Lido’s LIP-28 is in, heralding this exciting new age of “Dual Governance” by promising to give stETH holders more power. On the surface, it's a move towards decentralization, a corrective measure to balance the power between LDO token holders and those providing the lifeblood of the protocol: stETH liquidity. Beneath the shiny veneer of modernization lies a thousand thorny incentives and motives and some real dangers. The specter of beetle rule just makes this confusing landscape that much more complicated. Is this the real deal, or just a pretty decoy whale’s sanctuary?

Locking stETH: Real Skin in the Game?

LIP-28 gives stETH holders an opportunity to express their dissent. In the first case, they can effectively veto proposals they don’t like by locking their stETH in escrow. This is sold to the public as putting some real money with some “skin in the game.” How much skin are we actually exposing ourselves to? The indicators and thresholds for action, which I’m not going to bore you with the details of, are very important. If these thresholds are deemed too low, any number of frivolous challenges could hold the governance process hostage. Set them too high, and only the largest stETH holders – the whales – will have the power to meaningfully contest decisions.

Think of it like this: it's like a legal system where only the super-rich can afford to file lawsuits. Justice isn’t blind; it’s nearsighted, only able to see money the influence to the rich. Is this really the future of DeFi governance that we want to endorse?

Game Theory: Incentives and Strategies

Let's put on our game theory hats. LDO holders, driven by the value of their tokens, will inherently do whatever is in their best interest to return value to token holders. stETH holders, who want nothing more than to earn their staking rewards and keep the protocol humming along, face conflicting incentives. LIP-28 goes a long way towards bridging this gap. It introduces new strategic concerns that make things more complicated.

Large stETH holders could collude with each other to gain disproportionate power, in effect creating cartels within the governance system. Smaller stETH holders, who may not have the resources or ability to coordinate a challenge to every proposal, could be disproportionately sidelined. It’s a classic prisoners’ dilemma scenario, where individual rationality can often lead to collective sub-optimality.

Now picture a situation where a proposal greatly benefits whales but only marginally improves the situation for smaller stETH holders. The whales certainly have the will and the way to get it done. At the same time, smaller holders are discouraged from challenging them due to the expensive and confusing nature of locking up their stETH. The effect? A system of governance that privileges those already powerful, cementing current disparities.

Unintended Consequences: The Ripple Effect

As we all know, for every action there is a reaction, and LIP-28 is no different. One likely unintended consequence we can’t help but notice is that this may have a large unintended effect on staking rewards. Almost half of stETH is currently locked in escrow through governance disputes. This last point could reduce the effective supply of stETH in staking, potentially reducing rewards for all stETH holders.

A second significant worry is attack on governance. Malicious actors might abuse the counter-proposal mechanism. This might break the protocol, making stETH holders have to lock their tokens when they don’t need to and fanning the flames of instability. The smart contract implementation would have to be bulletproof, or else risk attack on attack.

Finally, consider the regulatory implications. As DeFi protocols get more advanced and governance models develop, regulators are taking notice. A broken governance model is extremely easy to co-opt by a small group of self-serving actors. This will attract third-party attention and could result in regulatory action.

What's Next? A Call for Vigilance

Lido’s LIP-28 is an incredibly bold experiment, and an important step in the direction of a more decentralized and inclusive governance model. It’s important to proceed with eyes wide open, understanding the potential pitfalls and unintended consequences. We need to face hard questions about the right time to act. Let’s turn to understanding the motivations of different actors and the risk of manipulation.

The future of DeFi governance rests on our collective capacity to absorb that knowledge from experiments such as LIP-28. As a community, we should strive to create governance mechanisms that are genuinely equitable, transparent, and immune from whale influence. We know this will take deep thought, robust experimentation, and commitment to iterate and get things right.

If ever effective, Lido’s move would establish a precedent defining how large DeFi projects can strike a balance between control and decentralization. Let's make sure it's the right precedent. Don’t fall for the hype of decentralization at face value. Question everything. Demand transparency. And hold those in power accountable. After all, at the end of the day, the future of DeFi hinges on it.