Last year’s Ethereum Merge – one of the largest decarbonization events in world history – represented the high point in a dismal year for crypto. With 2023 providing a cautious return to bullish optimism so far, the industry once again looks toward new developments on Ethereum like the recent Shanghai Upgrade.
In the meantime, the world’s original smart-contract blockchain is seeing intense competition between platforms offering liquid staking, which allows users earn a yield on their locked tokens while still holding them in liquid form through derivatives. This comes after 2022 yielded some controversy over staked ETH and the impact this had on the market.
Currently, the Lido Protocol still dominates the Ethereum liquid-staking market. However, it’s losing ground fast to rivals like Frax Finance and the tier-one centralized exchange Coinbase. What are these different platforms offering, and how are they positioning themselves amid the competition? Let’s take a closer look.
How does Ethereum staking work?
As of late January, only 13.87% of Ethereum’s circulating supply was staked, far lower than comparable tokens.
There are multiple ways users can go about staking Ethereum, let’s take a closer look at the various ways people are implementing staking:
The major problem with self-staking is the high threshold required to become a validator on the Ethereum network. In order to run a validator independently, it’s necessary to stake at least 32 ETH (roughly $50K as of late January 2023). Furthermore, the technical demands of running a validator involve expensive hardware more suited to a server farm than a living room, and any downtime could see the stake penalized through a process called slashing.
There is significantly more flexibility for users who choose to stake their Ethereum through a centralized exchange. However, the downsides are also considerable. While users can withdraw their staked Ethereum at any time, they must pay a fee. The reason for that is the exchange itself is unable to withdraw staked Ethereum, so they are managing risk on behalf of the users. Rewards are lower with this setup than either with self-staking or liquid staking. At the same time, there exist the ongoing risks of dealing with any centralized exchange, namely insolvency and hacks.
Liquid staking gets around the limitations of the other forms of Ethereum staking by providing a means to get in and out of the market efficiently. Users deposit ETH with a third-party such as Lido or Rocketpool, and they receive a derivative token in return, such as staked ETH (stETH). While the user continues to collect staking rewards daily, the derivative token can be used in other decentralized finance (DeFi) protocols. It can also be converted back into ETH at any time via a liquidity pool.
Competition between liquid-staking platforms
With the Shanghai UpgradeLiquid staking protocols are entering a period of high demand. Amid the recent rally in crypto markets in early January 2023, Lido Protocol, the leader among the liquid-staking platforms, saw its native token LDO jump 167% in three weeks.
Lido offers stETH, which is what’s called a rebasing token, meaning that it increases in number to reflect staking yield. Coinbase offers cbETH, a reward-bearing token that increases in value based on staking yield, while Rocket Pool does much the same with its rETH token. Frax Finance goes an altogether different route, offering a reward-bearing token (sfrxETH) and an ETH-pegged stablecoin (frxETH).
Fees vary between these protocols, with Lido, StakeWise, and Frax charging the lowest commissions at 10%, while Rocket Pool charges 15%. Coinbase, despite charging 25%, draws customers due to its sizable reputation as a trusted entity in the crypto industry, making it the second-largest liquid-staking platform.
Rocket Pool leads the pack in terms of the size of its distributed operator pool, and the platform allows users to set up a mini-pool validator with just 16 ETH, sourcing the rest from other depositors. Lido, while it has the second most nodes, has seen concerns raised about its centralized authority over a large pool of staked ETH.
Lido used to be the overwhelmingly dominant player in the liquid staking world, beginning 2022 with 85% market share. However, things are opening up in the field, and Lido’s market share has since fallen off to 77% a year later. The decline took off when Coinbase entered the market in June 2022, and now both companies are facing increased competition from Frax Finance and others. Currently, Lido is managing to pull in less than 40% of new ETH staking deposits, with Coinbase and Frax capturing 43% combined.