Liquid Staking Risks: How Can It Harm Ethereum Ecosystem?

• The report by HashKey Capital highlighted risks of liquid staking such as reduced competition, increased risk of censorship, decreased security and collusion by big players.
• The overall liquid staking derivatives (LSD) market has surged to more than $22 billion in total value locked in 2023 with a market capitalization of $18 billion.
• Centralization in liquid staking can have several harmful effects on the ecosystem, such as reduced competition and increased risk of censorship.

Liquid Staking Derivatives Market

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.

Risks of Liquid Staking

HashKey Capital highlighted risks such as reduced competition, increased risk of censorship, decreased security and collusion by big players. Centralization in liquid staking can have several harmful effects on the ecosystem, such as reduced competition and increased risk of censorship. There is a heightened possibility of censorship with centralized stakers due to incentives or regulatory pressure to censor transactions which disrupts trust within the network. Big players can also make it easier for attackers to carry out 51% attacks and collude against users for malevolent MEV extraction and frontrunning activities.

Decentralizing Liquid Staking

Most protocols are very recent and have made plans to decentralize and add distributed validator technology to their protocols for better decentralization and resiliency. These steps will help reduce centralization risks while allowing other validators to join the system with minimum requirements for entry barriers.

SEC Reviews Ripple Ruling

The U.S Securities Exchange Commission (SEC) is currently reviewing its ruling against Ripple following an appeal from its legal team seeking a reversal of its previous decision that XRP was a security under US federal securities law. Additionally, there is a new bill that seeks control over digital assets which could potentially affect digital asset firms like Ripple if passed into law by Congress this year.

Conclusion

Liquid staking brings considerable risks that need better decentralization for it not to harm the Ethereum ecosystem with centralization issues such as reduced competition, increased risk of censorship, decreased security and collusion by big players. However most protocols are taking steps towards decentralizing their systems so they can benefit from liquidity while protecting user interests at the same time