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Ethereum is trying to move to a ‘proof-of-stake’ model. If it does, a dominant DeFi platform presents a huge potential threat

April 21, 2022, 2:23 PM UTC

Over $35 billion has already been bet on the success of a massive upcoming change to Ethereum, even though it hasn’t happened yet and its timeline isn’t set

The change is known as the “merge,” and it’s supposed to make Ethereum more secure and decentralized, among many other things. 

But critics aren’t sold—and they’re especially concerned as a decentralized finance (DeFi) “staking” pool platform called Lido Finance seems to be on its way to monopolizing key aspects of the Ethereum network after its merge, including future network upgrades and which Ethereum transactions are processed.

Here’s what to know.

Breaking down the “merge”

To understand why critics see Lido as a potential threat, it’s helpful to first understand what Ethereum’s merge is and what would change after it happens.

The merge aims to shift Ethereum from proof of work to proof of stake. 

To be a validator of transactions on proof of work, miners must race to solve complex computing puzzles—using up enormous amounts of energy. On proof of stake, validators are chosen at random according to how much Ether they “stake,” or contribute, to the network. To be eligible, potential validators need to stake at least 32 Ether, which is around $98,000 at current pricing

Currently, Ethereum has both proof-of-work and proof-of-stake chains running in parallel. While both have validators, only the proof-of-work chain currently processes users’ transactions. Once the merge is complete, Ethereum is supposed to shift fully to the proof-of-stake chain, called the Beacon chain. 

Ethereum developers say the merge will happen sometime this year, but no specific time has been set yet. 

In the meantime, there’s been debate as to whether a move to proof of stake is best for the network’s security.

Potential threats

Contrary to what merge supporters believe, critics of Ethereum’s move to proof of stake say that it will hinder network security. They worry about one or more parties sabotaging Ethereum with a “51% attack” by garnering more than half of the staked Ether. 

Critics also fear the merge will lead to centralization, in which one central party would be able to control who processes transactions, which transactions are processed, and what future upgrades are made. 

Though neither sabotaging nor making Ethereum more centralized would be easy to pull off, and Ethereum developers have countermeasures in place, it’s still top of mind for merge opponents—especially with Lido Finance getting a lot of attention lately. 

What’s Lido?

Lido Finance helps users start staking on the Beacon chain, even if they don’t have the minimum 32 Ether, or $98,000, to achieve validator eligibility. 

Lido takes whatever amount of Ether a user can provide and combines it with Ether given by other users. Once Lido collects at least 32 Ether, it gives the funds to a service it trusts to set up validators. 

In return, Lido gives users a token that represents their staked Ether in Lido called stETH. 

When staking directly in the Beacon chain, investors wouldn’t be able to sell what they invested in the proof-of-stake chain until after the merge—whereas with Lido, users can sell their stETH at any time. That ability for users makes Lido what’s called a liquid staking platform. It’s become so popular that Lido has become the largest staker on the Beacon chain to date, with 30% of all staking activity, as CoinDesk noted. Of the $35 billion total staked on the Beacon chain, Lido accounts for $10 billion. 

With its success, some competitors have emerged, but Lido still owns 90% of the liquid staking market. 

This dominance has become worrisome to not only critics of proof of stake, but even some within the Ethereum community.

After Ethereum successfully tested its merge on April 11, Lido posted a blog post with a “decentralization road map” for Lido, acknowledging concerns from the community about its dominance.

“[S]ome people have expressed concern that this level of success can make Lido a centralizing force. We hear you, and your concerns are both important to us and valuable to Ethereum as a whole,” Lido wrote.

It promised to introduce methods of decentralizing the platform, but also noted that with the Ethereum network “effects at play,” it’s “likely that the market for staking will trend toward a ‘winner-takes-most’ outcome.”

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