This post is taking part in the Devconflict x Kiwi writing contest.
"Can we return to the original topic of the debate please?"
This statement echoed repeatedly throughout this heated Devconflict discussion, where two experts engaged in an unfiltered, direct exchange about one of Ethereum's most pressing issues. In this setting, gone were the usual diplomatic niceties typical of organizational discussions. Instead, Nixo, an ETH staker, and Dmitry from Lido tackled the complex question: Vanilla vs Liquid Staking - Does liquid staking pose more risks than benefits to the blockchain?
Understanding the Fundamentals
Before diving into the takeaways from this heated exchange, a clear understanding of both staking methods is essential. Vanilla staking, also known as solo staking, represents the traditional method of network participation. It requires individuals to run their own validator nodes, demanding a significant commitment of both capital, a budget for recurrent expenses and technical expertise. At least 32 ETH must be locked up, and operators need to maintain sophisticated technical infrastructure with 24/7 uptime. This method puts complete control in the hands of the staker, but it also means taking full responsibility for any technical failures or operational mistakes that could result in slashing penalties.
Liquid staking, in contrast, offers a more flexible approach to network participation. Users can stake any amount of ETH and receive tradeable tokens representing their staked position. These tokens can be used throughout the DeFi ecosystem while the underlying ETH continues earning staking rewards. The technical complexity is delegated to protocols that specialize in validator operations, significantly lowering the barrier to entry. This approach spreads risk across multiple validators and enables capital efficiency, but it introduces new centralization and systemic risk considerations.
The Opening Arguments
Nixo's Initial Position
"Liquid staking introduces the risk of concentration into one protocol, a state incompatible with Ethereum's goals of decentralization, and one that introduces a systemic risk that affects every ETH holder"
This statement goes straight to the foundation of the decentralization debate, touching on several critical aspects of network security and protocol design. The concentration risk Nixo highlights represents a fundamental challenge to the principle on which Ethereum was built. When large amounts of ETH accumulate under the control of a single protocol, it creates a potential single point of failure that could affect the entire network. This concentration doesn't just threaten technical operations. It also poses risks to governance, network security, and the very principles of decentralization that make Ethereum valuable.
From my research on staking protocols and other organizations in the ecosystem, I've observed how this concentration risk manifests in subtle ways. While liquid staking protocols often implement technical safeguards, the natural tendency toward consolidation creates pressure points that could become critical during network stress. From historical knowledge, it is quite obvious that the systemic risk extends beyond just the protocol itself. It ripples through the entire DeFi ecosystem, affecting lending markets, derivatives, and even basic trading pairs.
However, Nixo's argument, while compelling, is too absolute and rigid in its framing. The reality of protocol development shows that concentration risk can be managed through careful mechanism design and proper incentive structures.
Dmitry's Initial Response
"You can either accept reality and act accordingly, or you can ignore reality and advocate for ideal things. The reality is Liquid staking is a market preference."
Dmitry's response brings practicality to what could have otherwise become an overly theoretical debate. His argument acknowledges that market dynamics play a crucial role in protocol adoption and evolution. The preference for liquid staking isn't based on random choice or personal whim, it reflects real user needs and practical constraints that can't be ignored in pursuit of perfect decentralization.
Due to my activity on various DeFi protocols, I've constantly seen how user behavior gravitates toward solutions that balance security with usability. This is how I know that the market's preference for liquid staking stems from genuine needs: not everyone has 32 ETH to stake, many users lack the technical expertise to run validators, and the ability to maintain liquidity while staking is incredibly valuable for portfolio management.
Therefore during the opening section of the debate, I was drawn to see reason in Dmitry's points, because it is the reality. Yet Dmitry's approach with pragmatism, while valuable, shouldn't be taken as a complete truth because market forces move in line with many other factors. The fact that users prefer something doesn't automatically make it optimal for network health - the community has time and time again seen this pattern play out repeatedly in traditional finance, where convenient but risky practices led to the manifestation of the inherent problems on the network.
The Decentralization vs The Capital Efficiency Argument
After the opening statements and initial responses were laid down, an opening into the thought processes and stand of the debaters was known. Now the debaters decided to build on their positions with different perspectives.
Nixo builds a position with the opinion:
"Any contract that wants to swallow a majority of ETH into a single contract inherently misunderstands the concept of decentralization (Ethereum)."
This argument references the foundation of Ethereum's design. Nixo explained that the concentration of ETH in single smart contracts creates exactly the kind of centralization that blockchain technology was meant to prevent. Solo staking, with its distributed network of individual validators, more closely aligns with the original vision of a truly decentralized network. So therefore Nixo emphasizes that this makes solo staking the better choice for network health..
Dmitry also presents a compelling economic perspective that aligns liquid staking with capital efficiency :
"Liquid staking gives everyone the ability to use and reuse coins and that is what gives the DeFi ecosystem the power that it has today. Without liquid staking the DeFi ecosystem will be 3 times less than it is right now."
Dmitry stated this argument as a counter to the many purely theoretical theories against liquid staking that were being said during the debate. He explained that the argument goes beyond theoretical discussions about decentralization and then he touched on the practical impact of liquid staking on DeFi's growth. Dmitry explained that the ability to use staked ETH as collateral while earning staking rewards has created a multiplying effect on capital efficiency. Dmitry mentioned how staked ETH has helped create utility for Ethereum and has also supported protocols that do so. In the ecosystem right now it is proven that liquid staking derivatives have become fundamental building blocks for complex financial strategies.
"liquid staking is a fuel for the entire ecosystem"
When analyzed properly, it is discovered that the impact of liquid staking extends beyond simple numbers. When users can deploy their staked ETH in lending protocols, yield farms, or as collateral for derivatives, it creates new economic opportunities that wouldn't exist otherwise. Each ETH effectively performs double duty - securing the network through staking while simultaneously providing liquidity to DeFi protocols. This efficiency has attracted institutional capital and sophisticated traders who might otherwise have remained on the sidelines. From that standpoint Dmitry made a valid point about liquid staking being a valuable asset for the Ethereum ecosystem.
From my analysis of DeFi protocols' growth patterns, this transformation has indeed created substantial value. However, it has also introduced new forms of risk through the interconnectedness of protocols, which creates complex dependency chains that could amplify market stress events.
The Governance Challenge
At this point of the debate, both participants had thrown subtle jabs at each other, and Dmitry in particular had called multiple times for the discussion to be brought back to the main topic at hand. This is because at a point it migrated from talking about the topic in general to a personalized inquiry about an organization's modus operandi. Therefore at this point, the debaters settled on bringing up problems that cause or could be caused by liquid staking.
Nixo took the lead in this and raised a critical concern about governance:
"When it comes to liquid staking quorum is usually low, which is why it is unsafe. Only a few people are making the decisions. This is because most of the people who delegate to delegates are disinterested actors, they throw their money at protocols looking for yield."
This observation highlights a fundamental weakness in many DeFi governance systems. The separation between technical capability and governance participation creates a dangerous dynamic where crucial protocol decisions are made by a small subset of large token holders.
Through my participation in various DAO governance processes, I've seen firsthand how low participation rates can lead to decisions that don't necessarily reflect the broader community's interests.
Nixo states that the problem becomes particularly severe with liquid staking protocols because of their potential influence over the underlying network. When governance participation is low, it creates opportunities for well-resourced actors to exert disproportionate influence over protocol decisions. This risk is enhanced by the fact that many users, as Nixo points out, are primarily interested in yields rather than protocol governance.
Nixo further went on by presenting an illustration which depicted a situation where liquid staking protocols now hold the majority share of Ethereum in the form of staked ETH, and a malicious actor then performs a malicious action by manipulating the delegate to pass it. It’ll become a situation where malicious proposals are passed just because an attacker has a large majority of ETH. Nixo further emphasized the point that when large portions of staked ETH fall under the control of a single contract or protocol, it creates points of leverage that could be exploited in various ways, from governance attacks to economic manipulation. This in turn affects the base layer and the Ethereum ecosystem at large, because then decisions regarding the network are not made to determine what is best but are made in line with what the holder or protocol that holds the largest share wants.
Dmitry acknowledged Nixo’s observation and responded by making a counter-observation based on market dynamics:
"The beauty of the blockchain is that everything is transparent. So what will truly happen if Lido pushes for a malicious proposal to hold? Public sentiment will show that lido has done a bad thing and what will happen after then is that people will withdraw their staked ETH."
Dmitry’s argument presents transparency as a natural safeguard against malicious behavior. This argument states that the public nature of blockchain transactions means that any harmful actions by liquid staking protocols would be immediately visible to all participants. This would mean if a protocol (Dmitry used Lido as an example here) decides to move forward with a malicious proposal. What would happen is that holder's sentiment will come in and term that action bad. Due to this many holders will withdraw their staked ETH from the protocol, which will cause a scandal and ruin the protocol's reputation and business. No organization wants this and protocols are actually incentivized to fufill the best interest of their users and stake operators hold personal investments that are equal to the validator nodes they operate, eliminating fear or greed when approving proposals. Therefore a scandal like that is likely only to happen in theory and not in practice.
However, my experience in crisis management during exploits suggests that transparency alone isn't always sufficient protection. By the time malicious actions are detected and users begin withdrawing, significant damage could already be done. The irreversible nature of blockchain transactions means that certain types of damage cannot be undone, regardless of how quickly the market reacts.
Technical Solutions and Mitigation Strategies
The debate then turns to potential solutions against concentration risks which is a threat to decentralization, as that was the main problem of liquid staking brought up during this discussion. Nixo advocates for several technical approaches including- soft limits and correlation penalties.
These suggestions show an understanding of the technical options available to influence protocol behavior. Correlation penalties, in particular, represent a solution to the concentration problem. It does this by making it economically disadvantageous for too many validators to operate under similar conditions, due to this the network pushes toward decentralization.
Dmitry responded with the opinion that these technical solutions, while valuable, often face practical challenges. Soft limits can be bypassed through Sybil attacks, and correlation penalties require careful assessment to be effective without being extremely harsh.
In my opinion, the hack lies in creating systems that make decentralization the path of least resistance rather than trying to enforce it through strict rules.
Concluding Statements
Dmitry
“Liquid staking done right in a competitive ecosystem is a good thing.”
Dmitry reiterated that a well-executed liquid staking system operating within a competitive market proves itself invaluable to the Ethereum ecosystem. Dmitry's position highlights that the protocol's contribution extends far beyond mere convenience because by distributing staking capabilities across a broader user base, liquid staking protocols enhance decentralization rather than diminishing it. Liquid staking protocols break down traditional barriers to entry, allowing participants with varying levels of technical expertise and capital to engage in the ecosystem. This democratization of staking directly supports Ethereum's core mission of creating an accessible, decentralized financial system. Also, Dmitry states that by managing the complex operational requirements of validation, liquid staking protocols significantly reduce the technical burden on the base layer. Another advantage Dmitry mentioned is that the ability of liquid staking protocols to balance accessibility with security demonstrates that the benefits of liquid staking can indeed outweigh potential risks when implemented thoughtfully.
Nixo
At this point of the debate, Nixo acknowledges Dmitry’s point while also making a crucial point about the future of staking:
"People need to know that they can stake their own ETH without validators. Let us make it more accessible. We can make making a validator, running a validator and troubleshooting a validator easier and easier to do, hopefully to an end where people solo stake and participate."
This perspective of Nixo recognizes that the dominance of liquid staking isn't just about technical or economic factors - it's also about education and accessibility. Nixo further states that to solve this and encourage more individual solo staker’s who also want to participate in the decision of the ecosystem it is important to make the entire process more approachable and less daunting.
The Path Forward
The debate reveals several critical paths forward for the Ethereum ecosystem:
The first involves improving solo staking accessibility. As Nixo suggests, making validator operations more approachable could help maintain a healthy balance between liquid and traditional staking. This isn't just about technical improvements - it's about creating better educational resources and support systems for individual stakers.
The second path focuses on developing better governance mechanisms for liquid staking protocols. Current governance models often suffer from low participation and potential capture by large token holders. Through my participation in various DAOs, I've observed that effective governance requires both technical mechanisms and active community engagement.
The third direction involves creating better risk management frameworks for liquid staking protocols. This includes implementing programs and developing more sophisticated monitoring tools for systemic risk.
The fourth concerns fixing the disconnect between the developer and the users of the network. The gap between technical idealism and practical user needs often leads to solutions that look perfect on paper but face adoption challenges in practice, and this has been a constant issue in blockchain development. This can be addressed by creating solutions that users will adopt while maintaining the network's fundamental security properties.
Conclusion
After a deep analysis of both perspectives, it becomes clear that the question "Does the risk outweigh the benefits?" might be too binary. The reality varies in different ways. For one, liquid staking has become an essential part of the Ethereum ecosystem, providing benefits that can't be ignored. Which includes but is not limited to increased capital efficiency, broader participation in staking, and new economic opportunities.
However, the risks Nixo identifies are real and potentially substantial. Concentration risk, governance challenges, and systemic dependencies all pose significant threats to network health. The solution isn't to choose between liquid and traditional staking but to find ways to make both systems work together effectively.
The future of Ethereum staking likely involves a hybrid model where both liquid and vanilla staking play important roles. The key is ensuring that this hybrid system maintains the network's fundamental security properties while meeting users' practical needs.
As the ecosystem matures, it is important to remain focused on the core principles of decentralization while acknowledging the practical needs of users. The debate between Nixo and Dmitry serves as a valuable reminder that the most sustainable solutions often lie not in absolute positions, but in thoughtful compromise and continuous improvement.
