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Lido DAO mulls over objective-based liquidity for stETH

The DAO is currently discussing options for an objective-based liquidity design for stETH.

About three days ago, Lido DAO’s financial unit Steakhouse Financial started a discussion about exploring an objective-based liquidity option for stETH. According to the crypto-native financial advisory firm, LDO should no longer be used to pay liquidity incentives and the DAO should not be paying to create a significant liquidity buffer over trading volume. Notably, Lido DAO is spending excessively on liquidity without any meaningful change in the exchange rate for stAssets

The net effect of paying for anything in LDO is the equivalent of the DAO market-selling LDO for cash then using that cash for an expense.

Steakhouse revealed that only a meager 5% of the LDO distributed as liquidity incentives are held. Between January 2022 and February 2023, the protocol has issued almost 80 million LDO in the Curve incentives pool. About 98% of the issued amount has been claimed. However, analyzing the activities of the top holders shows that “a staggering 85% was dumped immediately,” with another 10% being dumped within six months.

Given the outcome of its research, Steakhouse argues that paying liquidity incentives with LDO was bad for the DAO in the long run.

Only 80 addresses claimed more than 100k LDO, of which 4 participated on less than 3 Snapshot polls and only 1 participated more than 5 times. Distributing LDO as incentives not only disproves the implied framing but is demonstrably bad for the DAO along those same lines. The net effect of using LDO to pay for incentives is that wealth is transferred from existing LDO users to 80 whales on Curve.

As an alternative, Steakhouse suggested that liquidity incentives should be paid in the token the protocol generates a surplus in, which in this case is stETH.

On the second issue of stopping the DAO from paying to create a significant liquidity buffer over trading volume, the financial firm states that “the DAO should not effectively hold the safety net for staking loops.” Although there is a large risk of cascading liquidations in the event of market dislocation, Steakhouse proffers a two-sided solution.

On one hand, lending protocols could implement hour-long delays on oracles or open the oracle set to new participants with hour-long delays. Alternatively, Lido treasury stop providing a buffer for looped staking users because “anyone with a leveraged position is incurring a risk and should be responsible for that risk.”

Commenting on the discussion, Paul Sengh, a contributor to Delta One, said that liquidity incentives need to do more than rent liquidity. Although they play an important role in bootstrapping a network, he believes that “the core product-market-fit of the DAO should sustain the network.”

Given that 95% of incentives are dumped within 6 months, we fully support the claim around weaning off LDO incentives for established pools, such as Curve’s stETH-ETH,” Sengh wrote. He added:

If the Curve pool is not paying for itself, then Lido needs to address the underlying problem: improving real use cases of stETH across the ecosystem to increase velocity, thereby increasing volume and fees for LPs.
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