Pantera Partners: Understanding How the Lido Staking Agreement Solves the Dilemma of Staking vs. Asset Utilization

Written by: Paul Veradittakit, Founding Partner at Pantera Capital Compiled by: Perry Wang

• A core issue with Proof of Stake (PoS) blockchains is the opportunity cost of staking assets. When users want to participate in network validation and earn rewards, they must stake or lock their assets in the network, meaning those assets cannot be utilized elsewhere. Therefore, users need to make a choice: either earn staking rewards while helping to secure the blockchain, or generate yields from various projects in the DeFi ecosystem.
• As Ethereum transitions from a Proof of Work (PoW) mechanism to a PoS mechanism, those who staked ETH in the Ethereum network initially could not withdraw those assets because the initial version of the network did not support the liquidity of staked or locked ETH. This means early validators on Ethereum would have up to a year without the ability to withdraw their staked assets, significantly increasing the opportunity cost of staking.
• Lido is a liquid staking protocol for PoS blockchains that allows users to earn staking rewards while simultaneously using the same underlying assets to participate in various DeFi projects.
• Currently, over 1.3 million ETH are staked in the Lido protocol, accounting for more than 1% of the existing circulating supply of ETH. The project has become the largest staking service provider on Eth 2.0, paying depositors an annual percentage rate (APR) of approximately 4-7% through staking.
• Finally, Lido proposes a revolutionary solution to the problem of illiquidity in staking. Users can earn high returns from staking while also utilizing the same underlying assets to gain additional yields from the DeFi ecosystem, creating endless new financial opportunities on the blockchain.

The Hidden Costs of Staking

One of the most anticipated releases in the crypto community is Ethereum 2.0—a new version of the Ethereum network that is better, faster, and more scalable. Ethereum 2.0 will leverage numerous technological advancements, such as a new blockchain sharding architecture, to increase the network's transaction capacity, speed up transaction times, and control gas prices to meet the needs of DApp developers and users worldwide.

A key component of the migration to Eth 2.0 involves transitioning Ethereum from its current PoW consensus algorithm to PoS, where validators are selected based on the amount of ETH they "stake" or lock in the network, rather than their ability to solve computational puzzles.

In the initial phase of Eth 2.0 (launched last December), the network will not support transactions or fund movement—it will only contain service data. This means that anyone holding assets in Eth 2.0 currently cannot withdraw those assets until transaction functionality is added to the new network (expected in about a year). Even after the withdrawal feature is added, staked assets cannot be used for other applications simultaneously; users must choose to stake their assets for network validation (losing significant liquidity in the process) or use their assets elsewhere (forgoing high staking rewards).

The opportunity cost of staking has long been an unresolved issue for many PoS blockchains. If users can achieve better returns by not staking their assets and depositing them in money markets or LP pools, the incentive to participate in network validation is minimal, severely compromising the security of the underlying blockchain. To ensure that the PoS algorithm can support a stable blockchain ecosystem, new methods must be established to release the liquidity of staked assets.

What is Lido?

Lido is a liquid staking protocol for PoS blockchains. The protocol allows users to seek yield opportunities elsewhere while staking their assets and earning staking rewards.

How Lido Works

Users can deposit ETH into Lido to participate in the validation of the Beacon Chain (the initial phase of Eth 2.0) and earn staking rewards. User deposits are pooled and managed by the Lido DAO, which then stakes these assets through a set of trusted node operators on Eth 2.0 to generate staking rewards. These rewards are paid out in real-time to depositors, allowing anyone to participate in network validation and earn rewards without crossing a minimum investment threshold or requiring complex validator infrastructure. 10% of the rewards are reserved for node operators, DAO members, and insurance funds.

In exchange for the ETH they deposit, users receive an equivalent amount of synthetic liquid staking tokens, stETH. One unit of stETH corresponds to one staked unit of ETH, but unlike staked ETH, stETH can be freely traded. Users can invest their stETH across the DeFi ecosystem, enabling them to earn additional yields from the same underlying assets beyond staking rewards.

Lido currently also supports staking on Terra (where users receive stLUNA) and Solana (where users receive stSOL). The project also plans to launch liquid staking solutions for Polkadot and Polygon blockchains in the future.

What is Lido DAO?

The liquid staking protocols for Ethereum, Terra, and Solana are managed by a decentralized autonomous organization (DAO) called Lido. DAO members hold LDO governance tokens and help maintain the project by deploying and upgrading smart contracts, updating protocol parameters, selecting node operators for staking, and managing the minting of stETH tokens (and ultimately unbinding stETH from ETH once Eth 2.0 supports withdrawals).

How is Lido Growing?

So far, nearly 24,000 unique deposit addresses have staked over 1.3 million ETH on the Lido protocol, accounting for nearly 1% of the current circulating supply of ETH. The Lido protocol is currently the largest staking provider for Eth 2.0, offering 15% of all currently staked assets. Users can earn approximately 5.0% APR by staking ETH, 3.4% APR by staking LUNA, and 6.2% APR by staking SOL.

Lido is currently the largest Eth 2.0 staking service (Source: TheBlock)

The protocol has also gained significant traction with its synthetic token stETH, allowing depositors to earn additional yields from their staked assets in various ways. Users can use stETH for yield farming across various DeFi projects, including 1inch, Curve, Anchor Protocol, Yearn, and more. The Lido protocol recently launched on Solana, after which many Solana DeFi projects also added support for stSOL, including Serum, Raydium, and SolFlare.

Final Thoughts

The transition of Ethereum from a PoW mechanism to a PoS consensus represents one of the most formative paradigm shifts in the history of Ethereum (and the broader crypto world). In a PoS model, blockchains can significantly reduce energy consumption, lower the entry barriers for network participants, increase the diversity of validators, and better support new technologies like sharding chains.

In addition to these benefits, PoS also brings some concerns regarding the opportunity cost of staked assets being unusable elsewhere. If users are forced to choose between staking assets to validate the network and utilizing assets in DeFi projects for yield farming, the underlying blockchain may fall into an endless loop, either failing to attract enough validators to secure the network or lacking a high-value DeFi project ecosystem to attract users with sufficiently high yields.

Lido offers a revolutionary solution to this problem by tokenizing ownership and releasing liquidity from staked assets. Users can earn substantial returns from staking while also gaining additional yields from the DeFi ecosystem using the same underlying assets.

With over 1% of the ETH supply participating in Eth2 staking through Lido, the demand for more functionality of the network token is evident. By eliminating the binary choice dilemma between staking and utilizing assets, Lido advances the vision of a fully programmable, highly versatile monetary system, creating endless financial opportunities on the blockchain. Lido's core mission is to maintain the accessibility, security, and decentralization of staked assets.