Lead Ethereum developer, Danny Ryan said that Liquid staking derivatives (LSD), such as Lido and similar protocols, can pose significant risks to the Ethereum protocol and pooled capital when they exceed critical consensus thresholds.
He highlights the dangers of cartelization and emphasizes the need for self-limitation to avoid centralization and protocol risks that could potentially harm the product. According to him, acknowledging and addressing these inherent risks is crucial to maintain the stability and integrity of the Ethereum ecosystem.
Ryan said that it is crucial to recognize the risks posed by LSD protocols to both the Ethereum protocol and the capital allocated to them. Cartelization, abusive MEV extraction, and censorship threaten the stability and security of the Ethereum network. While users and developers can respond to these threats, pooling capital into a cartelization-prone stratum puts both the Ethereum protocol and the pooled capital at risk.
He wrote, “ETH holders, in the long run, are just a subset of users, so staked ETH holders are even a subset from there. In the extreme of all ETH becoming staked ETH under one LSD, governance vote weights or aborts by staked ETH do not protect the Ethereum platform for users.”
To mitigate these risks, he recommends that LSD protocols, including Lido, impose self-limitations and that capital allocators refrain from allocating more than 25% of total staked Ether to LSD protocols.
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He added that another risk of governance deciding node operators is regulatory censorship and control. If pooled stake under a single LSD protocol exceeds 50%, the pooled staked capital gains the ability to censor blocks, and even worse, at 2/3 majority, they can finalize such blocks. This means that regulatory entities can request censorship from the governance token holders, who then become a specific target for regulation.