Thanks to @Fronta1pha for reviewing the initial draft
The purpose of this report is purely informational and educational and is not to be construed as investment advice. The author owns LDO tokens.
Link to the google drive pdf: https://drive.google.com/file/d/1OSmWv7ipTQbZRgeA5myVRPnDRsC44t-W/view?usp=sharing
ETH staking began with the launch of the beacon chain in December 2020, marking the start of Ethereum’s transition from PoW to PoS. The beacon chain fulfills activities similar to a fully function chain like block processing, validators verifying blocks, and penalties for malicious behaviour. Due to the costs and complexities associated with running a node and becoming a validator on the beacon chain, staking protocols have risen to provide convenient staking services to Ethereum users.
Lido is an Ethereum liquid staking solution that allows users to access the benefits of ETH staking while mitigating the costs and difficulty associated with running an ETH 2.0 node. Staking on the Ethereum beacon chain requires 32 ETH but Lido has created an environment where individuals can stake any amount of ETH they wish. In return, depositors are given stETH, Lido’s 1:1 derivative of ETH staked on the beacon chain. This is a representation of the ETH deposit balance in Lido and allows users to unlock the benefits of DeFi while accruing staking rewards.
Currently, deposits in Lido total 992,690 ETH, making up 13.9% of total staked Ethereum, and 83% of the ETH liquid staking market. In the 3 months from May to August growth in deposits increased 137%, with 51% MoM growth.
The number of unique depositors currently total 17.6k, a 212% increase in the last three months and 86% MoM growth.
Since its launch in December, Lido has had cumulative revenue totalling $36M. $32.4M of which has accrued to the node operators and validators while the remaining $3.6M has accrued to the protocol (90:10 split). In the last three months revenue increased 193% with 72% MoM growth.
TVL has risen to $5.1B with 218% growth in the three months and 131% MoM growth.
Note that TVL growth corresponds to deposit growth. This is a sign of real protocol growth and not solely based on the price appreciation of deposited ETH. The current market cap sits at $248M giving Lido a market cap/TVL ratio of 0.05 and a fully diluted valuation (FDV) of $5.6B.
Ethereum is making the switch to Proof of Stake (PoS) as part of the upgrades for ETH2. In PoS miners aren’t responsible for adding blocks to the chain, that is the job of validators. Validators stake ETH as collateral and are chosen at random to add the next block to the chain. While ETH is still currently operating under Proof of Work, the beacon chain is the PoS chain that ETH validators are currently staking in, which the current Ethereum network will merge to.
Costs associated with ETH2 staking
Since the beacon chain acts similar to an operational PoS chain, it comes with real incentives, in the form of block rewards, as well as penalties. For validators, there are three ways in which the staked balance can be reduced; penalties, inactivity leaks, and slashings. Penalties can come from instances where a validator is offline, for any number of reasons like internet/power failure, hardware failure, or cloud services failure. Inactivity leaks arise when there is a high correlation between validators being offline, resulting in missed network duties. Slashings occur when validators are being malicious or contradictory when producing blocks, which results in the removal of part of their staked balance. These are penalties for negative network behaviour, regardless of intentions. The role of staking services is to abstract these problems away so that users can enjoy the incentives of staking income from block rewards, without the risks, costs, and knowledge necessary to operate a node.
Regardless of the high capital requirements there is a lot of responsibility involved in simply maintaining the validator so that it is performing its necessary requirements, while not being punished in the process. This has led staking protocols to simplify the process of staking so that the complexities are placed onto the protocol while stakers can solely enjoy the benefits of yield from block rewards generated by their deposit.
Lido ETH liquid staking
To stake ETH with Lido, all that is required is for a user to deposit any amount of ETH they wish into the Lido protocol, and in return, they get a 1:1 derivative stETH. This is a representation of ETH staked in Lido which can be used to redeem the deposit only once ETH merges with the beacon chain and unstaking is enabled. To mitigate this problem, Lido has helped facilitate liquid markets for holders of stETH to transact in, where they can swap stETH for ETH or other tokens. This allows Lido depositors to receive yield from ETH2 staking without any of the associated costs and limitations of the beacon chain (capital requirement, capital lockup, etc).
On the back end, the ETH staking problems that are abstracted away for the users are the challenges that Lido must deal with directly. For Lido to provide staking to users that have less than 32 ETH Lido creates pools of users’ deposits. The deposits are distributed between node operators and deposited by validators in the required 32 ETH increments. Before July 15, 2021, deposits were custodial as a smart contract could not be set as the owner of a validator. This required validators to manually stake deposits. Withdrawals were controlled by a multi-sig contract that required 6 of 11 signatures, the threshold, to grant withdrawals.
11 withdrawal key owners
- Chorus One
- Staking Facitilies
- Certus One
- Banteg (Yearn finance)
- Alex Svanevik (Nansen)
- Anton Bukov (1inch)
- Michael Egorov (Curve)
- Rune Christensen (MakerDAO)
- Will Harborne (DiversiFi)
- Mustafa Al-Bassam (LazyLedger)
As of July 15, an upgradable smart contract was set as the withdrawal address, meaning deposits are now permissionless and not managed by a minimum of 6 out of 11 multi-sig owners. The problem faced by giving withdrawal credentials to specific individuals is that they could collude amongst each other to hold the ETH hostage by refusing to sign the withdrawals and ultimately steal the funds. New Lido deposits no longer face this threat, however, ETH deposited before the upgrade is still present in the old contract. Depositors would have to swap stETH for ETH and then stake the ETH back into Lido for the ETH to be deposited into the new permissionless withdrawal smart contract.
Node operators also pose a potential problem similar to the multi-sig withdrawal key owners. Since node operators are individually selected by the DAO this poses additional trust assumptions that depositors must take. Node operators are voted in, by nature making it a permissioned process. While this does contradict the trustless ethos of DeFi, permissionless node operation could potentially be more detrimental to the protocol than having permissioned processes for node operator selection. Since node operates are responsible for maintaining staked ETH, they are responsible for the assets that users deposit and for proper node management. Improper node management can result in penalties which reduces the amount of ETH being staked. Since node operator and validator penalties that result in lost ETH are costs that are distributed amongst the entire network of Lido depositors, node operators must be of the highest quality. As Ethereum liquid staking services mature, the right approach to node operators’ inclusion will become more evident, at which case Lido can shift towards if it differs from the current model.
Once ETH is deposited into Lido it is distributed among all active node operators. Authorized node operators, once voted in by the DAO, are added to the NodeOperatorsRegistry contract. The staking contract also has a list of node operators along with their validation keys and the logic that determines reward distribution.
”Oracle” is the contract responsible for tracking the changes in staking balances, from block rewards or slashing penalties. Lido takes a 10% fee of net rewards (rewards — penalties) which it distributes as newly minted stETH between node operators and the Lido treasury (90:10 split). This leaves the remaining 90% of accrued staking rewards to be distributed to stETH holders in the form of a rebase (an increase in the balance of their stETH tokens) which occurs once per day.
To protect stETH holders from losing rewards due to penalties, Lido purchased insurance on a total of ~400K ETH in to protect against up to 5% in slashing penalties. On July 18 a vote was proposed regarding the removal of staking insurance, which passed with 9 votes in favour of not renewing insurance. Subsequently, Lido will explore self-cover options (Appendix 1).
StETH within DeFi
stETH is Lido’s 1:1 derivative that gives stakers a market to participate in while simultaneously accruing staking rewards. The solves one of the biggest inhibitors of staking on the beacon chain, the deposit lockup. Since stETH holders are dependent on swaps top “unstake” this makes liquidity a significant part of Lido’s ecosystem and value proposition. If stETH holders want to swap out of stETH into a different asset and there is no liquidity for them to perform the swap they are essentially stuck with stETH. This renders one of the most useful value propositions of stETH useless. Currently, the stETH/ETH liquidity pool in Curve is one of the largest liquidity pools in all of DeFi, with a total of $3.6B in liquidity. That is 29% more liquidity in a single pool than all the liquidity in Uniswap v3, at $2.8B.
To bootstrap and incentivise liquidity providers Lido initiated liquidity mining programs, initially with Curve. This is done by providing rewards for LPs paid in LDO (the Lido governance token) on top of the base yield. The program, and subsequently others, were financed through the treasury, where the specifics of incentives were voted on by the DAO. Among Curve, Lido has had stETH integrated into many other protocols, including the likes of Uniswap, 1inch, Yearn, and Sushiswap, among others. This gives stETH holders the chance to participate in activities like borrowing and lending, yield farming, and liquidity providing.
While stETH holders can use their tokens to access more yield in protocols, certain protocols have no rebasing functionality for tokens when being provided as liquidity. This includes protocols like Uniswap, 1inch, and Sushiswap. When providing stETH liquidity into those protocols, rebasing rewards will not accrue. For protocols like Yearn and Curve the rebasing functionality still operates so stETH holders will continue to accrue staking rewards.
On August 13 Lido brought stETH cross-chain, onto Terra, through integration with anchor protocol. Anchor is similar to a money market where users can lend and borrow tokens, however, borrowing collateral is only reserved for liquid staking derivatives, like stETH. bAssets, bonded assets, are tokenized versions of staked assets of a PoS blockchain on Terra. Aside from Anchor’s stablecoin market, which only has UST (Terra’s native stablecoin), the bAsset market is only comprised of bLuna and bETH, both of which are Lido staking derivatives. bLuna is Lido’s Luna staking derivative (Luna is the native token on Terra), and bETH is the tokenized version of stETH on Terra. By moving ETH staking derivatives cross-chain Lido is expanding both the utility and value for stETH holders.
Based on Lido’s current integration of stETH into many DeFi protocols and the large amount of liquidity it boasts, it appears that liquid staking derivatives are likely to be a winner takes most market. The marginal benefit of adding a second ETH staking derivative as collateral to Aave may be useful for ETH staking collateral optionality, but the marginal benefit from the 5th or 6th staking derivative is unlikely to yield the benefit required to get it listed. DEX liquidity pools are permissionless, so any staking protocol can launch its own liquidity pool for trading, but even then users and liquidity providers are likely to utilise the ETH staking derivative with the highest liquidity, which has been the case in practice. Moreover, staking protocols still require certain trust assumptions, (deposits, withdrawals, node operators), so the number of integrations throughout DeFi and brand reputation play a significant role in a staking protocol’s moat. This compounds as the number of chains that the staking protocol operates on increases.
Since Lido has liquid staking services on multiple chains, those that stake with Lido are highly likely to continue using it as they move assets cross-chain because of the integrations and brand reputation Lido has built up. Considering there is no benefit to a liquid staking derivative that lacks DeFi integrations and liquidity, network effects will compound and create a moat among the market leaders in liquid staking, Lido being one.
The number of StETH holders is currently at 20.3k, up 16% in the last 7 days alone.
Demand for stETH expressed as the number of token holders has outpaced the number of unique depositors in Lido by a difference of 2.7k. This is demonstrative of demand growing rapidly for yield-bearing ETH, more so than the staking services provided by Lido.
StETH on Curve has climbed 76% in the last 3 months, with 22% MoM growth. 1inch has also seen recent growth of 54% in the last 3 months and a 55% increase MoM. Unlike the other two, Uniswap has seen little growth in balance. This is likely due to Curve capturing all the liquidity providers because of Lido’s Curve liquidity mining program which is still ongoing.
While it is unsurprising is that the curve stETH pool takes up a significant share of the total stETH liquidity (>78%), what is notable is that Anchor is second with a 10% share while bETH deposits have only been live Since August 14.
This disparity between Anchor and the rest of the stETH protocols becomes clearer when Curve is taken out of the equation.
Anchor is the only money market stETH can currently be used on, however, demand for bETH deposits on anchor is not indicative of potential stETH demand on other money markets because bETH can only be used as collateral on Anchor, not as an asset that can earn yield. There is likely little value that will accrue to money markets through listing stETH as demand for ETH borrowing is near zero so stETH borrowing is unlikely to differ — current compound ETH supply yield (7-day MA) is 0.15%.
In the first two days of the bETH launch on Anchor, 38,657 bETH were staked on Anchor protocol, totalling $123M at the time. Currently, bETH deposits in Anchor total 76.5K bETH ($244M), represented below, while bLuna deposits have climbed to 62.2M ($2B) since launch in March.
Unique bETH depositors total 2154, up 39% in the last 7 days.
ETH staking yield
The current estimated staking yield on the beacon chain is 6.45% APR when running a validator and 5.75% APR through stake pools, with an average stake pool fee of 10.89%.
The current Lido staking yield is 4.9% net APR (adjusted for the 10% fee).
Once the merge occurs staking yield will increase because of network activity (transaction fees) as validators are currently only receiving block rewards. Projections for ETH staking once the merge is completed vary based on a few key assumptions, primarily the number of ETH staked, daily network fees, and daily issuance. A conservative estimation of ETH staking yield is 8.4% APR with an optimistic estimation of 19.8% APR. Based on the assumptions laid out by ETH2 researcher Justin Drake, his middle-ground estimate sits around 11.9% APR.
Even the lean conservative estimate of 8.4% yield outshines current DeFi yields of similar risk. While DeFi yields can’t be projected to April 2022 yields in money markets for stablecoins are significantly lower than ETH2 staking projections. Current Compound supply rates for DAI, USDC, and USDT, based on a 7-day moving average, are 2.7%, 2.9%, and 3.3% respectively.
ETH yields in money markets also don’t fare well against stablecoin yields. The current 7-day moving average yield for ETH in Compound is 0.15%. Even if ETH2 staking yields and DeFi lending yields were to converge at a similar rate, users of stETH have the advantage of higher liquidity than cTokens, or any other deposit tokens (see curve stETH pool), and more composability within DeFi, both on Ethereum and cross-chain (see Anchor bETH stats).
While Lido solves many of the given limitations of current ETH2 staking, that value proposition is likely to remain unchanged once unstaking is allowed. The primary driver for Lido will be that Ethereum stakers will still have the capital cost of locking up their ETH. By using a liquid staking derivative, users have removed the opportunity cost of staking and are now able to utilise a yield-bearing ETH derivative across DeFi, and even across multiple chains. The value propositions that allow Lido to command such a large market share, mainly integrations and liquidity, are factors that regular staking can’t compete with. Upon the completion of the merge, Ethereum staking is unlikely to hinder stETH growth, but rather accelerate it. Once users are accustomed and aware of the benefits of native Ethereum staking, there are significant benefits to be accessed by switching from native Ethereum staking, to utilising a staking protocol with a liquid staking derivative like Lido.
ETH liquid staking market
While Lido has been seeing explosive growth and gaining an increasingly large share of the ETH staking market, it is important to demonstrate the competition and gauge how well they are doing relative to each other — this is likely a winners take most market.
ETH liquid staking protocol TVL rankings
It is worth noting that Lido’s closest competitor suffered a loss of funds through stolen withdrawal keys, resulting in over 38k ETH stolen. This demonstrates some of the risks that depositors face with a staking protocol where security is improperly managed. Lido’s next closest competitor, Ankr, has only 5% of their TVL — Lido’s market share cannot be overstated.
Ankr’s growth in deposits has increased 11% in the last 3 months and -1% MoM growth, compared to Lido’s growth of 137% and 51% over the same periods. With TVL valued at $157M and a market cap of $821M that gives Ankr a market cap/TVL ratio of 5.3, compared to Lido’s ratio of 0.05.
Lido’s third-largest competitor is Stakewise with 26k ETH in TVL ($115M), which is only 2.8% of Lido’s TVL — If the 4th largest protocol in a particular market is too small to have any accurate market data that shows the depth of competition is very shallow. Stakewise’s growth in deposits has increased 16% in the last 3 months and 0.7% in the last month — slightly higher growth than Ankr but still nowhere near Lido’s growth.
While growth metrics were kept simple when comparing Lido’s growth to that of its competitors, it is very clear that Lido is not only winning significantly but continuing to pull further away from the competition. Lido is sprinting while the rest are walking, and others are going backward. Simple metrics were used because growth in deposits is at the core of the staking business model so further metric dissections are unlikely to yield much additional insight.
On the Launch of the LDO token, 1 billion were minted and distributed between the DAO treasury, investors, initial developers, founders, future employees, validators, and signature holders according to their respective allocations.
Since there was no token presale, the treasury has been using its allocation of LDO tokens to fund liquidity mining programs, through Curve initially, which is the main method by which tokens are distributed into circulation (plus the initial 0.4% LDO airdrop to early stakers). Funds in the DAO treasury are also used for purposes like DeFi integrations, a slashing insurance fund, and community incentives. For founders and early investors their LDO allocation is locked for the first year and then vested over the following year, starting December 17. Since there is no concrete vesting or release schedule for LDO tokens, the following vesting schedule assumes linear vesting.
As tokens become available to founders and investors through vesting, if they sell it is likely to create significant sell pressure as the total number of tokens vested for the 3 groups amounts to 639M LDO (63.9% of total supply) which is 15.6x more than the current circulating supply (41M LDO). This is further emphasised through Lido’s Fully Diluted Valuation of $6B while the market cap is only $250M. Although sales from vested tokens during 2022 may suppress the price of LDO temporarily, with good fundamentals and strong growth prospects the price of LDO long term is likely to be unaffected.
The future of Lido
While Lido has been working towards building the go-to liquid staking protocol for both Ethereum and other chains, they still have limitations and upgrades planned for future improvements to the protocol. At the heart of these improvements is the move to a completely trustless staking service. The crux of the issue is that Ethereum staking has a natural tendency towards staking centralization, which is compounded by network effects. If a platform, centralized exchange, or DeFi protocol, controls a large portion of the Ethereum staking market but has either strong centralizing forces and/or security trade-offs it represents a significant liability to the Ethereum network. These are factors that Lido is actively pursuing to mitigate as they continue to expand. The area of focus is to transition current permissioned activities (deposits, withdrawals, node operator selection) into permissionless activities, thereby minimizing trust. The result of this “will be a maximally decentralized and immutable protocol, and this is the optimal end state for Lido”.
 Not just centralization of a few parties controlling majority share in the staking market, but for those parties to be decentralized themselves. Having a party that controls a large percentage of the staking market but is sufficiently decentralized represents a significantly lower risk to the Ethereum network — the manner pursued by Lido.
While Lido is still in the process of transitioning towards an ultimate goal of maximal decentralization and complete trustlessness, it has risen to become the dominant Ethereum staking protocol with future planned expansions to other PoS chains. The first expansion saw the successful launch of liquid staking on Terra with bLuna which was later followed by bETH.
While bLuna has only been live for five months, if Lido continues to expand and dominate liquid staking on both Terra and Ethereum, it will have demonstrated key implications for Lido and the entire crypto liquid staking market.
1. Liquid staking is a winner takes most market
2. Liquidity network effects compound protocol growth
3. Brand reputation is a value driver
Lido has already demonstrated that a single liquid staking protocol can obtain the majority of the market share on Ethereum, 83%, and the success of staking on Terra is a signal that growth compounds as momentum gains. It sounds odd for reputation to have relevance in a trustless market, but humans don’t live in a world without trust and reputation. Given the lack of regulation and the nature of crypto to have many scams, brand reputation is difficult and time-consuming to build and as such should be considered a moat. When Lido deploys to a new chain, will a staker choose some small staking protocol native to the chain, or the one that has >$6B in TVL across 2 chains and has the backing of some of the most knowledgeable minds in crypto? The market has shown that the answer is the latter.
The current limitations of interoperability between different chains have so far restricted the growth of multi-chain Dapps. With the success of Terra liquid staking and future chain deployments, Lido is set to expand unlike any other application in crypto. The chains Lido is currently focused on deploying to include Solana, Polygon, Polkadot, and Kusama. Combined market value of the chains sits at $59B, and with each additional chain Lido is deployed on is an increase in the total addressable market. Since we have yet to see many Dapps that have successfully deployed to more than two or three chains, the growth opportunities are unknown but unlikely to be bound by any growth metrics we have previously witnessed by a Dapp.
Lido is also in the process of expanding liquid staking services to Aave. If successful, this further increases the TAM of Lido because it is not only bound by the number of PoS chains but rather all PoS chains + all Dapps that have staking services. Since crypto is still in the early phases of global use and adoption, Dapps will both increase in quantity and quality as crypto continues to pull in smart individuals and as they become easier and more efficient to develop. Since staking is an integral part of DeFi and crypto, Lido’s liquid staking services can be seen as an integral part of the crypto economy, in contrast to most Dapps that only provide niche use cases.
Lido is a cross-chain liquid staking solution that has demonstrated liquid staking is a fundamental service required by a PoS chain. Since its launch in December 2020, it has completely dominated the Ethereum liquid staking market and has seen success in its first expansion to Terra. Lido has many growth opportunities through deploying to other PoS chains and to DeFi protocols which represent significant potential for value capture — something no Dapps have been able to do successfully to the scale at which Lido is looking to achieve. As Uniswap has demonstrated, Dapps that can realise dominance within a market can accrue a monetary premium, something which Lido will be deserving of as it continues to grow and capture market share.
The crypto market is extremely inefficient such that those who are willing to go beyond the surface level will be able to find information that few within the market are aware of. With the acquired knowledge that the market is either mispricing or has a poor understanding of, it will give those individuals asymmetric opportunities. Lido represents an asymmetric opportunity that the market is mispricing given its current success and future growth potential.
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