Growspace Research: Lido (LDO)

Updated: Oct 11

Introduction


Lido is a liquid staking solution for Ethereum, Solana, Kusama, Polygon, and Polkadot. Liquid staking allows users to earn staking rewards whilst maintaining a liquid variant of their stake. Lido's platform provides a convenient and decentralized way to earn staking rewards on supported cryptocurrencies. You no longer need to set up a node with powerful specifications or have the threshold amount of crypto to benefit from staking. With Lido you can stake any amount of crypto you desire, along with earning additional yields on the derivative st tokens in the DeFi ecosystem (more on this later). How do they do this? Read on..


How does Lido work?


User's Perspective:


Lido lets the users stake their crypto assets for daily staking rewards. A user can stake any amount of tokens (no minimum). When staking in Lido you mint staked tokens (st tokens) which are issued in a 1:1 ratio (1 stETH minted will be in return of 1 ETH staked). Users can then use these st tokens as collateral, for lending, and yield farming across the DeFi ecosystem to earn returns in addition to the staking rewards. The Lido DAO manages Lido's governance (more on that later).


Behind the scenes:


Key components of the Lido ecosystem are:


  1. Staking pool

  2. stETH

  3. Lido DAO


The staking pool is the core smart contract of Lido. It is responsible for:


-Ether (ETH) deposits and withdrawals

-Minting and burning stETH tokens

-Delegating funds to node operators

-Applying fees to staking rewards

-Accepting updates from the oracle contract


Sequence of events:


Step 1: Users send the ETH tokens to the staking pool contract, and stETH tokens get minted in return (in a 1:1 ratio)


Step 2: ETH from users gets distributed to the DAO-selected node operators. These node operators are the ones doing the actual staking and transaction verification on the Beacon chain on users' behalf.



Source: How Lido Works


Step 3: Oracle, assigned by the Lido DAO, keeps track of the balances of the validators on the Beacon chain. These balances can increase (due to staking rewards accumulation) or decrease (due to slashing).



Source: How Lido Works


The following infographic summarizes Lido's working very well:



Source: @Leo_Glisic


2 points to take note of:


  • As user funds are pooled together, the penalties from slashing will result in a loss of funds for all the depositors.


  • Node operators do not have access to the user funds, rather they have a validation key (public) which enables them to validate transactions on stake of the users. Thus, Lido is a non-custodial solution.


Value Proposition


The core value proposition of Lido is that it preserves the liquidity of staked assets. With Lido, users can earn the staking yields and simultaneously use the liquidity of their staked assets in the form of the derivative st tokens (like stETH). These derivatives can be used in the DeFi ecosystem as collateral, for lending, and yield farming as they are minted 1:1 against the original assets. By issuing an Ethereum-native liquid token (stETH), Lido allows you to use staked ETH as collateral within DeFi in the same way you can use ETH currently. Lido ensures this by having built strong partnerships with almost all the big players in the DeFi space like Aave, Curve, Yearn Finance and more. You can keep stETH as collateral in Aave to borrow crypto, swap stETH for ETH in Curve's liquidity pools, and so much more.


Tokens and Tokenomics


The Lido ecosystem involves 2 kinds of tokens, LDO token and st tokens.


LDO is an ERC-20 token that acts as the governance token for the Lido DAO. Key responsibilities of Lido DAO include:


  • Deploying protocol smart contracts

  • Setting fees and other protocol parameters

  • Assigning initial DAO-vetted node operators

  • Proposing and updating Lido's parameters

  • Managing the Lido DAO's insurance and development funds


LDO's voting weight is proportional to the amount of LDO staked by the voter in the voting contract. The more the number of LDO tokens in a user's voting contract, the greater their decision-making power will be.



Source: Introducing LDO (lido.fi)


At the launch of the Lido DAO, 1 billion LDO tokens were minted. Token generation event happened on 17th December 2020. The allocation of these tokens is as follows:


  • DAO treasury - 36.32%

  • Investors - 22.18%

  • Validators and signature holders - 6.5%

  • Initial Lido developers - 20%

  • Founders and future employees - 15%


Tokens are supposed to be locked for 1 year (locked till 17 December 2021), followed by a one-year vesting period (will vest by 17th December 2022). These restrictions apply to developers, validators, investors, founders, and employees.


The derivative tokens (st tokens) enable users to access the liquidity of their staked crypto in the DeFi ecosystem and earn additional yields. These st tokens are burned when the original/underlying tokens are redeemed.


Business Model


Out of the net staking rewards, Lido takes a 10% cut of the staking rewards, and the rest 90% goes to the st token holders.



Source: Token Terminal


Total revenue (green) represents the total staking rewards and Protocol revenue represents (blue) the 10% cut of Lido. Of this 10% amount, 5% goes to the node operators, and the rest 5% goes to the Lido DAO treasury.


Depending on the network (Ethereum, Solana, Polygon etc), the rewards either show up as increases in the st tokens through its balance or its exchange rate (how much underlying crypto you can redeem for 1 st token).


Competitive Landscape


Lido is the second largest protocol with respect to the total value locked (TVL), as of 23rd August 2022, and has ~90% market share of the non-custodial, decentralized Eth2 liquid staking category.



Source: Dune Analytics


The biggest competitor of Lido is Rocket Pool with a market share in non-custodial liquid Eth2 staking of ~5%. The major difference between Lido and Rocket Pool is the selection of validator sets. Lido’s validators are carefully selected node operators through voting in the Lido DAO. In the case of Rocket Pool, anyone can join the Rocket Pool decentralized node operator network by staking a minimum of 16ETH.


Also, Lido is a multi-chain solution provider whereas Rocket Pool only serves Ethereum stakers, thus considerably reducing its Total Addressable Market (TAM). Another key differentiator between the two protocols is the liquidity of their corresponding derivative tokens (eg: stETH of Lido and rETH of Rocket Pool). Lido, by incentivizing liquidity providers in the DeFi ecosystem through LDO token incentives has been able to build a deep liquidity for stETH. For instance, Curve’s stETH-ETH pool has a TVL (total value locked) of over $1.3 billion, as of 24th August 2022. This makes it more convenient for stETH holders to redeem back the actual ETH tokens (by swapping on Curve, for example), consequently increasing the user’s trust. Rocket Pool does not have such incentive programs to increase rETH’s liquidity in the DeFi ecosystem. Lido’s multi-chain presence, already strong adoption, considerably less liquidity of rETH compared to stETH, and the first mover advantage (of Lido) will make it extremely difficult for Rocket Pool to catch up.


Key Metrics


1.stETH/ETH ratio



Source: CoinMarketCap


stETH to ETH ratio has always remained within +/-10%. An interesting point to note is that if stETH/ETH < 1 then we are actually getting free money as 1 ETH is redeemable for 1 stETH token irrespective of the price.


2. Ethereum Liquid Staking Competitors



Source: Dune Analytics


Lido is clearly the leader of Eth2 liquid staking space, responsible for over 80% of the total liquid staking of Ethereum.


3. Total Value Locked (TVL)



Source: Defillama


The steep decline in TVL around mid-May was triggered by the depegging of UST (Terra) which marked the beginning of the market downturn we are undergoing currently. Although, the TVL is clearly recovering as can be seen from the chart above.


Growspace Thesis


Lido solves a fundamental problem for users by almost eliminating the opportunity cost of staking through its derivative st tokens. Lido offers a great investment opportunity because:


  • Lido’s effective tokenomics and integration within DeFi giants like Curve, Aave and Maker make these st tokens almost equally valuable as the original crypto assets. Ability to retain the liquidity of staked assets and possibility to earn additional yield is a significant value add.


  • Lido dominates the liquid staking market and is the single highest Ethereum staking entity in the world (representing over 31% of the total ETH staked). JP Morgan predicts staking to generate $40 billion by 2025, and Lido will be a key player in this industry.


  • Post the Merge, holding the LDO token will give you voting power in one of the most powerful DAOs in the crypto ecosystem as Lido DAO will then be controlling the single largest staking entity for the largest PoS blockchain, Ethereum

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