As it continues to grow, liquid staking brings considerable risks to the space and needs better decentralization, according to a report published by digital asset firm HashKey Capital.
According to the report, the overall liquid staking derivatives (LSD) market has surged to more than $22 billion in total value locked in 2023. In addition, the market capitalization of LSD projects has reached $18 billion.
While the growth of LSD protocols may be good for their respective communities and tokenholders, it also could be a double-edged sword. According to the report, it could harm the Ethereum ecosystem in various ways.
As the table above shows, many LSD protocols rely on a small number of node operators that centralize a large number of validator nodes. According to the report, the number of node operators should be a “point of concern for centralization.”
The report notes that centralization in liquid staking can have several harmful effects on the ecosystem, such as reduced competition and increased risk of censorship. According to the report:
“There is a heightened possibility of censorship with centralized staking players, as they may be subject to incentives or regulatory pressure to censor transactions. This can potentially result in a disruption of the trust within the network.”
In addition, as it gets further centralized, there are risks of decreased security, as big staking players can make it easier for attackers to carry out 51% attacks. Moreover, there’s also an increased risk of collusion.
“Centralized stakers can collude to carry out actions that go against the decentralization ethos and against the users, such as malevolent MEV extraction and frontrunning,” the report reads.
While there are centralization risks, HashKey also recognizes that most protocols are very recent and have made plans to decentralize and add distributed validator technology to their protocols for better decentralization and resiliency.