What is the value of Lido Finance, the leading ETH staking project?

Author: Daniel Li, CoinVoice

In the first half of 2023, the Ethereum Shanghai upgrade became the most notable event in the cryptocurrency space. This upgrade will allow staked ETH to be withdrawn, which is expected to attract more users to invest in ETH. Against this backdrop, Lido Finance (Lido) has become a focal point. As the largest staking protocol on the Ethereum Beacon Chain, Lido has a TVL of $8 billion, accounting for 30% of the staking volume on the Beacon Chain, making it the DeFi protocol with the highest TVL.

Positive News for Lido as the Biggest Winner

The U.S. Securities and Exchange Commission (SEC) action against Kraken has triggered a change in the ETH staking landscape. This has prompted more centralized institutions to shift their staked ETH to decentralized entities, with decentralized ETH staking protocols like Lido benefiting significantly. Additionally, the Ethereum Shanghai upgrade will introduce a withdrawal feature, which is expected to further promote the growth of ETH staking protocols. The combination of these news events has led more investors to have a positive outlook on Lido, making its token LDO a market focus. In the past month, LDO has risen over 50%, and as of now, the LDO price is $2.99, with a market cap of $2.513 billion, ranking 25th.

U.S. SEC's Heavy Hand Will Bring a New Landscape for ETH Staking

Last week, cryptocurrency exchange Kraken was charged by the SEC for failing to register its crypto asset staking-as-a-service offerings and sales. The SEC stated that Kraken attracted investors by promoting returns of up to 21%, but failed to provide adequate disclosures and investor protections. To settle the SEC's charges, Kraken agreed to immediately cease offering staking-as-a-service to U.S. customers and pay a $30 million fine.

The SEC's crackdown on leading staking platforms has sent shockwaves through the entire industry, and centralized exchange Coinbase, which also offers staking services, has expressed deep concern. Although reports indicate that Coinbase suspended ETH staking services last October, the amount of ETH staked on Coinbase still ranks second in the ETH staking market, only behind Lido. If the SEC decides to fully ban retail participation in staking services in the U.S. market, Coinbase is likely to become the next target.

Following the SEC's ruling, investors seem to believe this is favorable for "decentralized" staking platforms. Decentralized staking platforms are less affected by regulatory policies since they do not rely on centralized institutions or companies, but instead use decentralized smart contract mechanisms to provide liquid staking services for digital assets. According to data, the day after the Kraken penalty was announced, the governance token of the largest decentralized staking platform, Lido, surged by 11%. It is foreseeable that as some centralized staking platforms like Kraken cease their staking services, more users will flock to decentralized platforms, and Lido, as the leading platform, will undoubtedly benefit the most.

Shanghai Upgrade Will Ignite the ETH Staking Race

Ethereum has a relatively low staking rate among public chains, with only 12% of tokens currently staked. In contrast, other public chains typically have staking rates between 60% and 80%, indicating that Ethereum still has significant room for improvement. Additionally, other public chains often attract users to stake by increasing annualized returns, but this approach may lead to a depreciation of the staked token's value and lacks sustainability. Ethereum, on the other hand, has entered a deflationary phase since its merge, and with the continued prosperity of the Ethereum ecosystem, the economic incentives for ETH staking have become more sustainable and attractive. Overall, the ETH staking sector has explosive potential, and the only thing lacking is timing, with the Ethereum Shanghai upgrade likely to serve as this opportunity.

The Shanghai upgrade will inject long-term vitality into ETH staking. The upcoming withdrawal feature will allow users to withdraw from the Beacon Chain, enabling ETH validators to unstake and decide whether to sell or hold. A portion of the released ETH will enter the secondary market, but due to the validator exit mechanism's limitations, the market will not be significantly affected. Although there may be a short-term impact on the total amount of ETH staked, the staking ratio may continue to rise afterward. This is because the upgraded ETH staking mechanism becomes more flexible, allowing for free exits rather than requiring long-term locking, which may attract more holders to stake ETH for returns. This is akin to how bank deposits can shift from fixed-term deposits to demand deposits, where the interest calculation remains largely unchanged, but the deposit volume may increase.

The Ethereum Shanghai upgrade is good news for Lido, but it also presents a challenge. After the upgrade, the scale of ETH staking will surge, providing a great opportunity for decentralized staking platforms like Lido to expand. However, with the ability to withdraw staked ETH after the Shanghai upgrade, Lido's previous advantage of allowing users to redeem staked ETH at any time will no longer hold. For Lido, creating a new moat will be the challenge it faces.

Technical Analysis Highlights Lido's Advantages

Lido is a liquid staking protocol established in October 2020. It was created to address the limitations of ETH2.0 staking and the lack of liquidity. Users wishing to independently participate in ETH2.0 staking need to stake 32 whole ETH, which is very unfriendly to retail investors. Lido, however, allows users to stake any amount of ETH to participate in ETH2.0 staking. With its user-friendly staking model, Lido quickly gained market recognition upon launch, currently holding over 75% of the staking market share and 30% of the ETH staking market share, making it the undisputed industry leader.

Lido's Staking Principle

Lido introduces staked Ether (stETH) or Lido stETH as a liquid staking solution. This allows users to stake any amount of ETH they wish while still being able to use these ETH on other decentralized finance (DeFi) platforms. The specific process involves users providing their scattered ETH to Lido, which, upon receiving the user's stake, will allocate it to Lido DAO-approved node operators for staking in batches of 32 ETH. Stakers using the Lido protocol to stake ETH receive stETH on a 1:1 basis as proof, representing their staking share in Lido and corresponding to the staked ETH.

stETH plays a crucial role in the Lido ecosystem, serving as the main proof of the Lido platform. Users holding stETH tokens can earn rewards from their staked ETH, such as staking rewards and fee sharing. Additionally, users can use stETH tokens for trading and circulation within the ecosystems of Lido's partners, such as liquidity mining and trading on platforms like Curve, Yearn, and ARCx.

The transferability and tradability of stETH make Lido's staking model more liquid compared to other platforms. Furthermore, stETH can be exchanged for ETH at any time through the stETH-ETH LP on CRV. Before the Ethereum Shanghai upgrade, this was also an advantage that allowed Lido to quickly outpace other staking platforms.

Lido's Revenue Model

Currently, Lido's revenue model primarily relies on taking a 10% cut from staking rewards as protocol income, with 5% going to staking node operators and another 5% entering the Lido treasury, governed by LDO. Staking rewards are less affected by market fluctuations, so its token-based income is almost unaffected by bear markets. In December, Lido's protocol income was only slightly less than GMX, and its total protocol fees exceeded those of Uniswap. Additionally, influenced by expectations of the Shanghai upgrade and Lido's leading position in the industry, Lido is expected to attract more staked assets in the near future, which will also bring higher protocol revenue to the Lido platform. The continuous rise of LDO this year reflects the market sentiment towards Lido.

Lido V2 Upgrade

With the Ethereum Shanghai upgrade approaching, DeFi platforms providing ETH staking services must also upgrade immediately to adapt to the new changes. As the largest ETH staking service provider, Lido announced the launch of the Lido V2 upgrade on February 8, marking the largest upgrade to date and a significant change in its path toward further decentralization.

The Lido V2 upgrade will unfold in two areas: Staking Router and Withdrawals.

Staking Router

The staking router is a controller contract designed to gradually evolve Lido into a scalable protocol through modular infrastructure. The core idea is to treat various modules as potential suppliers for the protocol, forming a validator pool. Each module will be responsible for managing internal node registration, storing validator keys, and allocating staking shares and rewards. Modules can include various types of node operators, from community-evaluated stakers to professional or newly established staking institutions, as well as DAO organizations. They can operate independently or collaboratively through infrastructure like DVT.

The staking router is the main upgrade of the Lido protocol, allowing stakers, developers, and node operators to coordinate seamlessly and benefit from a modular and combinable architecture, including:

• Stakers: With the increase in node service providers, users' staking deposits will be distributed among more service providers, thereby reducing network downtime risks and enhancing Ethereum's resilience.
• Node Operators: Through the new modules, other types of node operators, such as independent stakers, small groups, DAOs, and professional node operators, will be able to increase their participation in the Lido protocol.
• Developers: Users can propose and implement models through different combinations of node operators and their competitive characteristics (such as coverage options and fee structures), and can also apply to join the staking router's module collection.

Withdrawals

Lido V2 will optimize one of its core features, the withdrawal function, balancing user experience, operational speed, and protocol security. After the upgrade, staked Ethereum (stETH) holders will be allowed to withdraw their tokens from the Lido ecosystem at a 1:1 ratio, without additional fees or penalties. However, due to the complexity of the Ethereum network, the withdrawal mechanism in the Lido protocol design will have two modes: Turbo and Bunker.

Turbo Mode: This is the default mode that can quickly fulfill withdrawal requests, but the time to exit the network is uncertain. Withdrawal requests may take several hours to process. To reduce potential delays, contributors have proposed automation tools to help the protocol and node operators automate the process around validator exits.

Bunker Mode: Proposed to orderly handle withdrawals in catastrophic scenarios, the Bunker Mode aims to prevent seasoned participants from gaining an unfair advantage over other stakeholders by delaying withdrawals across the entire protocol and socializing negative impacts.

The Lido V2 upgrade points the way for Lido's future development, while the new modular architecture brought by the staking router will further assist Lido in achieving decentralization. With the Beacon Chain's development of withdrawals, new requirements have been placed on the current ETH staking model. As an industry leader, Lido has long been prepared for this day. Lido V2 will become Lido's new moat, driving it to become a more inclusive, open, and transparent platform.

Can Lido Maintain Its Leading Position Long-Term?

Lido's extremely high market share nearly monopolizes the entire staking market, raising concerns among some investors. Among them, Vitalik suggested that staking projects should self-limit the amount of stake they control, proposing a 15% cap as a threshold. However, Lido did not accept this suggestion. As early as June 24 of last year, Lido DAO voted on whether to "self-limit," with 99.81% of LDO holders voting against it, opposing self-limiting Lido. The main argument of the opposition was: "We don't do what others will do," "CEX will do it," and "Currently, no one can meet the demand."

On the other hand, handing over the dominant position in the ETH staking market to centralized institutions, such as Coinbase, which has the second-largest market share after Lido, may not be a good thing either. First, it contradicts Ethereum's goal of building a decentralized network. Second, centralized institutions are more susceptible to regulatory intervention, as evidenced by the SEC's action against Kraken. Therefore, it seems unlikely that centralized institutions will replace Lido as the dominant player in the ETH staking market.

From the data, Lido is already in a leading position in the entire industry, making it difficult for successors to compete with it. According to Dune data, as of February 18, the total amount of ETH staked on the Ethereum Beacon Chain has exceeded 16.7 million ETH. Among them, Lido stands out with 4.92 million ETH staked, capturing a market share of 29.34%, equivalent to the combined total of the second to fifth centralized staking institutions. Coinbase ranks second with a market share of 12.34%, which is less than half of Lido's. Kraken ranks third, following Lido and Coinbase, accounting for 7.36% of the total ETH staked. Kraken has just received penalties from the SEC, and although Kraken claims to only suspend staking services within the U.S., customer attrition is still inevitable.

As Kraken ceases its staking services, ETH from centralized institutions will continue to flow to Lido, and Lido's market share is expected to remain stable and gradually increase.

Although Lido's high staking market share has been criticized, it is undeniable that, without ideological concerns and external interferences, Lido's liquidity, composability, and yield have an absolute advantage in the ETH staking market. In a winner-takes-all market, Lido's market share is a result of market competition and an inevitable trend toward the decentralization of ETH staking. With the Ethereum Shanghai upgrade and restrictions on centralized staking institutions, investors are generally optimistic about Lido's future development trend.

Conclusion

The goal of the Lido protocol is to make staking simple and secure while maintaining Ethereum's decentralization and censorship resistance. Over the past two years, the Lido protocol has continuously grown and has become an indispensable part of the Ethereum ecosystem and the entire DeFi space. Currently, Lido has over 100,000 addresses staking more than 4,815,040 ETH, achieving significant success in democratizing access to staking. In the future, Lido will continue to steadfastly move toward trust-based staking and network democratization.