Lido Faces Tooth and Nail Fight in Liquid Staking Arena

In the competitive liquid staking market, Lido, the second-largest protocol in DeFi, faces challenges from centralized exchanges like Coinbase. Despite Lido's dominance, Coinbase's entry has led to a decline in Lido's market share, raising concerns about centralization risks in the industry. Lido's co-founder emphasizes the ongoing battle between CeFi and DeFi, with capital efficiency being a key advantage for CeFi. Additionally, Lido has spent $300M on incentives to boost liquidity, but believes this may no longer be necessary due to increased interest in discounted staked ETH.

Lido Faces Fierce Competition in the Liquid Staking Arena

Amidst the burgeoning decentralized finance (DeFi) landscape, Lido, a prominent staking protocol, finds itself embroiled in an intense battle for market dominance within the liquid staking industry. Lido's co-founder, Vasiliy Shapovalov, acknowledged the stiff competition posed by Coinbase and other centralized exchanges at the recent Devcon, Ethereum's premier conference.

With approximately $6 billion in user assets under management, Lido stands as the second largest protocol in the DeFi ecosystem and the undisputed leader in the liquid staking realm. This entails providing users with tradable tokens in exchange for staking their Ether or other cryptocurrencies, including SOL, via their platforms. These derivative tokens, in turn, can be deployed within the DeFi space to generate yield.

However, Lido's market share has dwindled since Coinbase's entry into the liquid staking segment earlier this year. In May, Lido controlled nearly one-third of staked Ether. According to data from crypto firm Rated, that figure has since declined to 29%.

Conversely, Coinbase has witnessed a surge in its liquid staking operations, with nearly 800,000 ETH, worth approximately $1 billion, staked through its platform since June. This growth has accelerated following the launch of Coinbase's cbETH token.

Centralization Concerns Haunt Liquid Staking

A significant portion of the crypto community harbors reservations towards centralized exchanges like Coinbase. Despite their crucial role as gateways to digital assets, these entities operate as custodians, susceptible to state regulation – a stark contrast to the decentralized ethos of blockchain technology, which seeks to facilitate peer-to-peer transactions beyond government reach.

During his Devcon presentation, Shapovalov projected that the liquid staking industry would ultimately consolidate, with dominance likely falling either to a Lido-esque protocol or a centralized exchange. The latter scenario, he cautioned, would represent an unfavorable outcome for Ethereum.

Acknowledging the economic advantages enjoyed by centralized entities, Shapovalov asserted in an interview with The Defiant that the battle for the future of liquid staking remains "winnable," contingent upon the broader conflict between traditional finance (CeFi) and DeFi.

"We heavily rely on the entire DeFi ecosystem to triumph over CeFi options," he stated. "Currently, the only area where CeFi surpasses DeFi is arguably capital efficiency. Centralized exchanges facilitate derivatives with greater ease."

Shapovalov expressed confidence that DeFi would gradually improve its capital efficiency. However, he also raised concerns about regulations that could potentially favor CeFi as the primary on-ramp for users, preventing them from venturing deeper into the DeFi space.

Liquidity Incentives: A Double-Edged Sword

Shapovalov also addressed the substantial incentives that Lido has deployed to bolster the liquidity of its derivative token, staked ETH (stETH). According to data compiled by Lido, the protocol has disbursed nearly $300 million in incentives to date. Rocket Pool, Lido's primary decentralized competitor, has recently implemented its own liquidity incentives in an attempt to gain market share.

While acknowledging the necessity of liquidity incentives, Shapovalov believes that their use will eventually become obsolete, potentially sooner than anticipated by the Lido team.

Following the dramatic collapse of crypto hedge fund Three Arrows Capital in June, Lido was compelled to reassess its assumptions regarding the demand for stETH at discounted prices. Typically, stETH trades at or close to the price of ETH. However, in the wake of Three Arrows' implosion, the hedge fund attempted to liquidate its assets, including a substantial quantity of stETH, in a desperate bid to remain solvent. This sell-off caused stETH to "de-peg," plummeting to as low as 93 cents per dollar of ETH. Since then, it has recovered to its customary range of approximately 99 cents per dollar of ETH.

"Individuals were eager to purchase staked ETH at a discount," Shapovalov noted. "Subsequently, we do not need to heavily incentivize it. However, we must ensure sufficient price discovery and momentary liquidity pools to accommodate these bids, enabling users to make substantial purchases on automated market makers."

The Future of Liquid Staking

The competitive landscape of the liquid staking industry remains fluid, with both Lido and Coinbase vying for supremacy. The outcome of this battle will likely hinge upon the broader regulatory environment and the evolving relationship between CeFi and DeFi. As the DeFi ecosystem matures and capital efficiency improves, Lido may be well-positioned to maintain its dominance. However, the persistent threat of regulation and the allure of CeFi's convenience could pose significant challenges for the protocol's long-term prospects.