Attaining sustainability and consensus in the crypto platform is quite challenging; thus, most of the recent blockchains rely on staking mechanisms to achieve the goal. Being a trendsetter in the whole crypto ecosystem, Ethereum has shown significant developments in recent years. Liquid staking is one of the key innovations, a way in which crypto investors stake their tokens in order to ensure security and sustain liquidity within the crypto industry.
Lido is the liquid staking protocol of the Ethereum network, which we will be unleashing in this article in detail.
What is Liquid Staking?
In order to understand the Lido protocol fruitfully, one has to have a basic understanding of the Liquid staking mechanism.
Liquid staking is the mechanism by which a cryptocurrency is staked. The real asset is locked in a smart contract and their identical asset is rewarded to the user. The identical assets are tradable tokens with a value similar to the locked assets and can be sent, received, or staked as collateral at Defi apps.
Unlike the traditional staking mechanism, in which staked assets are received back with profits only after attaining the maturity period, the on-time tradable token provides liquidity and flexibility to the system providing advantages like managing risks, responding to market opportunities, and changing investment priorities.
What is Lido?
Lido is the liquid staking protocol of the Ethereum network. It allows customers to stake their Ethereum (ETH) assets to get a liquid token in return without setting any boundaries or limitations to their holdings as in traditional staking mechanisms. A Lido staking mechanism offers an investor an incentive two times more than normal investment schemes: a liquid derivative token for the staked asset and a yield earned from the stake.
Advantages of using Lido
1. Access liquidity
Liquidity is the major advantage offered by Lido, depositing Ethereum in Lido provides stETH (staked Ether) in return which can be utilized in different Defi platforms. Implying to Lido, one can send, receive, and trade their Ethereum assets and at the same time, earn rewards for the locked assets (though they are not actually locked).
2. Earn passive rewards
Once an ETH is staked in Lido, it can’t be utilized before a certain period, but stETH allows a user to earn rewards from staking while providing access to the assets. This is a great advantage as users can earn passive rewards even by utilizing the funds.
3. Improved security
Following a decentralized approach, Lido ensures security. By spreading out Ethereum across validators, Lido reduces the risk of losing funds due to a single-point failure. Utilizing professional node operators, Lido keeps the staking process safe and secure.
4. Decentralization and interoperability
Lido allows users to stake across the validators, preventing the need for running their own validator nodes. sETH can be used in many Defi applications, making Lido interoperable.
Components of Lido
1. LDO token
LDO is the primary token used to stake rewards in the Lido platform.
It governs Lido when new developments and protocols are introduced and also provides governing rights for holders to cast votes for a proposal.
2. Lido DAO
The community formed by the LDO token holders is known as Lido DAO. To keep up with the protocol, they control and guide the functionalities of the system. It monitors the distribution of funds and manages operational expenses.
How does Lido work?
- Lido is a staking platform for Ethereum that enables holders to earn rewards in the form of ETH tokens without the need to freeze investments.
- When a user stakes their Ethereum investment with Lido, the protocol collects the funds and sends them to a group of validators.
- Validators monitor these funds without creating any hurdles for the user.
- Users receive stETH tokens as a reward for their staked coins.
- The rewarded tokens can be utilized in defi applications to increase returns and liquidity.
Steps involved in the Lido staking mechanism
1. Connect the crypto wallet
Link the crypto wallet to the Lido ecosystem, this step is mandatory for secure ETH staking.
2. Choose the stake amount
Users can choose the amount of ETH they wish to stake. The minimum stake requirement set by Lido is 0.01 ETH.
3. Confirm the transaction
After selecting the amount, confirm the transaction by signing in to the wallet.
4. Staking process begins
The staking process begins after the confirmation of the transaction.
5. stETH token reward
As a return reward for the ETH stakes, users are offered stETH tokens. The quantity of stETH tokens indicates the amount of ETH staked.
Challenges of using Lido
Like any other crypto platform, Lido is prone to certain risks.
1. Diminishing the potential of smart contracts.
Though smart contracts offer secure and safe automatic transactions, any error in codes can result in severe losses. As smart contracts are codes written according to the conditions set by holders, the trustworthiness of the system can’t be guaranteed. Many cases regarding the failure of smart contracts add to the existing concerns.
2. Slashing risks
Slashing is a situation leading to a penalty that results in the reduction of staked assets, often caused by the malicious behavior of the validator. Slashing arises when assets are utilized for other purposes, making holders reduce their control over the assets resulting in unintentional actions.
3. Volatility
The crypto market is known for its volatility, which can result in both big gains and drastic losses. A Lido mechanism provides liquidity and flexibility, which means the system is more prone to market fluctuations than locked assets.
4. Third-party risks
To convert staked assets into liquid assets, third parties are often involved. Since their participation can affect the integrity and security of the system, they cause risks.
5. Limited governance
Liquid staking can affect the participation of investors in decision-making, precisely in voting.
When stakes are converted into liquid, holders can lose their voting rights, leading to reduced engagement.
Measures to overcome the challenges
- Regular auditing of smart contracts to analyze errors in codes.
- Adopting reliable validators to control or eliminate the slashing risks.
- Understanding the market risks and proper risk management can control the impact of volatility to a limited extent.
Final Thoughts
Lido is a decentralized liquid staking protocol for staking Ethereum. While staking an ETH, a holder receives stETH or wstETH as a reward which can be utilized in defi applications. It offers liquidity and flexibility to the platform, showing strong potential for growth in the Ethereum ecosystem. Though certain challenges like smart contract risk, slashing, etc can limit the scope, by mitigating them in the future, Lido can flourish the Ethereum network to a great extent.