Season 5 | Episode 9
In today's season 5 finale we take a deep dive into the multifaceted world of Liquid Staking. Mike and Myles scrutinize critical aspects such as market structure, exploring its influence on liquidity providers and governance. They also discuss social scaling, evaluating its role in the adoption and scalability of Liquid Staking solutions along with the implications of self-limiting. This episode is a holistic recap of the season and with the biggest takeaways from Season 5.
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Timestamps:
(00:00) Introduction
(02:58) LST Market Structure
(13:16) Social Scaling & Self-limiting Debate
(28:19) “Permissionless Promotion”
(29:15) Curation VS Permissionless
(35:25) Liquid Staking Router Outlook
(43:09) Re-staking & Liquid Staking Intersection
(52:15) Lido Governance Role & Impact
(56:16) Future of Liquid Re-staking
(1:01:10) Co-Opetition: Eigen Layer & Lido
(1:07:08) MEV & Liquid Staking Intersection
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Follow Myles: https://twitter.com/MylesOneil
Follow Mike: https://twitter.com/MikeIppolito_

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Use code BELLCURVE30 to get 30% off Permissionless 2023 in Austin: https://blockworks.co/event/permissionless-2023
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Resources:
Chorus One Validator Economics
https://medium.com/chorus-one/exploring-validator-economics-on-solana-cb1498a3aef6

How POS Networks Nurture Decentralization by Felix L
https://chorus.one/articles/how-can-proof-of-stake-networks-nurture-decentralization

Sreeram Episode
https://podcasts.apple.com/us/podcast/the-intersection-of-restaking-and-liquid/id1641356619?i=1000622262081 
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Disclaimer: Nothing said on Bell Curve is a recommendation to buy or sell securities or tokens. This podcast is for informational purposes only, and any views expressed by anyone on the show are solely our opinions, not financial advice. Mike, Jason, Michael, Vance and our guests may hold positions in the companies, funds, or projects discussed.

All right, everyone, welcome back to another episode of Bell Curve.

Before we jump in, quick disclaimer, the views expressed by my co-host today are their personal views and they do not represent the views of any organization with which the co-hosts are associated with.

Nothing in the episode is construed or relied upon as financial, technical, tax, legal, or other advice, you know the deal.

All right, everyone, welcome back to another episode of Bell Curve, special episode of Bell Curve, because this is the season finale for season 5 where Miles and I are going to be recapping all the episodes that we've done thus far on liquid staking.

It's a little bittersweet, you know, finishing a season.

But Yeah, I think we went into this season not sure if there was enough maybe to even have a full season on liquid staking.

By the end of it, I feel like we have even more to talk about that we didn't get to, but I think we still covered a lot of ground.

Yeah, I'm really, really happy we decided to dig in on this topic.

So I'm looking here and maybe to give just a little bit of a roadmap for the audience who's listening in.

We ended up covering an enormous amount of ground.

Some of the themes that we thought about going into this season was we were very interested in market structure.

So what was the market structure endgame going to be for liquid staking protocols?

And specifically, we were interested in looking at power laws, right?

So is this going to be very fragmented market or more of a winner take all or winner take most.

We're interested in the principal agent problem and how you could maybe mitigate that with different mechanisms, which we covered in detail.

And we didn't really talk that much about dual governance.

We will a little bit in this episode, but also the staking router that Lido's pioneering.

Social scaling, that was a really big thing.

And that is, you know, not to make this too topical, but the self-limiting debate is cropping up in a big way for Lido again, as it approaches 33% of stake.

We also talked about different approaches and sort of LST adoption across the ecosystems of not only Ethereum, but Cosmos and Solana.

And I think looking back at the history was very instructive about why Lido specifically found product market fit on Ethereum as opposed to some of these other ecosystems.

But there's some experimentation that's going on, especially in Cosmos land that I find super interesting.

And then last but not least, we spent a good amount of time talking about earlier in the season, the intersection between liquid staking and restaking, which I thought was great.

We kind of got at this tension between letting things be very permissionless and turning things over to governance, as opposed to this idea of training wheels and having a bit more of an opinion from a more centralized entity, but that actually might result in a better outcome in terms of even decentralization, paradoxically over time.

So we want to just start off, Miles, I'll turn this over to you to kick it off, but what are your thoughts on market structure?

And maybe we could talk about specifically within Ethereum and then how that might ripple out.

So I think we went into the season, or at least I did, with the assumption or with the thinking that this is likely going to be a winner-take-most, winner-take-all sort of market per ecosystem.

I think we can get into this, but I don't think these network effects necessarily travel that well as evidenced by Lido's domination on Ethereum that has not necessarily translated into their Solana products winning or their – we'll see with Cosmos.

But yeah, I think maybe just a couple thoughts.

I think as an LST provider, the most important assets you have are brand, which kind of comprises of security and really just Linde and integrations.

And so I think the long-term winners are probably in production today because these early mover advantages really just compound over time.

Earlier you are and without getting hacked, the more Lindy and you know that kind of kind of accrues to the brand right and then the more time you have to build up liquidity for your token which helps with integrations right so you can see Lido's early mover advantage materialized into being the first to integrate with Aave, the first to integrate with Maker, and that further boosted their lead.

And so yeah, I think, but it's at the same time, it's very interesting to look at, I guess, market penetration across these different ecosystems.

And we talked a lot about this, but it was kind of the perfect storm on Ethereum.

I think, I forget who we were talking to, I think it was Aiden who said basically the more broken your protocol is in terms of handling liquid staking, the more prevalent liquid staking is gonna be, or maybe the more broken it is at handling stake, right?

And so if it's very easy just to natively, within your Kepler or your Phantom wallet, delegate your soul or atom to a validator, then you're not going to necessarily need to go point to something like Lido in order to stake.

And so I think the difficulty of staking mixed with the existing DeFi ecosystem made Ethereum extremely attractive for liquid staking.

It's now gotten off to a lead that makes everybody nervous because they think about Lido as 1 entity.

I think about the stake in Lido as comprising of whatever it is, 30 validators.

But it is 1 entity in terms of its governance.

And So we can talk about it later, but how do you unlock further market share by getting the market comfortable with your lead?

You can mitigate the principal agent problems through something like dual governance, opening up the staking pools to become permissionless through the staking router, etc., etc.

So yeah, that was just kind of a long rambling.

Let's break some of this down and maybe try to give for listeners sort of a clear and explicit prediction or picture of how we see the future playing out.

But let's say maybe definitively at the end of the season, how we're feeling about it is there are very strong power laws or network effects within individual blockchain ecosystems that don't necessarily travel.

So what we would expect to see in the future is a liquid staking ecosystem on Ethereum dominated by probably at this point, it looks like Lido.

They have a lead that would be very, very difficult to beat.

And the reason for that is sort of this Lindy-ness and security-ness.

Obviously for those of us who've been paying attention to crypto over the last couple of years, hacks are still incredibly real.

And I think in order for you to justify not using the product or service of a leader, the product has to be an order or 2 orders of magnitude better.

And there's just not that much to really differentiate with in liquid staking.

So that lendiness and securitiness and the amount that will lead to liquidity, which is ultimately what you really want from a liquid staking protocol.

So what we would expect to see is probably Lido being dominant on Ethereum and then fragmentation.

What we would not necessarily expect to see is Lido being the dominant liquid staking provider across other blockchain ecosystems.

To your point about network effects not traveling, Lido made a pretty unsuccessful play into Solana a while ago.

It was very interesting to talk to Zave, who was the CIO at Chorus 1, and Chorus 1 was sort of the back end for Lido expanding into Solana.

He mentioned 1 of the lessons learned and when they were sort of doing their postmortem on why this didn't work, token incentives were actually a really big deal.

So that's 1 of the reasons why maybe concretely network effects don't travel.

So what you would expect to see is a dominant liquid staking provider in Solana take off in a very similar way that it had Lido has on Ethereum.

Maybe we talked to Lucas from Jito, maybe that's Jito's soul, maybe it's Marinade.

I think they're the front runner today, but probably very, very similar.

And then in the Cosmos ecosystem, I think Stride is the dominant provider now.

I'm not saying any of these things to, you know, King make or anything like that.

I'm just pointing out who the leaders are today.

So that's probably how we would expect to see it playing out in the future, right?

Liquid staking protocols, I just don't see them as the kind of product where there's going to be some big technical disruption in a couple of years that unseats or the existing incumbents.

We've talked about that a little bit and it's unclear exactly where that stacks up versus brand and security and you know, Lindy basically.

It seems like it doesn't actually, you know, an extra percentage point or 2 of yield does not really move the needle enough to like unseat Lido if there were to be, because I think Lido is not the highest yielding LST by a lot.

And yeah, I think maybe 1 thing also to note is that there is a market that at the moment can't touch Lido.

And this is, or I'd say this market is twofold.

The market that's not using Lido is the market that can't use Lido.

And there's also going to be a market that likely won't be able to, won't know about Lido.

And so I do think that it will be very interesting to see.

I think Lido wins the market of everybody that can use Lido.

But I do think there is a market of, you know, for the liquid collective for products like CBE that you know has a more I guess enterprise grade validator set KYC front ends things like that right that fiduciaries can offer to their customers And just how big a market that is in the end game, I don't know.

But I do see Lido, I think it's going to be very difficult for Lido to break into that market unless they give their users the ability to delegate to whatever validator they choose or whatever validator set they choose.

And we know that that in itself, you know, needs, has trade-offs, right?

Because that today is part of governance, right?

And governance allows, at least allows, you know, Lido to stay Ethereum aligned.

If you hand that choice over to the users and all of a sudden we have billions and billions and billions of stake pouring into Lido that is being deposited and delegated to, you know, a staking router pool of like 3 validators, right?

Then all of a sudden people are going to get like maybe these self-limiting debates get a little bit more legitimate.

But I think that's, yeah, I think Lido's gonna have to think long and hard about the best way to handle that and the trade-offs there in order to get, break out and reach that market.

But yeah, I think really there are winner-take-all, like, you know, a lot of effects here, But we have to keep in mind that the customer preferences, and some of them can't necessarily use the winner.

But apart from that, I don't see a lot of winners here.

It kind of depends on how many big proof of stake DA layers you see in the end game as well.

Maybe it's a handful of big layer 1, like Celestia and Ethereum, obviously, and Solana, Cosmos Hub.

Then this doesn't really apply at the roll-up level, right?

Or I don't think it's unlikely at this point that we're going to see a lot of like roll-up tokens, you know, with permissionless staking and for their sequencers launching LSTs themselves.

So it could be just a handful of winners at the end of the day.

And I think that Lido is really well positioned for Ethereum that is not extremely sensitive with KYC and enterprise grade validators.

I think there's probably another market that is on Ethereum.

And then I think Stride's really well positioned for a couple other layer ones like like Adam in the cosmos ecosystem, Celestia and I think Gito and there's a couple players.

I don't know how Solana is going to play out, but it is a little bit more fragmented over there.

It's pretty equal market share actually between the 3 players.

Well, that observation actually came from our Solana episode.

It was Zaver or Lucas that said that the more the protocol does, the less opportunity there is for external liquid staking providers.

So this is probably a good opportunity to transition to this idea of social scaling and the self-limiting debate.

So again, to just go back and do a little bit of a history lesson and this is something that we've covered pretty extensively throughout the season, So I don't want to get into too many details, but the history of why, at least from my perspective, Lido found product market fit on Ethereum where it didn't in Cosmos, for instance, where the concept was invented, or at least first conceived of.

So 1, there was the dynamic of the beacon chain and essentially the dynamic was when you staked your Ethereum before there was the merge, there was an indeterminate period of time for when you would be able to get that Ethereum back, if you would ever be able to get it back.

So when LIDO launched, the immediate value proposition was that you can stake your ether, but then you can continue to use it.

And that was an enormous value proposition for LIDO right off the bat.

Number 2, there's no in-protocol delegation for stake.

There's an enormous demand for holders of Ethereum to stake passively and to receive those rewards.

But Ethereum said, we don't want to put this in the protocol for a variety of reasons that we've covered in terms of how we want our validator set to ultimately look like.

And then 3, there was a thriving DeFi ecosystem on Ethereum.

So DeFi first really took off and is still most active by far on Ethereum.

So there was a capital efficiency question of, hey, I want to stake and secure the network and receive that yield, But I also don't want to give up the opportunity costs of participating in DeFi.

So liquid staking neatly solves all 3 of those things.

So now what happens is that you have liquid staking takeoff in Ethereum.

These market dynamics that we talked about, the winner take most or all, market structure is starting to play out.

And Lido is gobbling up stake on Ethereum.

And again, I don't think this, obviously, Lido executed, they were directionally right, they got a little bit lucky based on the ecosystem.

But this probably natural dynamic of a natural monopoly similar to a utility provider is starting to play out.

And then folks in Ethereum are saying, whoa, whoa, whoa, this is quite risky here.

If there were to ever be something like a catastrophic slashing event, an enormous amount of ETH got evaporated, this could actually mess with how the protocol comes to consensus and secures itself.

And another thing that could happen is ultimately if in a world where Lido has 100% of Ethereum stake for instance, then suddenly the governance token of Ethereum is really the Lido token.

And huge decisions for the Ethereum protocol can actually be made by a much smaller market cap subset token.

So I think these are the problems that are starting to get raised.

And I think there are good, good, there are good perspectives on both sides of this debate.

Miles, I'd be curious, what do you think about the self-limiting debate overall?

And then maybe we can get into some of the ways that Lido is thinking about mitigating these risks.

I think it is a, it's a very, there's a lot of dynamics that are interesting around the self-limiting debate.

You know, both kind of what it says about this social governance, right, that Ethereum follows, and it's a little bit, it's always a little bit opaque as to you know like how things how decisions are made in Ethereum and it's just very kind of interesting there's a lot of interesting stuff there.

I would just say that you know first of all the people who have come out and said we're going to self-cap at 22%, you know, they have a fraction of the market share of Lido and 22% would be an incredible outcome for these players given, you know, their current positioning.

And 2, you know, again, we're now, the focus is on Lido, but in a negative way maybe, but 3 years ago, Lido was really the 1 kind of hope for Ethereum to avoid network centralization with all these like pseudo liquid staking tokens from exchanges, right?

So there is the question of, okay, would Ethereum look, how would Ethereum look today if Lido didn't exist?

But at the same time, You can think about, all right, yes, it's not great that 1 governance token controls basically 33% of the network sake.

Because we know that all these validators, there's 30 validators and they're not controlled by the governance token of Lido directly.

So what is Lido doing to mitigate all this?

And are we okay with Lido having 66% in 2 or 3 years if dual governance is live, right?

And they've launched all these permissionless staking pools via the staking router.

And their stake is now distributed, not just across like 30 validators, but a thousand validators, right?

And that's really the question we should be asking is in 2 or 3 years, assuming that this chart of Lido's market share continues to go up and to the right, what will Lido look like at 66%, at

And if it's thousands of validators and that's not a terrible outcome and you just have to be also super realistic about what it would look like if Lido decided to, you know, hang up all of their work today and say, you know, that's it for us, like stop depositing to us.

What would Ethereum look like in 2 and 3, 2 to 3 years if that was the case?

So to summarize this, let's just go out and say it would probably be an undesirable outcome if Ethereum consensus was governed by this opaque centralized organization.

And I don't think that that's what Lido wants.

So there are a couple of different ways that you could continue to ensure that the liquid staking ecosystem on Ethereum remains not dominated by any, couldn't be easily co-opted.

So 1 strategy would be this self-limiting debate that you see.

And you could actually try to socially enforce the idea that no 1 liquid staking provider should get more than 22% of governance or of market share.

And there have been various suggestions for how to do this.

The 1 that I think makes the most sense to me if you were to go down this route is to gradually increase the rate that Lido takes on everything after 22%.

So for every bit of stake that you have over that 22%, Lido starts charging higher and higher fees to the point where that stake naturally moves to other providers.

You could just say, we want a healthy ecosystem of different participants.

The other approach would be to say, guys, there's no use fighting this.

This is, this is, there are natural market forces at work here.

And instead of trying to force an unnatural distribution of liquid staking providers, instead what we should do is accept that there's a natural monopoly here, and we should focus on making the winner take most, which is looking like it's going to be Lido, we should make them as decentralized as possible to the, to the point where governance is almost as decentralized as Ethereum itself.

And instead of having this white listed set of node operators, we have many hundreds or even thousands of validators and that's what the staking router is.

And then we should also make sure that the governance of Lido is very robust and that Steeth holders actually have some say in governance as well, which is where you get dual voting or dual governance rather.

I would probably not be on the side of self-limiting.

And I do want to give a shout out to folks like SuperFizz, who have just been extremely beneficial to the Ethereum ecosystem overall.

I totally understand the arguments and where they're coming from here.

And I think, you know, if I were to try to steal me on the other side of this debate and say, hey guys, there's a huge problem here.

I'm watching this meteor come right for us and at least I'm trying something, Right.

But what I would say is I think the downsides of trying to enforce a self-limiting debate would be a, you actually want to incentivize entrepreneurs to come and build enormous businesses.

And I think this, there are very few things in crypto that have true product market fit.

I think you can, we've talked about this before, I think you can make a really compelling, you can make a very compelling argument that it's basically Bitcoin and Ethereum.

It's the centralized exchanges, probably stable coins and it's liquid staking tokens.

And to take the dominant liquid staking token provider and try to cap it right out of the bag, I just don't think we have enough examples of product market fit in crypto that we want to be doing that.

And it just sets a bad precedent, I would say.

So that downside to me outweighs the upside.

And I think it probably makes sense to pursue a different approach.

The other thing I think is you're starting to see much more of this idea of Ethereum alignment.

And I think it's very well intended, actually.

The idea is that Ethereum has these values as an ecosystem.

We want to see these values propagated around different businesses and providers of products and services that crop up.

The problem is Ethereum doesn't have a formal governance system.

And when you don't have a formal governance system, there are pros and cons to that.

But then you start to get this idea of Ethereum alignment.

Everyone starts to ask, well, what does that really mean?

And who is setting the definition of what Ethereum aligned really is.

And it starts to feel very shadowy and Illuminati-esque when it really isn't like that.

It's a, it's a well-intentioned group of people that I think are trying to push a good set of values.

But there's an optics question that I think is only going to get worse.

So I really do think it makes sense for the community to question this idea of what Ethereum aligned really means and who is setting these ideas.

I think there needs to be a little bit more transparency for going down this route because I think people will continue to reject it as an idea.

I just also don't think it scales, right?

Like we can't just rely on what is considered Ethereum aligned and the depths of a bear market where it's really just like, you know, missionaries left at this point that are building and so maybe Lido doesn't look Ethereum aligned today relative to those people but again zoom out like 2 or 3 years and say we actually you know do grow the Ethereum user base by 10 or 100x.

Like, I think Lido is going to seem pretty aligned at that point, and you're not going to be able to rely on everybody, you know, kind of following suit and like into this kind of goodwill approach of building businesses.

I think the 2, if you're gonna be realistic, the 2 ways to approach this, if you don't like that future, are 1, to push to build some sort of regulation into the protocol itself, like the LSM, like that is a practical way of self-limiting or of limiting these different providers or to build a better competitor, right?

Because those are the only ways that you're actually going to unseat Lido, I think.

And like, it's just kind of nearsighted thinking to me.

And 1, maybe to put things in crypto talk is if blockchains are tools for social coordination, And in large scale human coordination, you need both carrots and sticks, I think.

And what my, at least my perception is Ethereum alignment is this emerging stick.

And if you don't do what we say or we want, again, I think in a positively intentioned way, there will be these negative repercussions for you.

And I think if that ends up being the dominant stick, so to speak, you open yourself up to a very specific type of griefing attack, which is exactly what Sam Bankman-Freed did, which is he said the right shibboleths.

But he obviously, he wasn't really aligned, but he made himself appear that way to many people very successfully over a long period of time.

And I think what you could see down the road is people saying they're Ethereum aligned and doing all the things that look, look right, but they aren't necessarily actually.

I'm imagining the Trojan horse, you know, like Ethereum aligned on top.

And I think that there's also, from a design standpoint, we can talk about training wheels.

And I think that that was the crux of the criticism last year in the self-limiting debate, right, that they had no plans to move off or they hadn't published plans to move off of this curated permission set.

But the reality is if they had had a permissionless set like RocketPool from the beginning, they would not have been able to scale to the size that they were at where they were actually the market leader instead of Coinbase and Binance and stuff like that.

And I think we're seeing that now with roll-ups too.

We'll see roll-ups that attempt to launch with a permissionless sequencer set, which will require, you know, getting a supply side to bond collateral and like that's going to be an economic cost of the sequencer, to the roll-up I mean.

And the ones that start off with these training wheels, right?

Let's say we have 4 or 5 increasing to 10, maybe to 20, governance-elected sequencers.

And they're going to act in the ways that we tell them to through governance or we'll boot them off, right?

Like that to me is a really good analogy of, you know, those roll-ups are gonna scale and have better economics and get to the point where, you know, they're big enough that people care and then maybe they move to some sort of, you know, more permissionless sequencer set if they're big enough for that to be necessary.

But yeah, I think we're starting to see those training wheels coming off with Lido and we're starting to see the introduction of dual governance as another way to mitigate the principal agent problem.

Hey everyone, we've got a great episode here, but before we do, I just wanted to give a quick shout out to Permissionless.

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