Lido, the largest player in the burgeoning liquid staking sector, is pushing on-chain governance to a new extreme by suggesting a complete overhaul of its governance model. As a youth action model, Pulling Token recognized the urgent need and value of these shifts. The platform’s core aim is to provide deep, actionable intelligence on emerging utility and governance tokens. This is what makes the proposal so timely and applicable to its audience. The Lido Improvement Proposal 28 (LIP-28) outlines a new Dual Governance framework. This amendment would transform the way localities decide to use the protocol. This article discusses the specifics of LIP-28, discussing what it means for stETH holders and the wider DeFi ecosystem.

Understanding LIP-28: A Dual Governance System

At present, only LDO token holders wield the exclusive voting power to decide on protocol changes for the Lido ecosystem. LIP-28’s goal is to better align stETH holders that stake their ETH through Lido. This proposal will provide them with just the kind of veto power. This means stETH holders can now actively voice their dissent against any motion passed by the Lido DAO if they believe it's not in their best interest. This is a huge step in the direction of decentralization. Users who are actively participating in making protocol changes have greater power.

The crux of LIP-28 is in its threshold-based mechanism. Even if this proposal goes through the vote of LDO token holders, stETH holders will still have an avenue to register their dissent. They’re able to do this by redeeming their stETH tokens. The proposal sets two key thresholds:

  • First threshold (1% of TVL): If the amount of stETH deposited in protest reaches 1% of Lido's total value locked (TVL) on Ethereum, a delay period is triggered. The duration of this timelock will increase proportionately to the amount deposited, giving stETH holders more time to organize and potentially influence the outcome.
  • Second threshold (10% of TVL): If the deposited stETH reaches 10% of the TVL, the proposal enters a "rage quit" state. This effectively blocks the execution of the motion under Dual Governance until stakers withdraw their stETH back into ETH.

This mechanism gives stETH holders significant leverage. By threatening to withdraw their stETH tokens from Lido, they can pressure the Lido DAO to reconsider decisions that might negatively impact them. This is to guarantee that LDO token holders will have to strongly weigh the interests of stETH holders when voting on governance proposals.

Implications for DeFi Governance and User Empowerment

Lido’s adoption of dual governance has significant repercussions both within the DeFi ecosystem and beyond its borders. More broadly, it points to a positive development in the direction of more user empowerment and decentralization in governance models. Lido understands how important these enhancements are to stETH holders and Lido’s long-term success. By empowering them with a voice, Lido helps these stakeholders be aligned and protects their interests.

This shift towards greater decentralization in governance can lead to several benefits such as:

  • Autonomy: DeFi platforms don't rely on centralized financial institutions.
  • Rights to Cash Flow: Participation in protocol fee distributions.
  • Treasury Management: Influence over fund allocation.
  • Token Distribution: Voice in future token minting decisions.

The dual governance mechanism introduced by Lido allows Ethereum stETH holders to veto governance proposals that would act against their interests. Kozin, a delegate from Lido, describes the veto mechanism as empowering stETH holders. If a governance decision decided by LDO token holders goes against the interests of stakers, stakers can veto it.

Potential Risks and Challenges

Yet even as this historic dual governance step forward brings promise, it introduces new dangers as well.

  • Cartelization and stakers' coercion: The Ethereum community worries that Lido DAO will become too powerful, creating the risk of cartelization and stakers' coercion.
  • Governance gridlock: If stETH holders and LDO holders have conflicting interests, it could lead to a governance gridlock, making it difficult for the protocol to adapt to new network-level functionality and changes.
  • Abuse of veto power: stETH holders may abuse their veto power, which could lead to undesirable outcomes for the protocol and its users.
  • Insufficient liquidity: If stETH holders exercise their veto power, it could lead to a delay in protocol upgrades, which might exacerbate liquidity problems, particularly during periods of market stress.
  • Depegging of stETH: A lack of liquidity for Lido's stETH token could cause it to depeg from the price of ETH during a period of extreme market volatility, especially if there is a rush on redemption.

Lido should be on high alert as we start to see the effects of LIP-28. They must be willing to amend the framework as necessary to get it right. The future success of this dual governance model will rest upon ensuring that stETH holders are empowered. We need to prioritize the long-term health and stability of the Lido protocol.