Lido’s market dominance and Ethereum decentralization post-Merge

The tentative date for the Ethereum merge was proposed to be Sept. 19, following a third successful testnet merger. Ethereum will transition fully from the proof-of work (PoW) consensus mechanism used by Bitcoin to the more efficient proof-of stake (PoS), which is used by younger networks such as Solana or Cardano.

The Merge will not solve Ethereum’s scaling problems on its own. It is only the beginning of a roadmap to achieve future scaling upgrades,” Jacob Blish (head of business development at Lido), shared with Cointelegraph.

After the Merge, the Beacon Chain’s staked Ether (ETH), which is the PoS network that mirrors Ethereum transactions, will be kept locked up for at most six months. Staked ETH liquid tokens that are not yet merged will be able to benefit from transaction fees and maximum extractable value. This will increase yields.

The Merge has received a lot hype. The Merge is the biggest crypto event for a long time. Rocket Pool founder Darren Langley said that it is “the single largest event in crypto.” He added, “The lockup is testing liquid staking protocols right now, but this is primarily due to macro conditions as well as the ongoing Centralized Finance drama (CeFi). Liquid staking will explode once it’s over.

According to StakingRewards, ETH staking yields currently earn close to 4% annually percentage rate (APR). Only 10% of the ETH supply is being staked.

Lido’s liquid stake service

The Beacon Chain’s launch created the need for a decentralized liquid-staking solution to compete with centralized exchanges (CEX). It could also be used in decentralized finance (DeFi), for borrowing, lending and other purposes.

Lido’s staking service has become popular as it was the first to offer a liquid staking derivative of Ethereum via the minting the stETH token. Contrary to popular belief stETH was not intended to be tied to ETH. Blish shared this:

Lido issues staked ETH, but the exchange rate can’t be pegged. It can fluctuate in price and trade at a premium, or a discount depending on secondary market forces. The underlying backing of StETH is not affected by this.

Lido’s advantage as the first to market a liquid staking product has allowed the protocol to move forward with more DeFi integrations of stETH and other multichain-staked products such as Polkadot, Solana, Polygon and Kusama. Recently, the team announced that stETH would expand to layer-2 solutions in order to improve their DeFi integrations.

As of May 20,22, there are a variety of staking protocols balances. Source: Twitter

This protocol brought liquidity to the Curve pool through incentives such as additional rewards for the Lido token LDO and a referral program. It also helped to consolidate its position as a temporary winner in the liquid staking area.

Lido is the only product in the DeFi ecosystem that can compete with and surpass other protocols, such as Binance ETH token (BETH), in terms of total value.

Alternatives to liquid staking derivatives

Although new products often start with market leaders, competition soon develops and innovation ensures that there are fresh entries to the market. Lido’s network effect has made it difficult for competitors to catch up with Lido and take a significant share of the market.

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While there are some differences in the fees, product decentralization, and token characteristics of liquid staking projects, the value proposition is the same: To empower users to maximize capital efficiency, compound their yield, and secure the network, while also securing it.

“The Ethereum ecosystem was built on trustless centralization. It is not right to have too much voting power in one organization,” Jordan Tonani, Head of Institutions at Index Cooperative told Cointelegraph. He added that “having healthy competition among multiple liquid staking protocol is better.” A new crop of liquid protocols will be promoted to encourage decentralization shortly after the Merge.

Rocket Pool holds over 1.5% of all Ethereum staked. It has 1,300 node operators in 84 locations. This could have a negative impact on Lido’s market dominance, and increase its relevance in liquid staking with new scaling solutions.

Stakehound and Stkr are three of the projects that attempt to reduce Lido’s market share, but still trail in terms of DeFi’s liquidity depth and utility as collateral.

Rocket Pool’s permissionless approach appears more decentralized than Lido’s permissioned. This is a tradeoff to ensure reliability of node operators in the early stages. Lido has been working to create permissionless onboarding that is based on their performance reputation.

Monopoly or Oligopoly? It has to be decentralized

Based on data, Lido has an immature liquid staking derivatives market monopoly.

Lido (a decentralized autonomous organisation (DAO)) opened the discussion on its governance forum about stETH being restricted to a certain percentage of the total ETH staked. Blish explained:

“We support Ethereum’s core decentralization ethos.” Lido can govern the protocol via a DAO to ensure that it does not engage in any activities that could be detrimental to our values and community.

A dual token governance proposal, which allows holders of stETH and LDO token holders to veto any governance proposals that could harm stakers on Ethereum network, was also recently approved.

Bitcoin (BTC), like the liquid staking problem, seems to have centralizing forces. The market has grown to the point that the top three largest mining pools now have more than half of the network’s hashrate. According to data, the top six mining pool accounts for over 80% of the network’s hash rate in the last three month.

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It is difficult to predict what changes will occur after the Merge, and what impact it may have on liquid stake products. Although liquid staking derivatives tend toward centralization, there is a possibility of a positive middle-term evolution from alternative products that gain ground and divide the market into an Oligopoly.

Langley stated that while there will be many participants in the Ethereum ecosystem, it is important to maintain a high level of decentralization. “The key to Ethereum’s success is lowering barriers to entry, including the collateral requirement and technical challenges.”

As the hype surrounding the Merge continues to grow around liquid staking products, volatility can be expected over the next month. These products are in high demand. Future developments will show if there will be any liquid staking derivative products in the space.

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