Unchained - Post-Merge, If Lido Becomes Dominant, What Does That Mean for Ethereum? - Ep. 372

Starting point is 00:00:00 Hi, everyone. Welcome to Unchained, your no-hype resource for all things crypto. I'm your host, Laura Shin, author of The Cryptopians. I started covering crypto seven years ago, and as a senior editor at Forbes was the first Main Tree Meteor Porter to cover cryptocurrency full-time. This is the July 12th, 2022 episode of Unchained. Oasis Network is one of the fastest growing layer-one blockchains designed to support privacy, speed, and scalability in web. Learn more and join the community at oasis protocol.org. Partners the full power of the Avalanche network with Core, your new Web3 command center. Built by Aval Labs, Core is more than just a wallet. It's a non-custodial browser extension, engineered for users to seamlessly and securely experience Web3 like never before. Explore Avalanche DAPs, NFTs, bridges, subnets, and more today.

Starting point is 00:00:57 With the crypto.com app, you can buy, earn, and spend crypto in one place. Download and get $25 with the code Laura, link in the description. Today's topic is the dominance of Lido. Here to discuss are Ryan Bergman's, Ethereum investor and community member, and Alex Bergeron, Bitcoin investor. Welcome, Ryan and Alex. Thanks for having me, Laura. Hi, Laura. Thanks for having us. Last week, I did a show, which was the first in a two-part series on Staked Eth or Steeth and Lido. And since there are actually a couple of big issues regarding Lido and liquid-staking derivatives, I felt that this should be broken into two different shows. Last week's show, the one with Hasu and Turun Chitra, focused more on Steath itself and the role it has played in recent crises in crypto involving Celsius and 3-0 capital.

Starting point is 00:01:50 This week, we'll look more at the first. role that Lido and liquid staking derivatives could have on Ethereum itself. One last note is that for various reasons, we're recording this almost two weeks before this episode runs. So if there's any recent news development that we are, for whatever reason, not mentioning, that is why. All right. So, Ryan, let's start with you.

Starting point is 00:02:12 Just so we can get all the listeners up to speed, make sure everyone has a basic understanding. Can you explain what Staked Eiff is and what Lido is and why they've become popular? Perfect. So staked ether is the idea that now that Ethereum is switching to proof of stake, everyone wants to get out on the staking game. You take your ether, you lock it up in the ETH2 beacon chain deposit contract, and then the network pays you rewards to participate in the validating of the chain. However, when you lock up your ether, it then becomes immobile, unproductive, inaccessible. And so Lido's staked ether token is a liquid staking derivative that aims to let you eat your cake and have it too, where you can participate in the staking process while retaining a fungible, tokenized representation of your staped ether that you're then free to use in defy for any number of wonderful things, especially borrowing against it and earning yield on it.

Starting point is 00:03:12 Interestingly, Lido accounts for about 32% of all staked ether at the moment and amongst the liquid staking derivative providers, it actually accounts for 90% of that. So it's quite dominant. If we look at even some of the other more centralized entities that offer staking, for instance, Kraken is the next highest in there at 8.5%, which is, you know, quite a bit lower than that 32%. And what also separates Lido apart is that it's non-custodial and therefore more decentralized than something like a Cracken or a Binance. So in general, you know, you gave some examples of how people can use their staked EVE or what it is that they can do with that. And so why is it that you think that this has really taken off? And Alex, you can also weigh in on this.

Starting point is 00:04:05 I think two main aspects are at play here. Obviously, Lido was the first one to lunch. And, Ryan, correct me if I'm wrong, but I believe LIDO was the first one to launch a steak-to-eat implementation at full scale. And this sort of first-runner advantage has allowed them to grasp quite a bit of momentum from the get-go. They have a very competent team. They've managed to roll out a whole bunch of defy integration, which is allowed them to gain a hedge in the ecosystem versus some of their other competitors. But the main aspect driving all of this is the incentive for network effect within the state E-Therium stake derivative model, whereas it benefits all of the users of a staking derivative to have as much liquidity as possible. And so you're seeing this right now at play, interestingly,

Starting point is 00:05:05 in the curve ST-E-2-E-Pool where there's been a bit of some call. it a DPEG and people will argue whether or not it should be a peg or not, but you're seeing a little bit of liquidity imbalance between ETH and Stake Thief in this pool. And the reason why it benefits people to all converge into a single staking derivative interface or implementation is to bolster that liquidity and try to correct those imbalance and try to allow for a solution that enables people to get in and out of that system as they please. Because we all know that although it is possible for people to get out of their stake feet position via the curve pool, they would have to wait up until the merge and some more

Starting point is 00:05:58 time for the actual stake either to be able to be withdrawn from Lido. And I think those two aspects have made it so that Lido has really shown itself to be probably the most credible implementation, and certainly their association with a lot of very influential funds and venture capital firms has certainly bolstered their case in that regard as well. I think Alex is absolutely right. Lido had a first mover advantage that because of their strength and their timing combined with the relative lack of strength and late timing from the most credible competitors has created a situation where the expected high degree of natural network effects in any liquid staking derivative system have really flowered in Lido's case.

Starting point is 00:06:54 And they're in a situation where they not only have a first mover advantage, but in an arena that has just extraordinarily winner take-all kind of rich get richer effects. I think that an oligopoly model where there are, say, four, five, or six good staking derivatives that each have a good slice of market share is probably the most diverse free market we can hope for in the liquid staking derivative industry. However, because of Lido's early traction, that oligopoly is something that we're really going to have to struggle to work towards because they have such an early lead to Alex's point. Alex mentioned the investors.

Starting point is 00:07:37 There are a lot of super credible names on here. Andriesen Horowitz, Paradigm, Alameda. However, there's also another one, Three Arrow's Capital, which, you know, obviously recent events have kind of shown that their approach to all this. Maybe wasn't one where they were managing for a risk. But anyway, what I did want to also address here is that, you know, it seems like you guys are implying.

Starting point is 00:08:01 And from what I've read it, I would guess the same thing, that over time, this hugely that staked ether and Lido have already will basically grow. I mean, it just feels like over time as after the merge happens and we really have staking as like a real part of the Ethereum ecosystem that we'll just have more and more people who will not only want to stake, but then also get some liquidity from the ether that they've staked. And it almost feels like you can't really think of too many reasons why someone wouldn't do that. And so if you were to make a projection, how much of ether staked in Ethereum would you imagine eventually gets turned into some kind of liquid staking derivative? And with Lido at 90%

Starting point is 00:08:53 market share, do you think that it would kind of continue to be that dominant in that space? I'd say so in other chains with mature staking economies such as Solana, we see something like, I think, two-thirds total supply staked. I think there's every reason to believe that Ethereum's total staked ether could meet or exceed that, especially given the additional real yield from our substantial transaction fees. And so as the amount of staked ether grows and the incentive to tokenize that staked ether will grow alongside of it as the liquid stake. derivatives become more trusted, more useful, more well integrated into all manner of products. I think we're going to see, you know, to the point of the seminal article written by Hasu,

Starting point is 00:09:41 Alito Advisor, as you know, and Georgios last year, you know, they had predicted that an overwhelming supermajority of staked ether would become staked with liquid staking derivatives. And that's a view with which I substantially agree. I was, I just wanted to chip in on this because I, I mean, it's funny you talk about this article because it actually most likely is what tipped me into this whole sort of dynamic initially. And people might wonder why you're having me on this podcast and why this Bitcoin guy might know a bit or two about this entire thing.

Starting point is 00:10:18 And so if you go on my Twitter account and you'll notice, back in July of 2021, I posted a thread about this entire dynamic. And I laid it out in a way, in a very public way, in a bit of a bombastic and some might call trollish way. But I feel like I was one of the very first people to air out sort of a bit of this dirty laundry that I think was familiar to more intimate, you know, engineers or protocol workers in the Ethereum community. But I can only imagine was not well known by many Ethereum people because if you go look at that tweet, I think, I think I've had over two million impressions on that tweet to this day. It was extremely popular. And one of the thing that's very important to point out, and one of the main concern about Lido's ability to gain further and further share is that post-merge, when the staking yield

Starting point is 00:11:17 become probably, you know, the common denominator in terms of having, in terms of a user choosing where to allocate its stake, post-merge is when. some of the most interesting aspects of MEV come into play. And MEV is a whole other topic. I'm sure probably you've had people talk about NVV on your show. But something that's very important to know and to understand is that when a staking implementation and staking validator has access to such a large share of staking on Ethereum, they are able to gain an outside,

Starting point is 00:11:57 outsized share of the MEV opportunity compared to smaller ones. And that is just because of variance, but also of specialization. MEV is sort of, I recently sort of compared it to a digital equivalent of mining specialization in terms of chip efficiency, in terms of operational efficiency, where validators like miners are able to allocate resources to NME, in a way that enables them to, you know, develop new, new sort of NMEV scheme and new ways to exploit that. And all of these things are, I mean, the gameplay for MV is just opens up to a whole new world when the merge comes around. And Lido's ability to, you know, bolster their resources

Starting point is 00:12:52 and target, you know, they have quite a bit of a tight-knit, I feel, with flashbots. Obviously, their investors, some of them are very well acquainted, I think, with MV. And so it gives them that much more of an advantage in terms of using that MV to convert it into higher staking yield, which will allow them to attract even more users compared to an alternative solution. I substantially agree with that. There is a very important initiative within the Ethereum community to standardize what we call a proposer builder separation, where the folks who run the large computers with fancy algorithms to discover the MEV opportunities will become a niche cottage industry, and they will bid in real time in an open marketplace to win the right to

Starting point is 00:13:52 capture the MEV in any validator's block. be that a Lido validator in a large Lido cartel or in an individual homestaker. And so on the one hand, we're hopeful that Proposer Builder separation will level the playing field and reduce some of those economies of scale around potential cartel type activity from, for example, the Lido validator set. However, to Alex's point, there are certain kinds of MEP which are only possible when you control multiple side-by-side blocks in the validator. Pardon me, as we're building the blockchain,

Starting point is 00:14:31 we have these proof-of-stakes slots that represents each next block being built, and there are some kinds of MEV which are unlocked when you know the person you're buying the MEV opportunity from controls both of those adjacent slots. So you can do what's called kind of cross-slaught or cross-eblock or cross-epic MEV. And so I think Alex is right that the large size of the Lido node operator set does pose the potential for greater, greater returns, like truly greater economies of scale in the size of those node operators, especially if they

Starting point is 00:15:09 lean into some of those cross-slot M-EV opportunities. Yeah, so essentially the point here is that because LIDO already has this first mover advantage, but then on top of that, that has led it to have these network effects that give it kind of prime partnerships, especially in the area of things like MEP research amongst other thing. This is not the only advantage, but that will then attract more users to it because the users will want to be part of a pool that has that MEP advantage because it's just going to make it a better opportunity for them. But amongst, there's many reasons actually why Lido has become dominant. And I just wanted to ask if you had any opinion on why it is that some of the other competitors who are sort of similar,

Starting point is 00:16:01 some of these decentralized liquid staking derivatives providers such as Rocket Pool or Staker STKR, do you think any of those could ever come close to its market share or at least begin to compete in any real way? Or do you feel like this competition's essentially over? I'm not nihilistic about the landscape. I don't think the competition is over. I do think that Lido has now established a lead that is going to take years to a road if we are successful. And so if we look at someone like Rocket Pool to zoom in on them,

Starting point is 00:16:34 today, Rocket Pool has at least two kind of headwinds that may prevent them from competing as effectively with Lido as all of us would like. Actually, three different headwinds. So the first is that Lido, to Alex's point, has superior DFI integrations. more defy integrations, all of the things equal, that's going to drive more yield, more trust, more confidence, more of that gravity well effect around the derivative. That's the first headwin.

Starting point is 00:17:02 The next headwin is that rocket pool sort of straight up charges a slightly higher fee than Lido, which is something I'd like to see them revisit. You know, the fee represents just yield that's not in the pocket of the end users. And I think in a hyper competitive landscape where Lido already has, an edge, I think, I think, you know, charging lower fees is something that every competitor should consider. And the third headwind is that rocket pool is actually a multi-sided market. So technically every liquid staking derivative is a multi-sided market because Lido has to recruit and support and vet and maintain relationships with node operators. These are professional operations that run these computers and custody, the validator keys, which is sort of their most important

Starting point is 00:17:49 job so they don't get slashed and extorted. Whereas Rocket Pool relies on a grassroots, you know, a growing grassroots and hopefully someday professional community of node operators that run sort of half the state ether. So in Lido, you have professional node operators and a marketplace of derivative customers. In Rocket Pool, you have a much more decentralized group of node operators who run the validators. And then the other half is the staking derivative customers. And while that offers the possibility or even the realization of greater decentralization in Rocket Pool versus Lido, in practice, the challenge they're happening is they're having trouble growing the side of the market of people who want to run Rocket Pool nodes. One of the reasons

Starting point is 00:18:37 for that is that if you run a Rocket Pool node, you're actually required to be long the RPL token. So it's not enough that you can just stake Ether and say, hey, I want to be a, I love Ethereum. I'm mistake ether, I'm going to stake on Rocket Pool. You also additionally have to love the RPL token. And I think that's created some friction for them. And so, you know, to kind of zoom out from Rocket Pool, there's a laundry list of important business line items as to why Rocket Pool is not directly competitive with Lido today. And I think if we look at some of the other competitors, we would find similar line items around community endorsement, decentralization, defy integrations. And what's happen is Lido's just sort of run the table on these line items. They've executed at such a

Starting point is 00:19:22 high level and masterfully and with such a strong team and great relationships that it's not simply the winner takes all network effects of the liquid staking derivative that's caused Lido's success. It's also that the other competitors just unfortunately have not done as good a job as Lido. And that sort of give and take has created the landscape we see today. Yeah, it's important to point out also that Lido is sort of. far ahead that they are actually able to look forward. And by that I mean that they are already actively working towards implementing their staking derivative solution on other chain. And that becomes very interesting because it's another aspect that allows them to compound their lead

Starting point is 00:20:09 by allowing in the future cross-chain MV opportunities for validators that are able to gain majority stakes or not even majority stakes, but significant enough stake across different, whether it's Solana or I'm not sure cosmos is one, I don't think, so they have a different model, right? But in any way, this lead that they've built allows them to further capital into development and pushing new initiatives that is very unlikely for me that another competitor would come around. I think, like Ryan said, if it is the case,

Starting point is 00:20:51 it'll take a couple of years. But ultimately for me, regardless of who's the winner in this staking derivative game, I tend to be of the opinion that it is a sort of natural monopoly because of the incentive of staking derivatives,

Starting point is 00:21:08 because of the MV opportunity and the way that, although there is a somewhat elegant solution that Ryan highlighted the proposer builder separation. But the concern is, and it's a concern that's been shared with Asu and some of the folks at FlashButs is there's a very real sort of dystopian alternative reality there. To me, very likely reality were the leading staking validator, whether it's Lytle or someone else that comes around in the future will simply choose to do away with that protocol and virtually

Starting point is 00:21:50 integrate the whole supply chain of MV. And because they have such a large advantage in terms of the stake and the resources, they're able to build, they're able to effectively build their own blocks and have the capacity to, you know, just relate them to their own, to themselves, basically. So you have a scenario where there's effectively a single block builder in Ethereum. And obviously you can imagine the challenges that this implies in terms of censorship resistance in terms of even just user experience for people that are participating in DFI and stuff like that. Well, but wait, I have a question because since they have different node operators, in that? Is that really the case? Or are you saying that, like, since they're kind of unified by the

Starting point is 00:22:45 LDO token, that that's how they become one entity? I thought that the node operators, it's like 21 right now or something. And that it's so they're, they're kind of separate entities and they're like geographically and jurisdictionally diverse. And, you know, for instance, they use different software clients. And so is, but is it that you're saying there's sort of like one entity because they're all unified by this token? I would say so at the moment. And I think it's an important point that you bring up. They are effectively a single entity at the moment because it is a permission system

Starting point is 00:23:21 for someone to be able to become a validator in LIDO. And so the LDO token owners have the ability to decide who gets to validate blocks on the LIDO staking implementation. And so it's a wide line. list from one day to another, an operator can be booted off the list, another can be added. But because it works in such a permissioned way, right? At the moment, you expect everyone to be aligned and, you know, it's a one-party sort of rule where there's not too much, I don't expect there to be too much divergence in terms of what rules are going to be broken or, you know,

Starting point is 00:24:05 There's going to be a lot of interesting crossroads that are coming up for LIDO in terms of to what extent they want to exploit MEV. There's a lot of very perverse MEP tactics out there. How much do they want to front run users? And it's a very difficult problem because the incentive financially is to exploit the MEP opportunity to its maximum because if someone, if you don't do it yourself, someone else is going to do it. And you're already, unfortunately, seeing this. I mean, you already sort of see the incentive play out,

Starting point is 00:24:39 the financial incentive play out in the recent vote that was proposed where I think Ryan was a major advocate for Lido to sort of, at least temporarily sort of self-limit their growth, to allow other players to catch up and make it this oligopoly that he refers to earlier. And it turns out that the Lido-DEO vote, was overwhelmingly in favor of continuing the pace of growth as it is and not self-limit. Perhaps the proposal was not adequate or was not something that the Lytle token holders would consider. Maybe there's something else that's going to come up.

Starting point is 00:25:23 But yeah, it really is a tough sort of push-and-pull game between financial incentives and sort of more altruistic motive of, you know, trying to do good for the Ethereum community. I substantially agree with that. And to add some color there, I think it's mostly correct to suggest that the Lido Dow and their node operators are typically likely to act as a single unit politically, operationally, sort of against or in concert with the Ethereum community, just to expand on some of the incentives there, just sort of a grab bag of some of the internal incentives. The Lido-Dou is famously closely held. I saw a stat recently that I think the top 100 LDO holders control like 94% of the token, just as one of the stats there. That's a startling stat.

Starting point is 00:26:21 another incentive that I think is very much at play is that because today we're at something, I think, what are we at about 15% total supply stakes plus or minus, a couple percent. We reasonably expect this to grow to 70%, 80% in the coming years. This is about to hit a hockey stick after the merge once withdrawals are enabled, once proof of stake, shows itself to have reduced risk. And this means that Lido's ability to cut off new or existing operators from the promise of the future hypergrowth, the hypergrowth that everybody expects is a very significant carrot and stick situation. Because as well as the operators have done so far, you know, it's really only, you know, one fifth of the business that's to come, if not more, if their share share of total steak beef grows. And so that is a significant powerful force that the Dow has over node operators.

Starting point is 00:27:24 But there's also sort of a force that pushes back on that, which is that today it's not possible for the holder of a staking withdrawal key to force the exit of a validator. And to my knowledge, although that's something the community is interested to explore, so if you, if you're in a non-custodial staking solution, I have my withdrawal keys. that's my property, and then I pay an operator to run my validators for me, I can't force them to offboard my validators by signing something with my withdrawal keys. I have to sort of trust them to offboard my validators when I ask, or in certain situations, they can actually provide pre-signed validator exit transactions so that I can hold these signed transactions in my custody, and if I'm sort of done with them, I can broadcast them myself and exit the validators myself. Now, I'm not sure if Lido has a practice today of requiring their node operators to provide

Starting point is 00:28:19 pre-signed exit transactions that would somehow be held in custody by the Dow, how that would work is kind of a TBD. But today, to my knowledge, Lido Dow relies on the node operators to exit the validators upon request as well, even if they could kick off, even if they did retain those transactions to offboard the validators. There's still going to be an offboarding period where the validators are in the exit queue, which could range from sort of hours to weeks depending on congestion. And during that time, a malicious note operator that was interested to kind of go nuclear or even defect could actually cause their validators to become slashed. They could potentially sell those slashing rights to North Korea to get a side channel payout. So there are a

Starting point is 00:29:10 attack vectors here for a node operator that was fed up with Lido and wanted to defect. And so I think in terms of the internal power balance between Lido and their node operators, on the one hand, node operators want to behave because they want future growth. They want to participate in this giant upswing of staking activity. On the other hand, the existing node operators do have some degree of power over Lido because Lido cannot force them out of the system today. So that all being said, I substantially agree with Alex that they operate as mostly a single political and operational entity. And when that entity has 21 node operators and 94% of the token held by the top 100 wallets,

Starting point is 00:29:55 I think that starts to look like sort of the opposite outcome that we were hoping to achieve when we spent years investing in client diversity and true decentralization. Yeah. So in a moment we're going to talk about how, this might worsen after the merge and after just in the post-merge environment. But first a quick word from the sponsors who make this show possible. OASIS aims to offer improved privacy and scalability compared to other existing blockchains. They feature 99% lower gas fees versus Ethereum, high throughput, instant finality, and defense against MEV, making it ideal for decentralized applications. OASIS invites prominent Web3 developers to apply for its grants,

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Starting point is 00:32:21 all feel that Lido's dominance will only increase over time. One other factor that I just wanted to raise, because I saw Shoresatz article about this. And some people in the Ethereum community did not like the source of this, but I still think that this is a good point. after the merge, I guess, the protocol will only allow four new validators to be activated per epic, which is every 6.4 minutes. And because there's going to be a lot more ETH available to be staked post-merge, people are expecting that there will probably be a long waiting list or like a long queue for new stakers to become validators, which would therefore give Lido more of an advantage because, again, they're going to have a larger set of active validators that will

Starting point is 00:33:07 attract more users who will want to, you know, try to get in on on that. So, you know, that's just like an additional factor that might worsen all this and accelerate it. So let's talk a little bit about this part about the LDO token. Given that the ownership is quite centralized, do you feel that there are kind of ways to mitigate that? Do you see that there any proposals to decentralize that further, or do you think really the ways to go right now are more about just minimizing the market share that Lido has? What do you think are some of the potential solutions here? There's a new proposal on the table for a novel governance mechanism. I think they're calling it dual governance, and that's where they hope to give the holders of the

Starting point is 00:33:57 actual Steeth tokens, the yield-bearing liquid staking derivative, the right to veto a certain governance proposals, maybe all governance proposals, pardon me. I think that's a fantastic novel governance mechanism. In a way, Lido's efforts to decentralize itself is interesting because on the one hand, they're doing a legitimate great job at attempting to grow their decentralization. It's a terrific team. They got a great mission. On the other hand, the more work they can do to convince the community that their monopoly is benevolent, benign, the more likely that monopoly becomes entrenched and we lose out on the opportunity for an oligopoly because it is path dependent.

Starting point is 00:34:42 It matter, you know, where we end up is a function of how we get there. And so, yeah, I think this dual governance proposal is quite novel, but to me it doesn't, you know, it doesn't give them a pass on the concept of becoming a super majority monopoly. And can you just describe the dual governance proposal a little bit more for people who are unfamiliar with it? Absolutely. So in traditional on-chain governance, you have sort of one token, one vote, people can propose governance proposals through the system. The governance proposals are actually executable programs that modify the system. So you'll propose a proposal that says, here's the English description of what this does and here's the program associated with it. And often a community of experts will check that. And in the Lido system, you have this ultra-concentrated governance where it's really a relatively centralized group of insiders that have the ability to kind of rock the vote on any given

Starting point is 00:35:36 proposal. And Lido acknowledges this. And they're working to grow towards greater decentralization. And to achieve that goal, they propose this novel mechanism where although one LDO token will still give them one vote, they're proposing that the Steath token holders who are kind of the the users, the end users of this product will get a veto. So the analogy here would be, you know, if there's a McDonald's shareholder meeting and they're voting on something, you know, one share of McDonald's is one vote. Well, what if everyone who spent money at McDonald's in the last

Starting point is 00:36:13 year had the ability to veto those shareholder resolutions, you know, pro rata with the amount of money they spent at McDonald's in the last year? That's sort of the dual governance idea that the users get veto power. And so we'll have to see how it works out in practice, but I'm certainly encouraged that it's something they're looking at. Alex, do you have an opinion on this dual governance proposal? I do. And I think it's a little ironic to call it, and no offense, Ryan, but I think it's a little ironic to call it novel, because ultimately for me, I found it to be very redundant in the sense that it effectively just turns Ethereum into a deep-a-dispost system, they would distribute a proof of stake system.

Starting point is 00:36:56 Because when you think about what is the LIDO token there to achieve, well, one of the main thing, really probably the main thing that it achieves is it decides on the list of validators that are to be part of the LIDO protocol, right? And so if you effectively give the stakers the ability to decide who the validators are and who should be assigned stake by their ability to, to veto the LDO token holders who were the ones originally responsible for achieving this, then from my point of view, yes, you've effectively devolved into distributed proof of stake, which is perhaps workable, but certainly I think far removed from, I think, the promises of

Starting point is 00:37:46 Ethereum's proof of stake implementation. In terms of the LIDO token itself, there is another proposal that exists that's been brought forth by LIDO itself, actually. It's not a concrete proposal, actually. It was mentioned on a, they published a roadmap to decentralization where they outline a few steps that they want to achieve to, you know, further disintegrate the ownership of the Lido token with the ability to make changes to the protocol. The end goal, really, for them is to effectively bake. into the LITO protocol a sort of layered protocol on top that allows validators to be selected

Starting point is 00:38:33 almost on a programmatic basis. It is a bit of a reputation system where there's some liveliness properties that are evaluated, whether it's the ability for the validator to remain online and so on and so forth. And so they are trying to do. design a system where they are hoping to remove the responsibility from LDO token holders to have access to write and edit the validator list. I think it's an interesting proposal, but to me it's, again, a debate of incentive because if you remove from the Lido token holders, the ability to, decide on the governance effectively of the LIDO protocol and its validator list and so on and so forth.

Starting point is 00:39:30 And the same goes for the dual governance proposal that Ryan talks about. Then what is the Lido token? What is the reason for the Lido token to exist if there's no governance to be had? I think it's an entirely valuable outlook to try to minimize governance as much as possible. But when you try to make it to the point where there's no governance necessary at all, then you find yourself with a token that just extracts value from the protocol and its end users, the stakeholders, to provide a sort of very obscure and not very clear to me exactly what value is being provided at that point. I substantially agree that even in the case where the node operators are picked in a semi-automatic,

Starting point is 00:40:23 fashion, it's still a gamable system. And in the case where the steep holders have veto power, well, they can vote no? Can they also vote yes? And how much organized political activity would it take for the steath holders to actually hold the Lido insiders in check? I just think there's so many potential issues here over the medium and long term that it transitions a huge chunk of Ethereum staking from the model we want, which is can't be evil, to the model we're trying to move away from, which is don't be evil. You know, please don't be evil. And I think, you know, to Alex's point, it's very problematic. I think, you know, perhaps an interesting question is, you know, among all the forces that are growing Lido, making Lido more dominant, what are the

Starting point is 00:41:17 opposing forces? Like, what are the reasons we could come up with that Lido won't earn 70% you know run 70% of stake three years from now. So yeah, I'd be happy to chat about those. Yeah. I mean, do you have thoughts on that? Because when I was doing research for this show, I felt like everything I was seeing was pointing the other way. I think, I wish I had a silver bullet. I wish I could say, here's this one thing that's going to happen that will create a feedback loop. I think that's not the case. I think that this is going to be a long sort of battle for, you know, potentially the soul of Ethereum, which sounds like a little melodramatic, but I don't believe it is. I've been in this space for many years, and I think

Starting point is 00:41:58 Lytocentralization is probably the biggest issue ever to pop up ever in my whole tenure, perhaps the biggest community issue since the Dow Fork. There was a time when programmatic proof of work was sort of a contentious fork that ended up getting shot down, and that was a very divisive issue. In a way, the threat that Lido presents is almost as if programmatic proof of work had been successful and gone south. And like, that's sort of the issue that's baking here. This is a very, very potentially destructive issue over the long term. And, you know, that's, that's sort of the view of Danny Ryan from the Ethereum Foundation who, you know, summarized Lido as a, if I paraphrasing correctly, he said a stratum for cartelization. Like, this is,

Starting point is 00:42:46 This is a place for centralized activity to take root and grow and strengthen itself and erode our credible neutrality. And so what are some of the factors pushing back against that? How do we avoid that? Well, I think, unfortunately, the number one thing is just education. We need to sort of get the word out there. Thanks, Laura, to let folks know that if you're a whale, if you're a professional custodian, if you're allocating at size into staked ether, you should think twice before putting all your money in Lido because you are not only potentially explicitly putting your money at risk in a single system,

Starting point is 00:43:26 you know, that has a set of node operators, but you know, ultimately sort of a single governance token in some ways, a single community point of failure. But, you know, you may also be making Ethereum literally less valuable when you allocate into Lido because the value of Ethereum is a function of its credible neutrality. That's really what separates us from other layers. The fact that someday the world's governments will be able, I think today, but the world's governments some years from now will come to believe that they can use Ethereum as a neutral,

Starting point is 00:43:57 a level playing field, a place where they can come and transact with each other and enter into bilateral fair agreements between nations. and Ethereum offers the promise of being this global public utility that keeps governments honest about their commitments in a way that has never before been possible. And that's only possible because we're a highly decentralized public chain. Yeah. Or if things go the way that we're discussing in the show, then they feel that maybe they could go to Lido and pressure Lido to do certain things to get their way.

Starting point is 00:44:33 Yeah, I think if we end up in a scenario three years from now where 85% of all ether is staked, which is potentially realistic, and 55% of its stake with Lido, which is potentially realistic. Some would even say that, you know, the current default outcome. I see governments looking at Ethereum and saying, well, you know, yeah, Solana's run in a data center. Yes, Solana requires these big, beefy computers that you could never run at home. Yes, Solana doesn't have client diversity. but Ethereum has been captured by this single entity that runs almost all their staking. So maybe it's six of one, right?

Starting point is 00:45:10 Where they, you know, I think the more dominance Lido has, the more Ethereum starts looking like some of its competitors at the highest level. And I think that's something they should concern all ether holders that are trying to grow the, you know, the premium of our token based on the neutrality of our chain. Yeah, and just to kind of play out or like really spell out, where this could go. You know, right now, Ethereum does not have on-chain governance. Obviously, there is the foundation. It appears that they, you know, they do a lot of their governance via forums and proposals and just sort of talking about things on the internet. But like you would essentially

Starting point is 00:45:51 have this kind of other entity, which we would be just, I mean, you could broadly say the Lido community, but since we're talking about the LDO token holders, essentially it would be those hundred entities that make up 94% of the token holders. So they would effectively, perhaps, in some way, bring some kind of on-chain governance to Ethereum, even if it were this sort of minimal governance style. And so that, you know, remove it from the wider community to those token holders. Is that a fair? I think that's absolutely right, Laura. And when we look at the prospect of the Steith token holders getting veto power over Lido, and we ask the question, does that substantially alter this governance landscape? Well, I think there's a rich set of viewpoints

Starting point is 00:46:39 on that topic. And one viewpoint put forth by Danny Ryan is that Ethereum should be governed by its users. And when you give existing users veto power over an important part of the system, that's going to affect, in my view, who the future users become. So even if Steeth users get a veto over Lido Governance Proposal, if the Steeth users are in practice, today's whales, today's funds, today's operators, maybe the world's governments look at that and they say, I'm not sure that we're going to put our eggs in the basket of LDO insiders and Steeth whales deciding the fate of this chain. One other thing that I wanted to say too about how you were saying that you felt that some of the ways out of this would be for people to recognize that putting their money

Starting point is 00:47:28 into Lido would be putting Ethereum at risk, et cetera. To me, frankly, that's sort of a tragedy of the common situation or like a climate change kind of situation because you're going to have the people who are more self-interested who will be like, oh, well, you know, it kind of hurts me to not be with the market leader. So why should I take the hit, you know, for the greater good of Ethereum. And so you're going to get this kind of dynamic where some people will be freeloaders. They'll be like, oh, I'm just going to, you know, I'm just a small staker. I'm going to be part of Lido, even if it's like bad for Ethereum and I'm going to reap the benefits of, you know, all these advantages that we discussed earlier. So, you know, I feel like if the incentives aren't

Starting point is 00:48:09 aligned for people individually, then I'm really not sure how how things are going to veer away from Lido's continued dominance. I don't know. This is just my opinion. I totally agree with that. I think that, yeah, Alex, go ahead. I personally, I mean, I absolutely agree. And I've been, you know, Laura, I've been talking about incentives this entire chat.

Starting point is 00:48:30 And I tend to side with incentives regardless of altruistic motives and things like that. Personally, I would say that if there is an escape a way out of this, it's likely to be technical because the crux of the issue here, and it's been, I think it's as we've talked about it, but I still feel like it's, it's been a little underplayed, is MIV. And if you are able to find solutions that remove MV opportunities from stakers, validers slash currently minors, then you significantly sort of are able to bring back a certain balance to the validating staking. field where as long as a lead staker that has significant share of the staking market isn't able to gain an outsized share of the MEV opportunity, then it's likely that you're going to get

Starting point is 00:49:32 much more of perhaps an oligopoly model like Ryan suggested earlier, where the margins are a lot smaller and there's a lot more competition between the validator. and the staking protocols. I know that it's a very intensely debated subject. It feels like this is absolutely not the way that Ethereum is going in terms of protocol design. Quite to the contrary, they're very much enabling MEV in the capture of MEV, but there are ways for application developer to design their applications to, I think,

Starting point is 00:50:15 remove these kinds of opportunities or at least diminish them as much as possible. And there are further, more complex protocol work that involves the encryption of transaction and stuff like that that could potentially, you know, the entire problem with NVV is that everything is public. So are you able to make transactions private in a way that allow people to not be able to front run them in such a way. I would think personally that this is where a bit more effort should be put in. There's a guy on Twitter that claims to be the first guy to have identified NVV back in 2014 called PMC Goodhen, I believe.

Starting point is 00:51:05 And he's been very vocal in the Ethereum forums in conversations about MVP-Boose, which is flashbuts, most recent implementation, and the proposal, the proposal builder separation proposal about are we doing the right thing in terms of enabling this capture of NV? There's a very decent argument that, yes, absolutely, you want to democratize this access to the MEP. But on the other end, if you choose to go there, there might not be a going back. And so technically, I think technical work perhaps is the way out for Ethereum as far as this Lido concern, as far as Lido's concern. But I think it's worth pointing out that we've talked a lot about social, political concerns and potential failure modes and whatnot. but there's also a very real technical concern there

Starting point is 00:52:07 where you can sort of see Ethereum piling in more complexity at the technical level, whether you know you've got a stack now that sits where it's proof of stake, staking derivatives, governance, LDO governance, and now perhaps a protocol to decentralize the governance that sit on top. And all of these layers are,

Starting point is 00:52:33 technical design that aren't, you know, well, obviously they're being worked on by, at least as far as Ethereum concern, probably their brightest mind. So you would hope that they're building something that's secure. But when you're piling in complexity like that, the concern is not only incentives and social failures is if something breaks along the way, then you could end up with a very unfortunate, perhaps catastrophic situation where, you know, you know, who knows what's going to happen from that point on Ethereum is a bit of precedent in that regard. But technical, I mean, you know, so that's, I guess my point is technology presents itself perhaps as a solution, but also perhaps as the downfall of Ethereum in that regard.

Starting point is 00:53:23 I can't remember if you mentioned this, but I think in osmosis, they do have that where, or at least they're, I think they're introducing it later this year threshold encryption, which, prevents people from being able to do front running because the transactions are private. So it's not like that doesn't exist. I do think that that's a really interesting point. Before we go, I do also want to discuss a couple of other proposals that I saw that Ryan had proposed earlier, which would be one was that Lido's competitors form an alliance. And Ryan said that what they could do is build a tokenized basket of their staking derivatives. and then agree that this basket token would be Lido's primary competitor in a duopoly.

Starting point is 00:54:09 What do you think of that idea? I haven't seen the details of that. It strikes me. I made the point earlier that you're already seeing the state Ethereum derivative kind of very wobbly. You know, you've had this event with 3AC where it seems like they lost quite a bit of money making that bet. had to withdraw a lot from the curve pool, and now there's an imbalance. It's trying to, you know, come back to parity, if you will. It's a game that's very liable, very vulnerable to financial speculation and therefore all sorts

Starting point is 00:54:50 of traps. To be honest, perhaps if you'd ask me three, four months ago, I would have said that sounds like it might be a decent idea to try. But given this state of the house of cards that have fallen in the recent weeks, I wouldn't bet too much on financial construction at this very moment. But I'd have to see a more fleshdown proposal to really commit to an answer. Yeah, I think Alex is right that the prospect of it being a silver bullet is potentially slim. The idea of a basket of derivatives is to Laura's point, if we have a long tail of Lido competitors where the most successful Lido competitor is something like about one-seventh the size, well, what if they just agreed that they were going to compete under a new ticker and join forces? And that would give them the opportunity to sort of punch above the individual weight of any one of them.

Starting point is 00:55:53 and it would also sort of provide the public good that they could invite new derivatives to join them to sort of grow their own importance. And I think in practice, this could be a very effective tool for combating Lido dominance or at least pursuing a duopoly. But I think there are sort of two practical challenges that have effectively turned it into a non-starter in reality. So the first challenge is that when you have a basket of derivatives, there's some governance around that basket. What are the weights? What are the percentages in the basket? Is it 30% rocket pool? Is it, who controls that? So you're adding another layer of governance on top of the existing governance communities in the underlying derivatives. So that's kind of a layer cake of governance. And that presents

Starting point is 00:56:41 both technical and sort of political risk and raises the question of like who gets these governance tokens. And then even if you pass the governance challenge and you say, all right, we found a working model, A huge problem with the basket model is that the people that you need to be in the basket the most are the ones who have the least incentive to join it. So look at Rocket Pool, the number two liquid staking derivative. Why would they join a basket? They're already the number two derivative. You're asking them to join forces with the other derivatives who are nipping at their heels. It's not clear why they would rather do that than just focus on their own success. So I think for those two reasons, the competitive reason and the governance reason, it makes a basket impractical.

Starting point is 00:57:28 But if we could wave a magic wand, I think it would be an effective way to compete with Lido. And to that point, I share Alex's concerns about MEV. And I think it's going to be a very significant problem moving forward. Yet I also have the view that we have to sort of maybe crawl before we can walk and run. And I think in this case, what crawling really looks like is the community. community needs to ensure that when a whale, professional or private, is open to the idea of not being in Lido, they say, oh yeah, I'm on the market for a staking derivative, that they have good options. We need to ensure that at a basic level, the Lido competitors are competitive.

Starting point is 00:58:14 And I'm going to pick on Rocket Pool here for a moment. But as long as you need to be long, the RPL token to participate in the mini pool process, it's always going to be challenging to grow that side of the market, you know, to even, to even keep up with Lido, never mind, close the gap with Lido. And as long as RPL charges a nominally higher fee than Lido, you're also losing on the basic fee comparison. And so you just got to ask yourself, why would someone who's open, to the idea of not using Lido, pick a competitor.

Starting point is 00:58:50 So for me, I would say that the highest priority of the community, if I could suggest something, is to ensure that the Lido alternatives are actually competitive for whales allocating. So we're kind of running out on time, but I did want to actually just mention one other option that Ryan had floated also. And Ryan, you could elaborate on this and then Alex can respond. but it was that you've said, and you even called this an extreme option, but you said that Lido token holders could air drop a vast majority of the LBO token supply to ETH holders. And then you said

Starting point is 00:59:26 that would effectively enshrined Steath, but it might help mitigate the potential downside of Lido governance by a small elite. I don't know if you have more to add. Yeah, I mean, I suppose I think I'd love to see that. Lido has generated a lot of wealth for its early insiders and I think a lot of folks would agree that they're on track to do quite well into the future. You know, there's a few problems with Lido. One problem is sort of a big problem of just having a monopoly derivative, but there are sort of two other problems that are unrelated and potentially independently solvable. First problem, in my view, is that Lido does business with other chains. If you're going to have a single staking platform be the monopoly derivative on your chain,

Starting point is 01:00:09 Maybe you want them to only do your chain and be sort of loyalist towards your chain. I think that's not an unreasonable request. So I think, you know, Lido committing to shutting down their business and other chains, it's not something I expect them to do, but I think it's something that would be a reasonable ask from the community. And then that kind of third problem is how closely the LDO token is held. You know, when you have that, you know, to my knowledge, the top 100 wallets holding 94% of the token, I mean, it's just a little silly. very centralized. And so maybe we could solve that problem by air dropping the LDO token to

Starting point is 01:00:46 not even Steeth holders, but maybe ether holders pro rata and just say, hey, we're going to, we're going to double this token supply of LDO. We're going to air drop one token for every one token that already exists. And we're going to give all these tokens to everybody in the community. I think that would be a shrewd move by Lido that would increase. Actually, I kind of hope they don't do it, because I think it would be so clever that it would get a lot of people interested in their success, and I think it would help to solidify their dominance. So I guess it's six of one. On the one hand, it would decentralize their governance token.

Starting point is 01:01:20 On the other hand, it would probably endear them to a very large audience. Alex, do you have any thoughts? Only one word, incentives. I personally don't. I would be very surprised if they were to do that. And I would also put it in a very hyperbolic way, but perhaps they'd be air-dropping tokens to themselves because, I mean, certainly the concentration of ETH

Starting point is 01:01:46 is not as cute as Lido is, but when you put into the same boat paradigm, A16Z, Alameda, you get quite a lot of Ethereum. Is it all the same players just colluding, but in a much more transparent way? To me, it feels like that at times. But certainly, I wouldn't go as far as saying that eat is the supply distribution is a centralized as lighto, but yeah, perhaps.

Starting point is 01:02:15 Yeah, I see my editorial assistant commented that because users usually sell theirdrop, that the only real outcome would be that the LDO token holders would get wrecked. So it's not in their incentive to do so. But anyway, this has been an incredibly fascinating discussion. I really appreciate that you guys did this. I just found it super fascinating. Hopefully it gives a lot of people food for that. Where can people learn more about each of you and your work?

Starting point is 01:02:45 I'm on Twitter at Ryan Birkins. I am on Twitter, solely on Twitter, at B-R-G-E-A-E-E-A-X-4, Virgil Alex-4. Awesome. Well, it's been a pleasure having you both on Unchained. Thank you so much, Laura. Good to meet you, Alex. Good to meet you, Ryan, as well. Thanks so much for joining us today to learn more about Ryan, Alex, and these issues with

Starting point is 01:03:10 Lido and Ethereum centralization, check out of the show notes for this episode. Unchained is produced by me, Laura Shin, with help from Anthony Yun, Matt Pilcherd, Juan Orenovich, Pamajumdar, Shashonk, and CLK transcription. Thanks for listening.

Unchained - Post-Merge, If Lido Becomes Dominant, What Does That Mean for Ethereum? - Ep. 372

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