👉 News . By switching to Proof-of-Stake, Ethereum no longer works with miners (like Bitcoin) but with validators.
👉 Background. To become a validator, you need to tie up 32 ethers (more than €40,000) on Ethereum.
👉 Why this is important. Lido is a rather ingenious protocol that allows anyone to become a validator without necessarily having 32 ethers.
For the past week, there has been a sense of relief in much of the crypto ecosystem. Ethereum's Merge, which we've explained to you in detail over the past two weeks, has gone very well. The blockchain is still working and consuming much less power than before - a 99.5% drop - thanks to Proof-of-Stake. Perfect, you might say!
Except that this update has also changed the way Ethereum works, which no longer runs in exactly the same way. It is no longer miners (Proof-of-Work) who run the protocol, but validators.
Or to be a validator, participate in the network and earn cryptos (ethers in this case), you need to "staker" (immobilise) 32 ethers. Even if prices have fallen sharply, that's more than €40,000! And just imagine if the price goes back up to where it was in 2021 (over €150,000)... Not very democratic or decentralised, is it? Fortunately, there are solutions.
There are two main ones:
Immobilise your ethers via an exchange platform like Kraken or Binance. This solution is the easiest for beginners because there is no technical complexity and no minimum threshold is required (exit the 32 ethers!).You can currently expect around 4% annual return via these platforms. On the other hand, this is a highly centralised option. You're obliged to trust Kraken or Binance, who hold your crypto-currencies and can take a significant commission on the rewards of *staking*.
Going through a liquid, decentralised staking provider (liquid staking) . It's a bit like using an exchange platform, but without the exchange platforms: the ethers you place remain associated with your wallet (non-custodial). Lido, Rocket Pool and Stakewise are the main protocols in this field. We are going to take a particular interest in Lido, as it is the largest and most innovative player in the sector. To date, around $6 billion worth of ethers have been placed in Lido, which accounts for 30% of Ethereum's validation market.
How does Lido work?
While Lido is commonly presented as a validator, it should rather be described as an "intermediary" of validators. All the funds that Lido receives are in fact distributed to 29 companies specialising in the validation of transactions on Proof-of-Stake protocols. They are selected by Lido's governance (the holders of its LDO token).
The advantage of this system is that there is no minimum deposit for users. "Lido democratises access to staking for crypto holders who don't have the amount needed to have an entire node at their disposal," points out Stanislas Barthélémi, blockchain and crypto-asset consultant at KPMG.
When users deposit their ETH in Lido's smart contract, they instantly receive its equivalent in stETH. "It's the first DAO (decentralised autonomous organisation, editor's note) to offer such a service, which is a significant advantage over competitors," he points out.
To put it simply, it's like your bank giving you a document certifying that you hold funds in an escrow account in order to use it as collateral.
Why use Lido?
The stEH offers a major advantage as it allows the representation of ETH to be used while the ETH has been immobilised. "This makes it possible to have a liquid version of one's investment, which can be re-used as collateral in decentralised finance protocols," continues Stanislas Barthélémi.
Example of a farming loop developed by Hugo Panczak, co-founder of the White Loop Capital fund:
A person holding stETH can collateralise them on the Aave protocol to borrow as many ETH as possible. Once this has been done, they can exchange their freshly borrowed ETH for stETH on the Curve protocol (to take advantage of the slight difference with ETH). With these new stETHs, ETHs can again be exchanged for other stETHs on Curve, before being pledged as collateral on Aave in order to increase its health factor and reduce liquidation risk."
This system can theoretically yield around 8% return per year at the current rate, compared with the 4.90% return offered by Lido.
The other advantage of stETH is its high liquidity. It can easily be exchanged for other tokens.
While holding a stETH is guaranteed by future convertibility with an ETH (probably in early 2023), its price can sometimes fluctuate in relation to the underlying asset. At the height of the crash in the spring, the stETH price plummeted to 0.88 ETH... Conversely, it also means that there are some great arbitrage deals to be had 😎.
How much can you earn with Lido staking?
Lido offers one of the best staking returns, but can never be better than that of an individual validator. And with good reason: Lido charges a 10% commission to remunerate validators and feed the cash flow of its DAO.
Currently, Lido's remuneration rate hovers around 5% a year, but experts estimate that it could rise to 8%. The more Lido users there are, the more value will be extracted through staking.
This is far higher than exchange platforms such as Coinbase or Kraken, which offer 1 to 2% less.
Is it risky?
Thanks to the transparency of the blockchain, we can constantly check that the ETH deposited in the validators actually correspond to the number of stETH issued by Lido. Contrary to what might be feared with a traditional player, there is therefore no risk to the level of the reserve.
On the other hand, as the funds are deposited via smart contracts, there is always the possibility that the latter could be attacked. It cannot be repeated often enough, there is no such thing as zero risk. What is certain is that the Lido code is audited every year by specialists: Quantstamp (December 2020), SigmaPrime (December 2020), MixBytes (April 2021), StateMind (September 2022).
How is Lido's governance organised?
This is surely one of Lido's weak points: at the moment, the LDO token holders (who provide Lido's governance) are highly concentrated in the hands of the team developing the project and the venture capitalists (Andreessen Horowitz, Paradigm, Alameda, etc.).
"Like many DAOs, decentralising governance via a token is a red herring. More than 64% of Lido's tokens are held by investors, team members or selected validators", points out Stanislas Barthélémi.
In detail, the distribution of funds among Lido's validators appears to be fairly balanced. None can control more than 1% of Ethereum's staking. Another important point is the geographical distribution of validators. "We need to continue to improve the geographical distribution of these companies to avoid over-concentration in the United States," stresses Stanislas Barthélémi. And quite quickly! The US Securities and Exchange Commission (SEC) has just explained that Ethereum could fall under its jurisdiction because many validators are in... the United States. 
