you is we kind of zoom out and look at this system, this beautiful thing called Ethereum that we've created.

And, you know, congrats on having such a vital part of doing this. I know it's not you. And you'll be first to kind of deflect some of this gratitude to all of the other core dev team. So thank them as well on our behalf. we've really created a fantastic computer here, piece of human coordination. It's very exciting to see, and we're all obviously vested in seeing that experiment play out

and be as incredible as it could be. Do you actually see any virtues that this centralization vector is coming to light now? One thing I've always observed in Ethereum is we don't fix things until we actually identify the problem. And then once we see the problem, whether it's like our damn gas fees are too high, we've got to like go fix that.

then it takes some time, but Ethereum kind of steers the ship and goes and fixes it. I'm wondering if this is kind of a silver lining here. This problem is becoming more well-known. And once it does get well-known, well, eth researchers, protocol designers, everybody who's focused on making Ethereum better is going to turn their gaze on it and for it to become the next, you know,

Moloch-slaying event that we have. So is that a silver lining here? Are you seeing some of that? I think so. I think so. Like, if you talk to the robust incentives group, rig, like, this is priority number one. This is what they're thinking about. This is what they're researching.

This is what they want to be working on design from now until it's fixed. And that's very valuable. It's very important. And I was actually talking to kind of like a macro finance econ guy who spends a lot of time looking at Ethereum the other day. And he's like, you know what? It's probably good that Lido came and did this now. And it's like, you know, I have issues with what we might call Ethereum alignment

with respect to Lido, but they're competent. They understand Ethereum, and they're not, they don't do, like, outwardly malicious things against, except for this thing that I claim in terms of key thresholds. But he's like, you know, if it's not them, it's going to be some trad-fi ETF thing that's going to attempt to gobble up all of this stuff. And so the fact that we get to address this problem today

and with respect to something a bit more crypto-native is probably better than if we had to address this problem, only when we realized it when, you know, TradFi showed up. Danny, if we need to continue this conversation, who do you think we should talk to? What would we talk about? There's definitely a bunch of emergent LSD protocols that it's probably worth giving some visibility to.

You know, what's the difference? What are they doing? Why are they doing it? So I don't necessarily need to make a bunch of ad spots for them, but I think there's probably like legitimate technical, interesting conversations to have with some of them. Barnaby's a beast. Barnaby, if anybody on his team,

they are thinking deeply, deeply about these problems. you know, ethconomics coming up at DevConnect. I think there's going to be a lot of like really cool, a really interesting conversation and research around this. And so like capturing some of that, you know, I'm talking much more about these kind of high level things, how the pieces fit together, how, you know, the risks play out. But they're getting deep, deep on the details of understanding the economics and the potential design paths here. So Barnabay, anybody at the rig team, I think would be quite good. And I think there's going to have quite a canon of research and literature to talk about between now and the end of the year.

The bitcoins will say we should have stuck with proof of work, Danny. What do you think of that? Any truth to that? No. For one, you know, I think the energy consumption, as we kind of like modernize the world, hopefully it becomes unconscionable. Like it's just not how we should be designing protocols. Additionally, like proof of work has incentive issues with respect to pooling and other things.

You know, Docker claims, if you let it play out enough in an MEV environment, people are going to tokenize mining hardware. Oh, wow. You know, with traditional contracts and things like that. And, you know, if you look at mining distributions and mining pools, they don't look good, right? There's a little bit of, like, more liquidity in terms of capital allocation, like, I can switch pools. But the incentives definitely exist, especially in, like, these high-em-been environments

to pool and to create structures that are maybe akin to LFCs. You know, when you don't have a fee, when you don't have, like, appreciable fee regime, like, in Bitcoin in most contexts, I think they have, like, BRC-20 or something. now, then, like, a lot of these problems just don't show up, right? Like, Ethereum is awesome because it's actually used. And so we actually see emergent problems very quickly. In my piece, I wrote, you know, like, these may seem like tail risks that are hard to take seriously, you know, might never happen. But, like, Ethereum is like, you see the tail risk play out all the fucking time. Like, you see, like, you think you understand the world, and then, like, it blows up

because people actually use the system. And so, like, I don't think it has an incredible amount to do with, staking versus mining in terms of the particular problems of each are going to be different, but there are going to be distinct problems that emerge in either regime if you have a very utilized and desirable system like we do. Well, Danny, thank you for engaging in the conversation today. This has been supremely useful. We appreciate you. Oh, thanks for having me. It's a lot of fun. Take care. Action items for you, Bankless Nation. You've got to hear the other side of this argument. If you want to go do that, we have an episode called In Defense of Lido with the guest, Hasu, who takes the opposite perspective of Danny Ryan, our guest today.

So you can hear both sides of that argument. And of course, we'll be following up on this episode with more episodes like it in the weeks and months to come. But now, Dave and I are off. We're actually going to record our debrief episode. And that's where we unpack the conversation we just had with Danny. If you're bankless citizen, you already have access to that in the bankless premium podcast feed. That is ad-free and it includes bonus episodes like the debrief.

If you're not a citizen, you can become one. There's a link in the show notes to unlock. that. Got to end with this. Crypto is risky. You could lose what you put in, but we are headed west. This is the frontier. It's not for everyone, but we're glad you're with us on the bankless journey. Thanks a lot.