$26.31 billion of Ethereum has been assigned for staking…and that’s not even a sixth of its overall circulating market cap.
The launch of Beacon Chain marked the beginning of proof-of-stake (PoS) on Ethereum as it commenced its migration from a proof-of-work (PoW) consensus algorithm (i.e., crypto mining).
Whether PoW cryptos such as Bitcoin, Litecoin, and Dogecoin; PoS, including Cardano, BNB Chain, Polygon, and now Ethereum; or otherwise, there is an ongoing issue with dominant players in mining and stake pools respectively, not to mention whales with disproportionate influence over a given crypto asset.
In this piece, specifically with Ethereum, the elephant in the room is Lido DAO’s stake-pool dominance, now at ~25% of all Beacon Chain (ETH) depositors, the largest stake pool out of all of them.
Why is this important?
All public blockchains should (aspire to) live up to this core mantra of decentralisation in their network, and with this comes measures to objectively achieve this. This is far from the truth for many blockchains and their respective assets (Bitcoin is widely considered the most decentralised of all of them), but I digress; more on this in a future piece.
Before continuing, I am referring to liquid staking derivatives (LSDs). Liquid staking allows people to stake crypto through an LSD, such as Lido, to earn a liquid token (e.g., stETH) for delegating your Ether to the staking protocol. This is popular for many ETH holders as it bypasses the staking requirement to lock up your coins (32 ETH min.) through solo staking or a third-party provider.
This is a serious concern if it were to get majority control of stake pools or could collaborate with another significant player to get an overall majority share.
Don’t just take my word for it; various media outlets have covered this matter for several months.
One source, in particular, stood out for me. Danny Ryan, a researcher and programmer at the Ethereum Foundation, wrote this piece titled The Risks of LSD.
One of the most concerning lines from this is:
“If pooled stake under one LSD protocol exceeds 50%, this pooled staked gains the ability to censor blocks (and worse-so at 2/3 due to being able to finalize such blocks).”
Now that Metamask offers ETH staking for Trezor Model T owners via Lido DAO and Rocket Pool, both will benefit from this new option; I expect the former’s dominance to increase further.
Based on the above points, how is this “the elephant in the room” if it has been widely acknowledged? Well, I wonder how many people (i.e., various retail investors of ETH) understand the ramifications of having dominant stake pools. If they did, how many would seek alternatives to minimise the dominance of a few players?
Fortunately, solutions already exist, are on the cusp of being implemented or are still in the works.
What are some solutions?
Thinking of a significant Ethereum competitor, Cardano, its devs created the idea of stake pool saturation — reduced rewards as a given stake pool reaches or becomes over-delegated.
This sets up Cardano to have multiple pools distributed worldwide (over 3,200 of them to date), with each pool capped at 64 million ADA to be eligible for maximum rewards, down from 210 million ADA when staking was first launched on the Cardano mainnet.
“The goal is to avoid any single pool becoming too large – thereby disincentivizing delegation to other pools – and receiving a disproportionate amount of the rewards.”
Cardano
Other than Cardano’s approach, I acknowledge that Lido’s V2 aims to expand its number of node operators (which it should, as it only has 27 at present (Q3 data 2022). Despite this being almost double Q4/2021 data, this is still way too low for proper network decentralisation.
For comparison, Rocket Pool has over 2,000 node operators spanning 113 regions across all continents (almost all…except for Antarctica) and counting, with the added benefit of a lower entry barrier: 16 ETH (8 ETH through a mini pool, which appears to be more profitable) versus 32 ETH for independent node operators when going elsewhere.
So Lido has a long way to go if it considers itself relatively decentralised in how it operates.
Concluding thoughts
I am glad to see Ethereum making the complete switch to PoS and allowing anyone to earn staking rewards. Whilst there is a specific requirement of 32Ξ (ETH) per validator (serving as both a min and max value), and this helps decentralisation of the network, this doesn’t apply to liquid staking pools (Lido DAO) or those controlled by an exchange (Coinbase, Binance, etc.).
I don’t have a problem with Lido or any other legitimate staking entity (liquid or otherwise); I want to see adequate network decentralisation and the Ethereum ecosystem remain as secure as possible and thrive, let alone all other reputable blockchains and their associated coins/tokens.
Looking at the bigger picture, it will be interesting to see how Ethereum liquid staking services fare post-Shanghai upgrade, which will finally allow ETH delegators to withdraw funds that have been locked up for several months (if not over a year).
It’s important to remember that whilst you can have stake-pool operators (SPOs) distributed around the world, decentralisation is also measured by the ownership of these pools; even if they’re geographically distant, is there still a select group controlling the majority of stake pools (let alone mining pools for Bitcoin)? This is something people behind a given blockchain need to monitor continuously.
On a positive note (for decentralisation), it seems that Lido has gone from a 30% to 25% overall market share, the latter according to the official Beacoincha.in website. Remember that <15% of the overall ETH circulating supply has been staked, so there is still plenty of room for growth for Lido and all other stake pools.
Ultimately, do what works well for you, whether or not that involves sticking with Lido, Coinbase, or Binance. To help you decide which stake pool is suitable, these resources from Ethereum’s website will help you understand the pros and cons of each available option.
Disclaimers
The opinions expressed within this piece are my own and might not reflect those behind any project listed here.
Please do sufficient research before investing in any crypto assets, staking, NFTs and other product affiliated with this space.
ETH is a major holding in my crypto portfolio, so I want it to do well.
I received no incentive from companies or entities listed throughout this article to discuss their product.
Statistics and price data were obtained on 14 February 2023.
If you enjoyed this article, I recommend following my Medium page for regular reports about crypto assets, blockchain technology, and more. Feel free to check out my publication as well, Crypto Insights AU.
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Cover image by Trichaiwat on Shutterstock.