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Issue #7: The king of liquid staking protocols welcomes ETH’s Merge

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Summary

SymbolLDOCirculating Supply (estimated)556,257,679
Rank (MCAP)#47Total Supply1,000,000,000
Price (08/31/22)US$1.83Market CapitalizationUS$573,756,625

Complete historical LDO price chart. Source: CoinGecko

In this report, we’ll answer:

What is Lido?

Lido DAO (LDO) provides liquid staking for proof-of-stake (PoS) blockchain tokens. In decentralized finance (DeFi), staking lets a user deposit tokens to earn rewards. Liquid staking lets them reuse their deposits in other protocols to generate more yield.

It’s the most popular liquid staking provider in the ETH ecosystem. It has over 90% of ETH2’s liquid staking market share. Meanwhile, it’s expanding from ETH to other blockchains.

The protocol has seen significant interest as ETH prepares to upgrade in the “Merge”. This upgrade will transition ETH from a proof-of-work (PoW) to a PoS blockchain. At the time of writing, developers targeted mid-September 2022 for the Merge.

Lido’s liquid staking lets users generate more profits

On many protocols, staking tokens locks the staked tokens. This locking creates drawbacks.

Stakers can’t use their locked tokens for other purposes. For example, stakers can’t use their staked capital to generate more yield in other places.

Lido’s liquid staking works around this problem. It gives stakers a new token substituting for the staked token. In return for staking a token like ETH, stakers receive stETH tokens (staked ETH).

The stakers can then use these tokens in other parts of DeFi to earn extra rewards. By doing this, they increase their “capital efficiency”. They’re able to generate more yield with the same amount of capital. This makes their capital more efficient.

Illustration of how Lido’s liquid staking works on ETH. Source: Liquid Staking with Lido | Messari

Lido makes staking easier

Staking on ETH2 required a minimum of 32 ETH. At the time of writing, this amount of ETH costs over US$60,000. This expense creates a barrier for many would-be stakers.

Lido doesn’t enforce a minimum deposit. This feature users with a small amount of ETH can still stake for rewards.

Lido also simplifies the staking process by handling the required infrastructure. Setting up this infrastructure can be technically challenging. Stakers on Lido sidestep this need and only have to deposit their tokens.

Lido’s liquid staking is non-custodial and decentralized

Other staking providers also remove the need for stakers to maintain staking infrastructure. Often, these are crypto exchanges. Many of these alternatives are in the form of centralized custodial staking.

Centralization comes with risks. An old saying in crypto is “not your keys, not your coins.” Custodial staking trusts the custodian with the staker’s keys. Surrendering their keys puts the staker at risk of losing their coins.

Also, much of the crypto community supports the ideal of decentralization. Lido matches this ideal while providing decentralized security.

What are the LDO token’s uses?

The LDO token is Lido DAO’s native utility token. Its primary use is for governance, which lets holders vote on changes to the protocol. 

Holders can manage fee parameters and distribution. They can also add or remove node operators from LDO’s network.

Who’s behind LDO?

A collective of groups and individuals launched Lido to make staking on ETH easier.

The Lido DAO manages Lido. A DAO is a decentralized autonomous organization.

This DAO means that Lido has no central authority. No founders or other managers are running the system. Instead, LDO token holders make proposals and vote on these decisions through governance.

Its DAO members include:

The DAO’s mandate is to ensure Lido is efficient and stable. It also recruits new node operators, validators and users.

It takes a part of service fees for the Lido treasury. These funds pay for the protocol’s insurance, developers, and other expenses.

Lido DAO’s draft budget in July 2022 shows expected costs for Lido DAO. Source: [PUBLIC] Lido Budget Draft – Provisional – 07/11/2022

Lido’s angel investors include prominent names such as:

How does Lido distribute and release its tokens?

How did Lido launch?

Lido launched in December 2020 after ETH’s Beacon 2.0 Chain went live. It minted 1 billion LDO tokens and distributed:

LDO initial supply distribution. Data sourced from Lido | Introducing LDO

It locked non-treasury tokens for one year after distribution. Holders could use their tokens for governance but couldn’t transfer them.

The lockup period ended in December 2021. Lido began releasing these tokens into circulation during a one-year vesting period.

LDO non-treasury token vesting schedule. Source: Token Unlocks | LDO | Token Unlock – Tracking Vested Tokens and Unlock schedule

Current locked and unlocked LDO tokens as of August 2022. Source: Token Unlocks | LDO | Token Unlock – Tracking Vested Tokens and Unlock schedule

Lido vested a significant part of its supply for only one year. This short period could cause some concern since it doesn’t enforce a long-term view.

Yet, Lido has dominated its niche. As the vesting period nears its end, Lido continues to gain more market share.

This success encourages a long-term view despite the short vesting period.

Why could LDO tokens be valuable in the future?

ETH’s Merge increases interest in staking

Lido may be one of the biggest beneficiaries of ETH’s upcoming upgrade. ETH’s switch to PoS increases demand for staking.

This demand is clear even though the Merge has not yet happened at the time of writing. ETH staked in the Merge’s smart contract via Lido grew from 3.38 million in June 2022 to 4.16 million in August 2022.

Lido solves significant problems with PoS staking

Smaller stakers can use Lido to overcome challenging roadblocks. Lido lets them stake with

Both smaller and larger stakers benefit from Lido’s liquid staking. They’re free to earn yields in the rest of DeFi on top of their profits from Lido’s platform.

Also, LDO’s decentralized nature is a powerful draw for risk-averse and idealistic investors. Many stakers prefer its non-custodial nature.

These advantages created a snowball effect. They continue to increase the protocol’s value and its token’s valuation.

Thanks to its popularity, LDO’s solution is becoming a cornerstone of DeFi

LDO’s solution to significant staking problems created momentum. This momentum helped Lido secure the dominant position over its competitors.

Lido’s has a significant market share lead over other ETH2 liquid staking competitors. Source: Eth2 liquid staking balances (list) | Dune.com 

Lido’s popularity encourages other DeFi platforms to integrate Lido’s liquid token variants. For example, you can trade stETH for ETH on Curve Finance, a major liquidity source.

More uses for liquid token variants make Lido more helpful. This integration with other parts of DeFi gives Lido an advantage.

It’s hard for competitors to fork or replicate these integrations across DeFi. They create a network effect for Lido by attracting more users.

Prominent players have incentives to hoard LDO tokens

More users on Lido increases the protocol’s revenue. Being the dominant validator on a significant, profitable protocol is a valuable position.

This value encourages getting a significant controlling stake in the network through governance. The more tokens someone holds, the more votes they get.

The desire for this control encourages them to buy more LDO for more votes, driving the token’s price up. This incentive increases as Lido grows.

The Lido DAO is an example of successful governance

The DAO is succeeding in managing a multi-million dollar operation. It’s constantly innovating and ensuring the protocol’s security.

Continual audits show the development team’s dedication to security. Source: Github – lidofinance/audits

LDO will likely continue growing. It has revenue to support its treasury. It’s dominating the market and successfully governing itself.

This growth encourages the price to climb as governance votes become more valuable.

The community often submits new governance proposals. These may eventually include changes to accrue more value to LDO token holders.

If these changes occur, they may make the token much more valuable.

What’s in the future for Lido?

At the start of 2022, Lido’s team published their objectives for the coming year. These goals include:

The community has also shown interest in a governance reform. This reform would aim to help the economic interests of LDO holders.

Lido began on Ethereum, then expanded to more blockchains. It added Solana (SOL), Kusama (KSM), Polygon (MATIC) and Polkadot (DOT). It’s likely to continue expanding to other PoS blockchains.

These goals of expansion and a better user experience may raise the LDO token’s valuation.

What is the market saying about Lido?

Investors are trusting Lido despite a series of black swan events

At its height, Lido’s TVL (total value locked) reached over US$20 billion. This TVL showed significant interest and trust from the market.

In May 2022, several factors crashed Lido’s TVL. First, the crypto market began falling fast. Then, the collapse of Terra (LUNA) rippled through the market.

Informational tweets by @LidoFinance during the market crash of May 2022 as stETH depegged. Source: Lido (@LidoFinance) | Twitter

Large funds and lending protocols began collapsing. To avoid liquidation, they sold large amounts of stETH on the market.

Now that these events have passed, Lido’s investors are re-entering the platform. Its TVL came close to doubling within two months.

Lido’s TVL is recovering after the market’s collapse. Source: Lido: TVL and stats – DefiLlama

Lido’s community reinforces its market lead

Besides its dominant market share, Lido has a massive community on social networks. Its community includes:

Its community activity has increased with a jump in social volume since March 2022.

Lido’s social volume is trending upwards. Source: LDO | Sanbase

Rocket Pool is Lido’s closest ETH2 liquid staking competitor by market share. Its community is much smaller. Rocket Pool has approximately 15,500 Discord members and 26,000 Twitter followers.

Marinade is like Lido, offering liquid staking on Solana. Its social community is also much smaller than Lido. Marinade has approximately 13,500 Discord members and 31,000 Twitter followers.

There is a disparity between Lido’s community and its competitors. This difference reinforces its massive market share edge over its competitors.

It will be difficult to overtake Lido. Competitors might find it more profitable to join Lido in the future.

What are the risks for Lido?

Every protocol has its risks. Despite its current dominance, some factors could affect Lido’s future success.

Hacks, exploits, and other security issues

Almost every week, some news breaks about another protocol that had security issues. Sometimes these events resolve without much impact. Other times it destroys the protocol.

Since it depends on smart contracts, hacks or exploits could also affect Lido. The DAO takes careful precautions against these risks by conducting frequent audits.

Problems or a lack of adoption with ETH2

Although it’s expanded to other protocols, Lido still has significant ties to ETH.

It seems likely that ETH2 will be successful. Yet, there’s still a chance of problems with the network or a lack of adoption.

Either of these scenarios could negatively affect Lido.

Risk of liquid token variants depegging

Lido’s liquid staking gives substitute tokens to stakers in exchange for deposits.

It aims for these tokens to have a 1:1 peg to the staked tokens. For example, one stETH should be worth approximately one ETH. If this peg fails and never recovers, it could hurt Lido.

As the bear market progresses, some crypto funds and lenders face trouble. Market conditions force them to sell large amounts of stETH, causing it to depeg from ETH.

Graph of stETH’s historical peg to ETH. A value of 1.0 is ideal. Source: @LidoAnlalytical – Lido Finance Extended | Dune.com

Excessive leverage can also cause depegs. For example, Aave users can borrow ETH using their stETH. They can then stake that ETH and receive more stETH.

This dynamic can turn a mild depeg into a more significant crash. Repeating this leveraging cycle increases the risk of liquidations during a stETH depeg.

These liquidations would force liquidated stETH holders to sell. This selling pushes the price down, creating more liquidations in a feedback loop.

These types of depegs have destroyed other projects. In the past, Lido’s peg has successfully recovered. In the long term, it’s likely to recover again. Yet, depegging still poses a risk.

New competitors could arrive

There is always the risk of powerful new competitors emerging in any industry. At the moment, Lido is dominating its niche. Yet, the coming years could pull it from its throne.

It would be difficult for competitors to overtake Lido. Its backend and industry connections create a significant hurdle for challengers.

Lido’s treasury and revenue also increase the odds it can absorb any competitors. Its popularity and integrations in DeFi are hard for competitors to replicate.

A small set of hands held a large part of Lido’s tokens and power

Lido’s initial distribution gave much of its total supply to a small group. This group is team members, investors, staking validators, and withdrawal key signers.

This allocation gives more control over Lido to fewer people. Many of the governance votes have been unanimous. Some had the exact same vote count. These could be hints that a small group of holders has significant influence.

As tokens unlock, they also put downward pressure on LDO’s price.

Yet, these risks decrease as the vesting period continues. Tokens began unlocking in late 2021. Holders have likely sold some of their tokens to others. As unlocks continue, sell pressure and concentrated control should continue to decrease.

Bottom line

Lido established itself as the major player among liquid staking providers. It solves a significant problem for stakers on PoS blockchains.

Its DAO has performed well and focuses on expansion. As ETH2 releases, Lido’s popularity is likely to continue growing. This expanding popularity and a potential governance reform may increase the token’s value.

In this bearish market, small projects with few resources risk failure. Meanwhile, Lido is a behemoth with higher odds of success.

What can I do from here?

Who should I follow?

Sources

The information that Ticker Nerd provides is general in nature as it has been prepared without taking account of your objectives, financial situation or needs. It is not intended as legal, financial or investment advice and should not be construed or relied on as such. Ticker Nerd is for information purposes only. Ticker Nerd is not responsible for any damages or losses that may occur as a result of reliance on this information. Before making any commitment of a legal or financial nature you should seek advice from a qualified and registered legal practitioner or financial or investment adviser.
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