Introduction

In the cryptocurrency world, proof-of-stake is a common method where users can earn passive income and help secure the network by staking their crypto assets. For new users, staking is like a term deposit at a bank; you provide your cryptocurrency for a while and earn low-risk rewards.

However, staking has some downsides. Your staked crypto can only be withdrawn after the staking period ends, which can be inconvenient when managing your funds. Different blockchain networks also have varying staking requirements. For example, Ethereum 2.0 requires at least 32 ETH to become a validator and earn rewards, which is a lot for many users. The nearly two-year staking period since the end of 2020 is also a deterrent.

Lido is a protocol offering liquid staking services. It allows users to stake their crypto on networks like Ethereum, Solana, Polkadot, Polygon, and Kusama. By doing so, users receive derivative tokens that can be traded, giving liquidity to staked assets and helping nodes gather scattered funds to operate efficiently. Lido makes staking simple and convenient and is seen as a promising solution after the Ethereum 2.0 upgrade.

Lido’s History

Lido was founded in October 2020 by Konstantin Lomashuk, Vasiliy Shapovalov, and Jordan Fish. Konstantin has a Ph.D. in finance and founded P2P Validator, which provides validator node services on various proof-of-stake blockchains. Vasiliy is an experienced software engineer who served as the CTO of P2P Validator in 2020, responsible for creating a third-party staking service for the upcoming Ethereum beacon chain, which became Lido Finance.

A few weeks after Ethereum 2.0’s beacon chain staking contract launched, Lido went live on the testnet in late November 2020 and officially launched in December. Lido’s initial blog post highlighted several barriers to participating in Ethereum 2.0 staking:

Indefinite Staking Commitment:

1.The ETH 2.0 upgrade is in several phases, and while the staking contract is deployed, the full transition to proof-of-stake will take time. This means staked tokens could be locked up for 2-3 years, during which users can’t move, trade, or use them.

Lack of Liquidity:

2.Staked ETH can’t be transferred or used in DeFi protocols for earnings until the ETH 2.0 upgrade is complete. Users must choose between staking for rewards and using ETH in DeFi protocols for earnings.

Minimum Staking Amount: As of mid-2022, with one ETH priced at $1600, 32 ETH is worth over $50,000. Even when Lido first launched, staking required over $10,000 worth of ETH to become a beacon chain validator, making it difficult for users with fewer ETH to participate. Additionally, users with more than 32 ETH can’t use the fractional part for staking.

3.Lido aims to solve these issues by offering non-custodial staking services, supported by well-known staking providers. By issuing stETH (a staking ETH derivative token) on a 1:1 basis, Lido gives liquidity to staked ETH, allowing users to stake any amount of ETH. This addresses concerns about indefinite staking, low capital efficiency, and fragmented liquidity.

Lido’s success is evident in its total value locked (TVL) growth. Within a year, ETH staked through Lido grew nearly 700 times. This attracted investments from institutions like Alameda Research, Coinbase Ventures, Jump Capital, and Paradigm, as well as support from notable individuals like Rune Christensen (MakerDAO founder) and Kain Warwick (Synthetix founder).

Due to its success on Ethereum, Lido is expanding its staking services to other networks. For example, staking began on Terra in March 2021 and Solana in September 2021. By mid-2022, Polygon, Kusama, and Polkadot networks also support liquid staking through Lido. However, the UST decoupling event in early May caused Luna’s price to plummet, significantly reducing Lido’s TVL by over 30%, and leading to the shutdown of the Terra staking service.

How Does Lido Work?

In proof-of-stake networks, users must stake a certain amount of cryptocurrency in smart contracts to become validators. They help verify transactions and create new blocks while earning rewards. The staked cryptocurrency can’t be withdrawn before the staking period ends. Setting up nodes requires professional knowledge, and if disconnections or malicious attacks occur, the staked crypto may be penalized.

Lido issues stETH, an ERC-20 token, to provide liquidity for staked ETH. For every ETH staked through Lido, a stETH token is issued. When Ethereum 2.0 completes its upgrade and allows the unstaking and trading of ETH, users can redeem their stETH for an equivalent amount of ETH through Lido’s smart contract. For every ETH redeemed, one stETH is burned to maintain a 1:1 ratio.

Staked ETH through Lido enters a smart contract called the staking pool, which manages user deposits, withdrawals, minting and burning of stETH, delegating funds to node operators, distributing rewards, and receiving updates from Oracle contracts. Node operators are staking providers authorized by the Lido DAO, ensuring continuous node operation. The staking pool contract holds the list of node operators, keys, and reward distribution logic.

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Oracle Mechanism

The Oracle smart contracts dynamically track the staked ETH balance of different validators. Depending on their status, validators’ ETH balance may increase with block rewards or decrease with penalties. The oracle provides accurate stETH balances daily based on all validators’ staked ETH. If rewards are earned, new stETH tokens are minted, with 90% going to stETH holders, 5% to node operators, and 5% to the Lido DAO for insurance and protocol development.

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stETH maintains its price peg to ETH through three primary mechanisms:

Rational Trader Arbitrage:

1.stETH is minted by staking one ETH. When stETH’s price is lower than ETH, traders can sell ETH to buy stETH, obtaining more ETH after the Ethereum upgrade.

Liquidity Mining Rewards:

2.On decentralized exchanges like Curve and 1 inch, users can add liquidity to the stETH/ETH pool to earn rewards.

Organic Demand:

3.Leading lending protocols like MakerDAO and AAVE support borrowing with stETH as collateral. Since stETH is an interest-bearing asset, it is suitable for collateral.

Thus, stETH issued by Lido is a financial derivative of staked ETH. Although stETH can’t be used to pay Ethereum transaction fees, it overcomes various staking challenges on the beacon chain: no minimum 32 ETH threshold, no need for professional knowledge and equipment, and flexible use of staked funds in DeFi protocols. Therefore, Lido calls it “liquid staking.”

About the LDO Token

Lido Finance is a decentralized liquidity staking protocol aiming for community governance and operation from the start. The LDO token is the governance token for the Lido DAO, allowing token holders to vote on decisions impacting the Lido protocol. This ensures everyone has a voice, promoting decentralization and creating a trustless liquidity staking platform.

After its launch in December 2020, the Lido DAO created 1 billion LDO tokens. The initial distribution is:

• Lido DAO Treasury: 36.32%
• Investors: 22.18%
• Founding Development Team: 20%
• Founders and Future Employees: 15%
• Validators and Withdrawal Key Signers: 6.5%

Apart from the DAO treasury, all LDO tokens have a one-year lock-up period, then are released gradually over the next year.

Since 2021, LDO has seen two rounds of institutional investments. In May 2021, $73 million was raised from several institutions led by Paradigm, and in March 2022, $70 million was invested by A16z, which also helped A16z stake some of its ETH on the beacon chain. Further investments were made from the Lido DAO treasury, buying LDO with 21,000 ETH, approved by the Lido DAO community. Like the initial distribution, the new LDO tokens have a one-year lock-up and gradual release over a year.

Anyone holding LDO is part of the Lido DAO community, managing protocol settings, adding or removing node operators, using the oracle list, and voting on upgrades. Any member can propose changes, with voting power based on the amount of LDO held. Proposals need more than 50% approval and must surpass 5% of the total LDO supply to pass. Lido uses Aragon for on-chain voting, with over 100 proposals voted on by 2022, showing active community governance with nearly weekly new proposals and discussions.

Features of Lido

Lido solves many issues with Ethereum 2.0 beacon chain staking and has become a pioneer of liquid staking, providing a model for other proof-of-stake blockchains. Key features include:

1. Users can earn staking rewards without fully locking up their funds.
2. Users can stake with less than 32 ETH, offering flexibility and enabling more people to participate and earn rewards.
3. Professional staking service providers manage the staking tokens, so users don’t need technical knowledge or equipment, reducing the risk of losing staked tokens due to node failures or attacks.
4. Staking certificate token derivatives, like stETH, can be used in other applications and protocols, such as being collateral for loans or used in liquidity mining and other DeFi projects to earn rewards.
5. It provides an alternative to individual staking, exchange staking, or other semi-custodial staking options.
6. It aggregates market liquidity, encouraging users to participate in staking and various decentralized financial services, thus maintaining blockchain network security and revitalizing on-chain capital flow.
7. DAO governance ensures the stable operation of the liquid staking protocol’s ecosystem, avoiding risks from third parties and single points of failure.

Compared to individual on-chain staking and custodial staking on centralized exchanges, Lido offers several advantages:

Users staking ETH through Lido receive stETH, an ERC-20 token accepted as collateral in decentralized lending protocols like MakerDAO and AAVE. This practice, called “recursive staking,” can increase staking yields.

For example, a user staking 10 ETH with Lido receives 10 stETH, which can be used as collateral to borrow 5 ETH (depending on the protocol’s collateral ratio). If the borrowed 5 ETH is restaked with Lido, the user gets another 5 stETH and can decide whether to use these 5 stETH as collateral for more ETH. As long as stETH’s annual yield is higher than the borrowing rate, users can use recursive staking to earn higher rewards with less ETH, while paying minimal borrowing interest.

The biggest risk in staking loans is if the collateral’s price drops, users may be forced to sell their collateral to repay the loan. Since each stETH is guaranteed to be redeemable for 1 ETH after the Ethereum 2.0 upgrade, when stETH’s price drops below ETH, arbitrage opportunities arise to restore stETH’s price, maintaining a stable exchange rate with ETH. Operationally, users borrowing ETH can hold onto their stETH and wait until the Ethereum upgrade is complete to repay the loan. Users can use the recursive staking strategy to boost Lido protocol’s staking yield by up to 50%.

Controversies of Lido

Lido has been successful since its inception. On-chain data shows that the number of unique addresses using the protocol and the total value locked (TVL) has continuously hit new highs. However, like all decentralized finance applications, Lido’s liquid staking is not without risks.

First, it’s important to understand that they are ultimately different things regardless of how stable the price peg between staking certificate token derivatives (like stETH) and the underlying staked assets (like ETH) is. stETH is an ERC-20 token, whereas ETH is a native asset on the Ethereum blockchain. They have different uses and functions, and users cannot use stETH to pay network transaction fees. People hold stETH primarily because they believe it can be exchanged for ETH at an equal value. If this trust is broken, stETH will lose its value.

In early June 2022, stETH faced a crisis of decoupling from ETH. Due to the revelation that the crypto lending platform Celsius Network lost 35,000 ETH due to key loss, and because Celsius had staked 44% of the ETH received from users into the Lido protocol for stETH, users began a run on withdrawals fearing they wouldn’t be able to withdraw their funds. Additionally, a crypto whale sold a large amount of 19,998 stETH on Curve, causing the stETH/ETH exchange rate to drop by nearly 10%, further fueling market panic.

Although the stETH/ETH exchange rate has since recovered to 0.97, this does not mean that stETH is free from other decoupling risks. During a security audit in October 2021, a code vulnerability in the Lido protocol was discovered, posing a risk of losing 20,000 ETH. In March 2022, there was an error in the web front-end. As Ethereum 2.0 upgrades, it is certain that the Lido protocol will need to update its existing smart contract code. No matter how skilled the development team is or how many audits it passes, there is no 100% guarantee against other errors. stETH must protect its staked ETH to maintain its token value.

Another issue with the Lido protocol is its governance. Lido DAO can be considered a highly centralized decentralized organization. This is evident from the LDO token distribution, where the founders, development team, and institutional investors monopolize more than half of the LDO token supply. LDO holders can vote on which node operators work with the Lido protocol. Given the large amount of ETH staked through the Lido protocol on the beacon chain, if Lido Finance continues to grow at its current pace, the Lido protocol may become a governing layer for Ethereum.

Currently, Lido staked ETH accounts for about 30% of the total ETH staked on the beacon chain. Although this has not reached the 51% attack threshold, the demand for liquid staking continues to grow. Once Ethereum transitions to the proof-of-stake consensus, node operators under the Lido protocol may threaten the security and reliability of Ethereum 2.0.

To prevent Lido protocol and LDO token holders from effectively monopolizing the upgraded Ethereum, a dual-token governance model of LDO and stETH has been proposed. In the new governance model, LDO holders can still propose and vote as before, but stETH will have veto power over specific Lido proposals. This means stETH holders can veto proposals they believe are harmful to the Ethereum network, providing a counterbalance to LDO governance. However, this creates another power dynamic because ETH tokens do not have governance rights over Ethereum, but stETH can influence Ethereum through Lido node operators. This could lead to more users supporting the Lido protocol and stETH, raising centralization concerns.

Latest Updates of Lido

1.The Lido Alliance

Lido DAO has been actively working to promote the decentralization and security of the Ethereum staking ecosystem. The Lido community voted to create a special working group called the Contributor Alliance, which aims to evaluate and guide potential new members through the governance process while promoting the development of products that fit within the stETH ecosystem. This alliance focuses on supporting projects that align with Lido DAO’s values and mission, especially those committed to smart contract and product security and the decentralization of Ethereum validation. With potential inclusion of other DeFi projects like Aave, The Lido Alliance aims to expand its influence and enhance the infrastructure development of the Ethereum ecosystem.

2.Symbiotic Project Funded by Crypto Venture Paradigm

Lido is also exploring new opportunities for innovation and expansion. Recently, Lido received funding from crypto venture firm Paradigm to develop a project named “Symbiotic.” This project aims to enhance capital utilization and yield potential by re-staking users’ staked assets.

Symbiotic will use Lido’s liquid staking technology, allowing users to re-use their stTokens in other staking or lending activities while still staking. Symbiotic hopes to create a multi-layered yield mechanism through this method, enabling users to achieve higher returns without increasing risk. Paradigm’s funding signifies their recognition and support of the Symbiotic project’s innovative potential.

3.Comparison of Ethereum Liquid Staking Providers

In the Ethereum ecosystem, liquid staking has become highly competitive. Besides Lido, many other protocols are exploring and developing in this field, including Rocket Pool, Ankr, and StakeWise. Here’s a comparison of some main liquid staking protocols:

• Lido: As the largest liquid staking provider in the market, Lido supports various assets’ staking and provides liquidity through stETH. Lido has a broad and extensive user base with high liquidity, making it very popular in the DeFi ecosystem.
• Rocket Pool: A decentralized Ethereum staking pool allowing users to participate with smaller amounts of stake and using RPL tokens as staking collateral. Rocket Pool emphasizes decentralization, allowing anyone to run a node and participate in network maintenance.
• Ankr: Provides multi-chain liquid staking solutions, supporting users staking on different blockchains and achieving liquidity through tokens like aETH. Ankr’s multi-chain support places it in a unique position within the cross-chain ecosystem.
• StakeWise: Uses a dual-token model to maximize staking rewards through sETH2 and rETH2 tokens. Its unique reward distribution mechanism attracts many users seeking flexible staking options to earn rewards.

From these comparisons, we can see that each liquid staking protocol has its unique advantages and features. Lido continues to maintain significant influence in this field with its market-leading position and broad support.

Conclusion

The Lido protocol has achieved significant success in just over a year since its creation. By providing liquid staking services, users can delegate any amount of cryptocurrency to node operators working with Lido to assist in transaction verification and earn staking rewards for the blockchain network. Users receive certificates of the staked assets, which can be freely exchanged for other tokens in the market, not restricted by different blockchain protocols’ staking period and fund limitations.

Lido Solves Liquidity Issues in Staking and Improves Capital Efficiency

In a sense, the Lido protocol is an excellent example of a shared economy model. Most people face various technical, financial, and time challenges when staking, while node operators can meet these needs. Through shared staking rewards, a win-win situation is created, benefiting the blockchain network by improving capital turnover efficiency and increasing participation, thereby enhancing blockchain network security and decentralization.

Lido’s Success Raises Monopoly Concerns, Competitors Emerge

However, Lido’s success may also lead to developmental bottlenecks. The proportion of ETH staked through Lido now accounts for over 30% of the total staked on the beacon chain. Although Lido DAO has mechanisms to prevent collusion and monopolization among nodes, the convenience of liquid staking might lead most users to abandon staking methods requiring lock-up periods. While Lido currently holds a dominant position in the liquid staking field, other competitors like Rocket Pool and pStake Finance are emerging. If Lido’s market share grows, Lido DAO could indirectly become the governing body of many blockchain networks.

Staking Derivatives Face Decoupling Risks, Regulatory Challenges

Additionally, liquidity staking token derivatives still carry the risk of price separation. If hackers find vulnerabilities in the smart contract code, the staked tokens could be stolen, rendering the token derivatives worthless. Furthermore, using circular collateral and large withdrawals in lending agreements can trigger chain reactions, leading to price crashes. Recently, policies from regulators worldwide have become another concern. These token derivatives that offer returns might be classified as “securities” and be subject to regulation. To prepare for this upcoming regulatory wave, Lido has restricted users from certain countries/regions, mainly those sanctioned by the United States and its allies. This restriction raises doubts about Lido’s claims of being “decentralized,” “trustless,” and “permissionless.”

Lido’s Diverse Development, Committed to Providing Staking Liquidity Solutions for Various Digital Assets

Despite these controversies and issues, Lido remains a significant innovation, bringing numerous benefits to blockchain development through liquid staking. It has significantly contributed to the growth of ETH staking numbers in the Ethereum 2.0 upgrade. Lido is gradually expanding its focus from Ethereum to other blockchain networks like Solana, Polkadot, Polygon, and Kusama. The Lido DAO community is very active, recently planning to offer liquid staking services for Near, Avalanche, and Cosmos protocols. Many well-known investment institutions are optimistic and have purchased LDO tokens. The future development and performance of the Lido protocol are worth watching.