The State of Ethereum Staking in Q3 2023
TL;DR
- Staked ETH has grown 17% in Q3 2023
- Stake centralization remains a major risk
⇒ Lido at 32% market share presents systemic risks which must be addressed
⇒ Attack vectors include stETH & LDO holders, and Lido node operator - The network capacity is increasingly overloaded
⇒ Сonsensus overhead
⇒ Scalability concerns - Potential solutions
⇒ DVT is emerging for more efficient and decentralized staking
⇒ Some projects decided to self-limit their share to protect Ethereum
⇒ EIP-7514 will limit validator creation to favor new solutions - Economics updates
⇒ Staking APR declined by 39% as new validators got added
⇒ Deposit volume consistently exceeds withdrawals in liquid staking
⇒ LSDfi is growing rapidly, but over 50% dominated by 3 staking pools - Users start caring about usability, in addition to incentives / risk / utility
A year has passed since the Merge introduced staking, which dropped the need for high-end hardware and expensive computing resources, and invited a broader audience to participate in running the Ethereum network. This is however not what happened and validator business was never democratized, with solo stakers still representing a small fraction compared to professional operators.
The liquid staking revolution that followed encouraged smaller ETH holders to participate in staking and unlock liquidity. It led to 27M ETH being staked by now, or 23% of the total supply, and it just keeps on growing, up 17% compared to 20.5M ETH at the end of Q2.
Today it’s still easier to buy a liquid staking token that automatically accrues staking rewards minus an intermediary service fee, than set up and run a validator node to solo stake on the network directly. There’s too much perceived effort for home staking, not to mention the 32 ETH (~$50k) investment requirement, which is not accessible to the general public.
The unprecedented growth of LSTs presents a number of challenges around staking, centralization being the top concern.
Centralization worries
Many of the largest staking players are just companies like Coinbase that have one node operator, but even “decentralized” collectives can only use a handful of them, for example about 30 organizations in case of Lido. Some liquid staking providers allow permissionless access, but still there’s no breakthrough way yet to onboard the next million nodes to Ethereum easily.
The Q3 2023 discourse was centered around Lido’s dominance approaching the 33% threshold that raised centralization and even security concerns in the Ethereum community.
At this level, it can theoretically delay finality in case of collusion among the node operators that would not close blocks. Danny Ryan has identified more key thresholds and their consequences:
- Above 33% — an LST can disrupt finality ⇒ Lido is only 1% away from this threshold!
- Above 50% — an LST can censor network ⇒ Lido + Coinbase + Figment are already here
- Above 66% — an LST can achieve finality ⇒ Top 10 pools can fork Ethereum
If a majority of ETH is staked, it can also distort the economic landscape of Ethereum. External interests may affect Ethereum’s off-chain governance as well.
While there are several Node Operators under Lido’s umbrella, the fact that Lido is the gatekeeper for who gets ETH gives them hard and soft influence over their operations. Mike Neuder summarized possible attack vectors into
- stETH holders can
⇒ Cause governance standstills with their veto power, if implemented - Node operators can
⇒ Destabilize the price of stETH & LDO through coordinated slashing
⇒ Collude with builders to obfuscate MEV rewards - LDO holders can
⇒ Attack Lido to potentially steal its ETH by upgrading contracts
⇒ Damage Ethereum consensus by coercing node operator behavior
⇒ Attack due to positioning and soft power in the ecosystem - The Lido Oracle can additionally manipulate the price of stETH
Above all, the concentration of staked ETH under one provider contradicts the decentralized nature of the blockchain.
So far Lido has disagreed with being a threat for the entire validation ecosystem, and strives for dominance with daily net inflows of around 18K ETH. As a solution, it may introduce a dual governance governance system where both LDO and stETH holders will have the right to veto on certain proposals, but this proposal is not without issues. There are also plans to modularize its operations with the introduction of a staking router.
Self-limiting validator share
A more realistic approach is to realize the risks associated with one entity having too much staking power. Some projects stepped forward to self-limit their staking share already:
- Rocket Pool and Diva Staking have passed DAO resolutions to self-limit to a maximum market share of 33% and 22%, respectively
- Stakewise, Stader has stated on Twitter that they would not exceed 22%
Centralization concerns are likely to force a social push for user activism and finding ways to increase staked ETH of multiple players. There are community members who advocated for vampire attacks by creating incentives to choose more decentralized staking options.
Some of them include only 1 ETH as a minimum requirement after Diva Staking launch, or the planned LEB4 mini pools by Rocket Pool with 6.8 ETH as collateral (4 ETH + 2.8 ETH).
The rise of DVT
Distributed Validator Technology (DVT) is the most recent infrastructure trend after the season of pool staking, re-staking, and MEV yield-sharing protocols.
The initial idea was to mitigate the risks of setting up a node by providing a sort of multisig to share a single validator across a network of independent nodes. Distributed key generation split the keys, which makes staking more efficient and decentralized.
It also offers a range of benefits to the Ethereum ecosystem, like liveness and fault tolerance, and has been on Vitalik’s roadmap since 2021.
The first movers were SSV and Obol, originally developed by teams working on Ethereum. Both protocols are approaching the mainnet launch while testing integration with Lido and other providers.
Diva Staking takes DVT to the next level by pursuing an integrated approach of Liquid Staking + DVT instead of being one of the building blocks. It introduces an economic model based on unique concepts like bonds for operators and permissionless access, and offers several advantages over Obol or SSV:
- Built-in liquid staking as divETH / wdivETH provider
- Advanced integrated cryptography, whereas others use modular components
- Resilient to node failures and maintains network liveliness
- Built-in economic incentives for node operators
DVT has a chance to shape the staking landscape moving forward with more efficient, decentralized, and secure mechanics.
Consensus overhead
More staked ETH means more participating validators, which may potentially cause delays and even cascading failures in the consensus layer. More specifically, Ethereum already verifies about 800k signatures per epoch, which hinders scalability.
Vitalik recently suggested improvements to the staking mechanism and protocol structure, which aims to reduce the number of consensus signatures to 10k per slot, enhancing overall decentralization.
Current staking pools’ node operator selection process is also somewhat centralized. He’s proposing to let delegators choose node operators for the stake, making their participation less difficult than full staking, but also their role in the consensus less prominent.
Dankrad also addressessed economic and technical consequences of liquid staking that cause network issues, such as increased messaging and a growing Beacon chain. While a larger stake improves network security, the benefits diminish when the stake volume rises much higher.
Inflow of validators
As liquid staking surged post Shapella upgrade earlier this year, the validator entry queue grew very long, peaking at about 45 days for new validators to begin staking, while the exit queue remained very low during this period.
The related EIP-7514 proposal is planned as a part of the Dencun upgrade. While it does not provide a direct solution to the technical and financial difficulties that arise from the rapid expansion of ETH staking, it already helps to prevent:
- Network overload
- Consolidation of the market into Lido + CEX
by temporarily capping the growth rate of validators, lowering the rate of ETH staking, and giving new solutions time to grow.
As of October 10, there are only just over a thousand of validators in the queue, as a sign of slower staking demand and increased validator churn, which could be processed faster.
Declining staking rewards
The Ethereum community largely welcomes more staked ETH, as it implies a strong network of engaged validators that efficiently reach consensus and confirmations. For liquid staking applications, it also represents a higher TVL, which is recognized as improving the security level of the network.
As of today, the staking ratio of Ethereum (proportion of tokens staked relative to the total number in circulation) is 22%. While this growth is significant, it is still far from other top POS Networks, such as Cosmos (68%) or Polkadot (48%), which are rather close to the ideal figures of 67% and 50% respectively, due to their tokenomics design.
On the contrary, Ethereum has characteristics that largely discourage substantial staking as higher staking ratio causes greater issuance and lower staking rewards. For example, as staked ETH increased to 40M, the reward was reduced from 6.3% half a year ago, to 5% at the end of Q2, to the current 3.6%.
If improved, it presents an opportunity for much higher staked ETH levels.
On-chain economic updates
Deposits surpass withdrawals
The trend of deposit volume being consistently larger than withdrawals continues from Q2, when it experienced some spikes. Staked ETH movement has stabilized last summer, but deposits still outpace withdrawals across most of liquid staking protocols.
Shifting staking rewards distribution
Liquid staking protocols distribute about 100k ETH of staking rewards quarterly, which is half of all ETH emissions since last year. While Lido still distributes the majority of rewards, Coinbase, Rocket Pool, and Frax now cumulatively account for one fifth of the total volume, while Ankr has been losing traction.
LSDfi TVL continues to grow
While LSDfi is beyond the scope of this report, it’s definitely worth mentioning as a utility aspect of liquid staking solutions.
The TVL of LSDFi protocols grew thousands of times since the beginning of the year, and has reached $300M TVL. The landscape is rather concentrated, with the top five players holding over 74% of the market share. Curve leading the way with TVL about $70M, which corresponds to a 25% market share. Other notable and growing players are Lybra, Pendle, and EigenLayer.
More than yield
The user perspective on selecting a staking solution prioritized the following criteria in Q3:
Incentives
Historically, most staking projects used their tokens as incentives in the initial go-to-market strategy that attracted users looking for higher yields. This often led to the situation when they moved on to the next one once promotion was finished. These days returns are only one of the factors that drive demand for the staking solutions.
Risks
Stakers are now more cautious about the involved risks. Just now, Lido had 20 slashing events amounted to $31k worth of ETH, taking the involved validators offline. Even pooled staking can be affected by a combination of counterparty, smart contract and execution considerations. DVT helps achieve a better uptime by sharing the Ethereum node with a dozen of other network participants and providing fallbacks in case some nodes are offline or causing troubles.
Utility
Liquid staking offers improved liquidity with a range of options to gain additional rewards, while reducing the opportunity cost of locking up the funds. Seamless integration into the DeFi ecosystem remains a core requirement to access yield opportunities and acquire their benefits directly and without delays.
Usability
As the market matures and we start moving from early to late majority phase, many less tech savvy people are looking for easier user experience to onboard to staking. Surprisingly, usability is becoming an important factor when selecting a staking solution, given the above requirements are met.
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