In the evolving landscape of Ethereum liquid staking, Lido Finance has emerged as a prominent player. However, recent trends suggest that its flagship product, stETH, may not be achieving the anticipated network effects or market dominance. This analysis explores the adoption challenges, competitive pressures, and structural issues facing Lido, arguing that its current valuation might not fully account for these risks.
Key Observations on stETH Adoption
The data reveals several concerning trends for Lido and stETH:
- The percentage of stETH and other liquid staking derivatives (LSDs) relative to total ETH staked is declining, indicating a loss of market share.
- stETH has not achieved meaningful DeFi network effects that differentiate it from smaller, more competitive LSD providers offering better yields.
- Overcoming the behavioral inertia and native token preference for WETH within DeFi ecosystems proves more difficult than anticipated.
These factors combined suggest that stETH's adoption is underperforming expectations, warranting a more cautious outlook on Lido's consensus-driven valuation model.
The Shift Toward Non-Liquid Staking
Between April and August 2023, Ethereum's staking ratio surged from 14.13% to 21.32%, representing a 50% increase in just four months. However, of the additional 8.6 million ETH staked, the majority (67%) went into non-liquid staking solutions. Lido's stETH accounted for less than 25% of all new ETH staked during this period, causing Lido's share of total staked ETH to drop from 35% to 31.5%.
Even considering additional Ethereum issuance from higher staking ratios and excluding volatile factors like execution layer rewards, Lido's total revenue actually decreased between April and August, despite the circulating supply of stETH growing from 5.8 million to 8 million tokens.
This divergence suggests fundamental challenges in stETH's value proposition:
- Pricing: Lido's 10% fee structure negatively impacts staker incentives compared to competing validator services offering 4.4% APY versus stETH's current 3.8%.
- Network Effects Deficiency: stETH/wstETH currently has only one substantial use case: serving as collateral for USDC/DAI loans on Aave and Maker. However, with net borrowing rates of 4-5% and maximum loan-to-value ratios of 72%, borrowing/leveraging operations alone don't provide strong enough demand drivers for stETH.
Current stETH Utilization Patterns
Examining stETH distribution across DeFi reveals limited utility:
- 55% of stETH tokens are held passively outside DeFi contracts (store of value)
- 40% are held in lending protocols like Aave and Maker (borrowing/collateral)
- 3% are used for liquidity provision on Curve and Uniswap (exchange medium)
- Less than 1% are utilized in newer "LSDFi" protocols like Pendle
This distribution indicates stETH primarily functions as collateral rather than achieving broader utility across DeFi ecosystems.
The Limitations of Collateralization
While stETH/wstETH has become the most used collateral asset on Maker and Aave, surpassing even ETH itself, this success comes with important caveats. Notably, there is virtually no borrowing of wstETH/stETH on Aave, resulting in a 0% supply APY. This indicates limited utility beyond collateralization.
Crucially, collateralization as a use case doesn't inherently create network effects: Aave can accept multiple different LSD varieties simultaneously. stETH's presence doesn't affect rETH's loan-to-value ratios or interest rates. Even as the largest deposited asset, this status alone doesn't provide compelling reasons to purchase, hold, or borrow stETH over alternatives.
Exchange Medium: Limited Progress on Uniswap
A critical aspect of liquid staking is DeFi compatibility, with the aspiration that stETH might eventually function like WETH does today. An important step in this process is establishing stETH as an exchange medium—if users perceive stETH as the most convenient token for swapping to any other asset, they would willingly hold it, while large holders would provide liquidity on exchanges like Uniswap.
However, despite hundreds of new trading pairs launching monthly on Uniswap V2 and V3, nearly all remain WETH-based. stETH maintains minimal presence on Uniswap, treated more as a commodity to be exchanged from WETH/USDC rather than functioning as an exchange medium itself.
Centralized exchanges show even less interest in stETH than decentralized liquidity providers, suggesting higher cognitive barriers to stETH adoption compared to ETH. Newcomers who hear about Ethereum's wonders or check CoinMarketCap will likely continue using and holding ETH for transactions. 👉 Explore advanced staking strategies
EVM Interchain Money: Limited L2 and Bridge Progress
With increasing Ethereum DeFi innovation occurring on Layer 2 solutions, strategic availability of stETH at the forefront of DeFi innovation is crucial for Lido. However, examining cross-chain data between EVM chains reveals WETH and USDC as the dominant cross-chain currencies, with stETH virtually absent from these flows.
The New Frontier: Pendle and Lybra
The final piece of the puzzle involves emerging "LSDFi" innovations. While some argue that stETH is achieving significant success in new venues like Pendle and Lybra, closer examination suggests limitations:
- Pendle functions as an interest rate swap market based on APY-yielding assets. Its liquidity depends on stETH's market capitalization. Similar to real-world interest rate swaps, a derivative market is unlikely to drive adoption of the underlying asset.
- As stETH yields gradually decline, Lybra's substantially subsidized ponzinomics will face increasing pressure. While eUSD has theoretical breakthrough potential, the probability of successfully launching a new stable币 in today's DeFi landscape remains low based on historical precedents (see Maker and Luna). Systemic downside risks from large-scale eUSD redemptions/liquidations could leave stETH vulnerable.
In summary, we haven't seen encouraging signs that "LSDFi innovation" will drive stETH adoption in the near future.
Behavioral Inertia and Historical Parallels
Liquid staking presents formidable challenges across blockchain ecosystems. Examining Solana reveals similar patterns: despite high staking yields (initially over 8%), high staking ratios (over 70%), and minimal friction costs (<$0.001 gas fees), Solana's primary LSD provider Marinade Finance has less than $200 million in total value locked compared to over $7 billion in total staked SOL tokens—a worse ratio than Lido's figures.
Similar patterns emerge across other PoS leaders including Polygon, BNB, Polkadot, Avalanche, and formerly Luna, suggesting structural rather than ecosystem-specific challenges.
The Network Inertia Challenge
Several behavioral factors contribute to this inertia:
- Lending integration is relatively straightforward—stETH is a transparent synthetic asset backed by ETH's credibility, and Aave/Maker voters can easily approve new assets. This doesn't require significant network effects.
- However, decentralized exchange and Layer 2 integration present greater challenges. Transitioning from WETH to stETH on Uniswap or across L2s requires convincing everyone to switch approximately simultaneously; otherwise,惯性思维 and liquidity fragmentation will prevent adoption.
- Cognitive barriers: Everyone holding ETH understands it as the legitimate native token representing the chain. stETH presents a steeper learning curve for newcomers to on-chain worlds, particularly as attention shifts post-Shanghai upgrade and LSD adoption loses momentum.
- Gas fee payments and centralized exchange interactions still require native tokens. Like most people using primarily one credit card, stETH appears optional by comparison.
Overcoming network inertia requires aggressive efforts in adoption incentives, partnership development, brand awareness, and L2 expansion—initiatives historically incompatible with Lido's chosen slow, steady decentralization governance model.
Lido's current situation bears resemblance to early MakerDAO:
- Both building public goods for Ethereum and Web3
- Both facing powerful competitors with network effects (USDT and ETH)
- Neither choosing to expand beyond ETH L1
- Both making slow progress on DeFi integration beyond lending
Could DAI's decline foreshadow stETH's future? We hope not, but concerns remain.
Conclusion: Comparing with Bullish Perspectives
Finally, we compare our perspective with important LDO bullish arguments, highlighting two flawed assumptions and adding one strategic risk:
- Staking rewards don't grow linearly with ETH staking ratio increases. The actual mathematical relationship follows a square root function. For example, if ETH staking ratio increased from the current 22% to an astonishing 88%, total rewards would only double rather than quadruple, limiting Lido's primary revenue upside.
- LSD market share is shrinking rather than growing. While stETH has outperformed Coinbase and Binance's LSD offerings, LSDs collectively are losing market share to non-liquid validator-as-a-service solutions.
Strategic Risk: Investigating LSD market share decline reveals that stETH has failed to establish moats in areas where network effects matter (DEXs, CEXs, or cross-chain locks).
- Lack of network effects may hinder stETH's future growth
- Without network effects, stETH's current use cases (store of value and lending collateral) remain fairly generic, leaving Lido vulnerable to competition from both non-liquid staking and LSD competitors, potentially triggering fee compression
For investment purposes, we believe this analysis offers two important counterpoints:
- Until stETH's network effects materialize, secondary LSDs still have opportunity to wage price wars against Lido and fragment the LSD market
- Until network effects emerge, Lido's ETH exposure should be discounted due to potential long-term market share decline (whether from competition with non-liquid staking or LSD fragmentation)
The bear market hasn't ended, and Lido still has time and resources to build its network effects and establish positive feedback loops when markets recover. We continue monitoring these developments closely.
Frequently Asked Questions
What is liquid staking and how does it work?
Liquid staking allows users to stake their cryptocurrencies while maintaining liquidity through derivative tokens that represent their staked assets. These tokens can be used across various DeFi applications while continuing to earn staking rewards.
Why is stETH losing market share in the staking ecosystem?
stETH faces competition from both non-liquid staking services offering higher yields and emerging liquid staking alternatives with better terms. Additionally, its limited utility beyond collateralization and higher fee structure compared to competitors have impacted adoption rates.
What are the main use cases for stETH currently?
The primary uses include serving as collateral for loans on lending platforms like Aave and Maker, with minimal utilization as an exchange medium or in emerging LSDFi protocols. Most stETH remains held passively as a store of value.
How do network effects impact stETH's valuation?
Network effects create competitive advantages through increased utility and adoption. Without strong network effects, stETH remains vulnerable to competition and fee compression, potentially justifying a discounted valuation relative to expectations.
What challenges does stETH face in becoming a dominant exchange medium?
stETH must overcome significant behavioral inertia, liquidity fragmentation issues, and the established dominance of WETH. Achieving critical mass requires coordinated adoption across multiple platforms simultaneously, presenting substantial coordination challenges.
Could Lido overcome these adoption challenges?
While possible, overcoming these challenges would require more aggressive business development, partnership initiatives, and potentially governance modifications—approaches that may conflict with Lido's current decentralized governance model and gradualist approach.