Ethereum, Lido and Fairness in Governing Computer Code

Introduction

Amongst all successful democratic nation states, there are early decisions where authority is ceded to those who are being governed. For example, Britain introduced a second House of Parliament, the House of Commons. This acted as a check and balance on the decisions made by the House of Lords and involved regular people in government decision-making. By allowing those being governed to be involved in their governance, nations have flourished in democratic and fair societies.

Blockchain protocols are like digital nations: they have systems of rules and governance structures.

Ethereum is a blockchain that enables decentralized computation. The security of Ethereum is maintained by “Proof-of-Stake”. Those that control this staking process, control Ethereum.

Lido is a joint staking blockchain – it allows people with small sums of Ethereum to stake by pooling their ETH tokens together. The decisions made by Lido affect those who stake using Lido.

In order to ensure fair governance, Lido have introduced a new process called Dual Governance. Akin to introducing a new House of Parliament, Dual Governance is a self-limiting initiative that ensures those affected by Lido’s decisions are able to participate in the decision-making process.

In this article, I explain what Ethereum and Lido are. I then discuss blockchain-based governance and highlight the significance of Lido’s Dual Governance initiative. Lido recognised the risks of their own power and chose to voluntarily accede authority to their Users. Such actions embody the spirit necessary to move towards governance by code.

What is Ethereum?

Ethereum is a global supercomputer that enables decentralized code. Using Ethereum, applications can be run without any central authority in-charge. Decentralization brings a myriad of benefits including censorship-resistance, reduced rent-taking and greater innovation.

Ethereum has enabled decentralized exchanges, decentralized social media and decentralized identities. With these applications, instead of a trusting a single cooperate company we rely on a decentralized network of computers. These computers verify the code of our applications using a process called Proof-of-Stake.

Proof-of-Stake is the security mechanism underlying the Ethereum blockchain. In Proof-of-Stake, a set of computers called “Validators” put up some money (the “stake”) and ask to be selected to verify a block. One of the Validators is selected to run the computation and verify the contents of a new block before adding it to the chain. The computation is one-way, meaning it can easily be checked by all the other Validators.

If the computation was done correctly, the selected Validator is given a reward (Ethereum tokens). However, if the computation was not done correctly then the stake put up by the Validator is lost. Since everyone can check the validity of the computation, the validators are likely to carry it out correctly. Otherwise, they lose their stake. By combining cryptography, game-theory and economics; Proof-of-Stake ensures decentralized computer programmes are run correctly.

For people who believe in the long-term viability of Ethereum, it makes sense to stake. If you stake you contribute to the security of the blockchain and at the same time receive staking rewards. However, staking is expensive: to become a Validator you need at least 32 Ethereum which is around ~$100,000. Many people with less than 32 Ethereum would like to participate in staking.

Lido solves this problem.

What is Lido?

Lido literally means a shared swimming pool. They were common in Britain before people could afford private bathtubs. Lido, the cryptocurrency project, is also a public pool – a pool for collective staking. Rather than stake individually, people contribute their ETH tokens to Lido who stakes for them and shares a portion of staking rewards with those that join the pool.

Besides allowing you to stake reasonable sums, Lido also enables “Liquid Staking”. In finance, “liquid” means you can move it around. In normal staking, your Ethereum is locked up and you cannot use your staked Ethereum tokens elsewhere unless you unstake. However, if you stake through Lido you are provided a new token that represents your staked Ethereum. The new token is called stETH. The stETH token is “liquid”, you can use it for trading, for lending or for other financial applications whilst still being given staking rewards.

Lido itself is a blockchain protocol. The code of Lido is maintained by the Ethereum blockchain. This code makes decisions including how to split staking rewards, and which Validators to stake with. If you use Lido to stake, you hold a token called stETH. However, another token called LIDO is used to maintain the Lido Protocol. The LIDO token gives you the ability to vote on the Lido Protocol; controlling decisions such as how much of the staking rewards to give to stETH holders and how stETH tokens function.

Holders of the LIDO token are governors of those who hold stETH.

Blockchain-based Governance: Code, Voting & Human Negotiations

Governance is the process of making decisions which affect other people.

Governance in blockchain protocols is multi-faceted; it includes the code itself, on-chain voting, and off-chain human influence.

All three of these routes; code, voting & human negotiations; often interplay with one another to contribute to final outcomes on blockchain.

To explain governance via code is to explain blockchain itself. In blockchains, a set of rules dictate how participants are allowed to interact with the network: e.g. you cannot send bitcoins you do not own over Bitcoin’s blockchain.

Whilst the utopia of blockchains envision governance being handled completely by code, in reality the core code of a blockchain can be updated if those that control the network agree to do so. In some blockchains, like Bitcoin’s, this requires all the Validators (called miners in Bitcoin) agreeing to shift to a new chain with the updated code.

In more modern networks, on-chain voting is formalised via Decentralized Autonomous Organizations (DAOs). DAOs are pieces of code that run on-chain and self-execute when certain conditions are met. Lido is a DAO. In the Lido DAO, you use the LIDO token to vote on decisions about changes to the protocol. When a specified threshold of token votes are met, the actions will self-execute on-chain. This is governance via on-chain voting.

Finally, and most importantly, is the inescapable governance of human influence. At its core, blockchains serve human beings: over the long-term, Ethereum, Bitcoin and any other blockchain will only last if they are useful for humans*. At the extreme, if nobody held Ethereum tokens, then Ethereum becomes non-existent and none of the voting mechanics or the ingenuity of the code mean anything. More practically, proposals for on-chain decisions necessitate some human initiation.

One such proposal is Dual Governance.

Dual Governance: Aligning Lido DAO & stETH holders

Dual Governance is a proposal made to improve Lido. Via Dual Governance, the interests of those that use Lido (stETH holders) are brought in-line with those who govern Lido. Dual Governance makes Lido more democratic.

The Dual Governance structure allows stETH holders to initiate "Veto Signalling". Initiating the Veto Signal is the first step in Dual Governance. The second step is how the veto is dealt with.

If Lido proposes a change that goes against the interests of stETH holders, then stETH token holders can signal a desire to Veto this new decision. Once this signalling has taken place, no new decisions can be passed unless the “Veto Signal” is resolved.

The Veto Signal can be resolved in one of two ways:

1. stETH holders who join the veto are able to exit the Lido protocol; or

2. The veto is deactivated.

If the veto is completed, the holders of the stETH are able to remove their Ethereum before the new decision is passed. Therefore, stETH holders have a mechanisms of preventing decisions they disagree with from affecting them.

By implementing a dual phased veto, this governance model improves social negotiations.

When the Veto Signal is activated the stETH cannot be immediately removed. Instead, a certain threshold of stETH must join the Veto Signal. By starting the Veto Signal, stETH holders are given time to rally other stETH holders around preventing the adverse decision affecting them. Only if other stETH holders agree the decision necessitates exiting, will the Veto Threshold be met.

However, to prevent the Veto Threshold being met, Lido will likely act in the interests of stETH holders. This might include adjusting their proposal, or finding stETH holders via social channels and justifying their decision-making process. Such social negotiations should be sufficient to make stETH holders deactivate the Veto Signal.

The Significance of Dual Governance

Dual Governance brings a few obvious benefits. The first is pragmatic. The mere ability for users to leave the protocol without having Lido decision’s affect them will bring greater harmony to the protocol. Lido holders are aware that any decisions they take will be subject to the veto of stETH holders. Therefore, decisions will act in the best interests of the users to prevent them going to competitors.

The second benefit is democratic. Those that are affected by a decision should have some influence over that decision. The risk of veto’s being applied to decisions will act as a check and balance against capricious proposals. Therefore, Dual Governance increases the fairness of the Lido Protocol.

More significantly, Dual Governance explicates the reality of decision making in blockchain. A social contract already existed between Lido and its Users, however, formalising this social contract with an explicit mechanism is crucial. As Jo Freeman explains in The Tyranny of Structurelessness, in informal structures rules & leaders inevitably emerge but they are the product of inscrutable social dynamics rather than thoughtful & fair design. Thus, formal rules that enable greater cohesion and involvement of all stakeholders are necessary – it cannot be left to informal structures of “trust”.

If the blockchain vision is to succeed, more and more of our on-line activities will be governed by on-chain code. To ensure such governance is sustainable, it must be made fair. Involving those who are affected by decisions and making mechanisms of decision-making explicit are crucial to ensure such fairness. Dual Governance is a well-considered process that introduces fairness to Ethereum’s ecosystem, Lido’s protocol and the blockchain vision of governance by code.