Lido is considering giving governance powers to stETH holders, the same as LDO token holders. At first glance, this change seems like one of the biggest wins for decentralization. More voices, more accountability, right? Before we uncork the champagne, let's consider a less rosy scenario: a potential Trojan Horse, bringing with it instability and unintended consequences for the entire Ethereum staking ecosystem.

StETH Holders: Misaligned Incentives Ahead?

The core issue boils down to incentives. After all, LDO token holders are, one would assume, extremely well aligned with the long-term health and success of the Lido protocol. Their fortunes are now inextricably linked to the value of LDO and the broader performance of the platform. What about stETH holders?

Though some may further own LDO, most of these actors are no doubt optimized to maximize their ETH staking rewards. They mostly do it by focusing on yield. Their loyalty to Lido is based on it being able to at all times offer the most enticing returns. This can be troublesome in-and-of-itself, but establishes a serious conflict of interest.

Now picture a situation where a better proposal comes along. Though it is designed to improve Lido’s long term stability by diversifying its validator selection and improving security audits, it has the potential to lower stETH yields marginally in the near term. Would stETH holders who are only interested in short-term profits vote in favor, risking the long-term viability of the protocol?

This isn't just hypothetical. Think about the history of corporate governance. Time and again, we’ve seen shareholders put short-term profits above long-term sustainability, resulting in catastrophic consequences. What we don’t realize is that we’re creating a similar dynamic internally within Lido.

The Siren Song of "Decentralized" Control

The appeal of such “decentralized” control is tempting, particularly in the DeFi space. True decentralization is more than just redistributing power. It takes a shared-responsibility approach and it makes sure that those making the decisions have the proper incentives and the necessary know-how.

Are holders of stETH really in a position to determine the appropriate protocol parameter settings, safety and security upgrades, or overall protocol risk management practices required? Or will they be pulled into the abyss by misleading narratives pushed by people with self-serving agendas? Remember, even a well-intentioned mob can still wreck the cathedral.

As of today, Lido controls more than 25% of all staked ETH. That's a huge responsibility. Impose strict conditions before experimenting with changes to the governance structure of this highly politicized, poorly performance-oriented, hard-won infrastructure. This is not some hot new initiative in “radical decentralization.”

Dynamic Timelock: A False Sense of Security?

Lido touts the dynamic timelock as a safety net, giving users time to unstake their ETH if they disagree with a governance decision. This sounds reassuring, but let's be realistic.

Beyond the politics, unstaking ETH is a kludgy, arduous, and frustrating process. It’s not something you can just decide to do at the last minute. And during that unstaking period, your capital is completely trapped, unable to earn yield in other ways.

  • Complexity: Navigating the unstaking process can be daunting for the average user.
  • Time: Unstaking takes time, potentially missing out on other opportunities.
  • Opportunity Cost: Capital is tied up during the unstaking period.

In addition, what if a highly controversial proposal were to be approved with a narrow margin leading to a run on stETH? This would ultimately destabilize the entire protocol, creating a cascading effect that affects the rest of the Ethereum ecosystem. Is the dynamic timelock really enough to avoid this nightmare?

Look at the real world: The US congress has a veto power, and even with checks and balances, they still managed to rack up over $34 trillion in debt.

LDO Price Surge: Don't Be Fooled

The recent 6.5% explosion in LDO values after the governance proposal was made public should be taken as a warning sign. Market reactions rarely take a long view, and instead get caught up in hype without an understanding of what the long-term outcomes may be.

Traders are abuzz with talk of short-term profits from heightened stETH holder involvement. This price increase could simply be a textbook “buy the rumor, sell the news” scenario. It doesn't necessarily reflect a fundamental improvement in Lido's governance or its long-term prospects. It represents, in truth, a perfect case of story trumping substance.

A Call for Prudence, Not Panic

I’m not suggesting that Lido should give up its plan to decentralize governance over time. Here, I am calling for a more humble and nuanced approach. Before taking the step of empowering stETH holders with veto power, Lido must have a more robust discussion about what risks and unintended consequences it may unleash.

  • Incentive Alignment: Explore mechanisms to better align the incentives of stETH and LDO token holders.
  • Education: Invest in educating stETH holders about the complexities of protocol governance.
  • Phased Implementation: Consider a phased implementation of the new governance system, starting with less impactful decisions.

The future of Ethereum staking, and maybe even Ethereum itself, depends on the governance of protocols like Lido being done wisely. Let’s not trade long-term strength and flexibility for the appearance of a pretty buzzword or a short-lived price increase. Let us not be fooled and swing wide the gates to our own Trojan Horse. The stakes are simply too high.