Smol thots on competitor selection and industry structure for liquid staking in Ethereum
The below thots emerged following a discussion with hasu, a crypto enthusiast, researcher & investor. He encouraged me to read the relevant chapter of Michael Porter's Competitive Advantage and I synthesized some observations below.
The idealized academic microeconomic model for a simple market is one of perfect competition, where firms produce undifferentiated goods and on average earn no economic profits over the long-run. In this structure, many indistinguishable firms enter and exit markets without friction, a Sisyphean dystopia of Darwinian capitalism where no one firm prevails.
Conversely, Peter Thiel argues in Zero to One that competition is something undesirable and that firms should strive towards monopoly capitalism, in the vein of Google in the search engine market. His chief maxim is to seek contrarian truths and to pursue them to where they might lead.
1. It is better to risk boldness than triviality
2. A bad plan is better than no plan
3. Competitive markets destroy profits
4. Sales matters just as much as product
His observation is that conventional beliefs only ever come to appear arbitrary and wrong in retrospect. Before electricity, nobody would have thought twice about hunting whales to light street-lamps. He argues that, if you can identify a delusional popular belief, you can find what lies hidden behind it: the contrarian truth. Once you have your hands on a truth that nobody is not even wrong about, you can play for 100%.
This approach is suitable in new categories or in existing categories that are being redefined. For instance, Canada Goose and Moncler are both ‘Category Killers’ in the outdoor-wear market. They are just jackets, yes, but they found success at an unprecedented category price premium, each with its signature mini-category of one.
However, what this view misses is the realpolitik of competition that does eventually emerge. More importantly, it misses the analysis of how to leverage the presence of competitors to drive industry structure in a positive-sum direction.
For instance, when Uber faced new or existing competitors in ride-hailing apps, instead of approaching industry formation constructively, it often resorted to chasing 100% share at all costs. This superficially seemed to follow Thiel’s maxim of aspiring to monopoly capitalism. However, it also violated some important guardrails that reduced industry attractiveness through overly intense competition. Canada Goose succeeded by increasing the demand for outdoor jackets as a whole, not by fighting tooth and nail to take share from lower-quality jacket manufacturers.
Ethereum staking as an industry is reasonably unique in that it doesn’t have a pure profit objective. It plays an essential role in maintaining the security of the Ethereum network, by incentivizing the emergence of a decentralized set of validators who participate in the consensus of the blockchain. It still needs to be an attractive enough market to draw a broad base of profitable validators. But it primarily needs to perform the role of securing the network that everyone depends on. The incentives are reasonably well-designed, in the sense that if one central player did manage to capture a majority validator share, the network would cease to be useful and would therefore lose value.
Liquid staking allows users who have Ether, but not the technical know-how or time / resources, to deploy their validators. Decentralized liquid staking providers, such as Lido or Rocket Pool, serve as deposit brokers to a large network of validators and attract a large network of users holding Ether. Centralized liquid staking providers, such as Coinbase, concentrate validators in their exchange and offer their users one-step access to staking yields. The benefits for both sides are clear. On top of it, the deposit ‘receipt’, or token, is often tradable as a unit of account itself.
Players in this mini-industry need to understand and internalize how they are contributing to the overall public good objectives, so that each player can press their strengths for everyone’s benefit in a positive-sum way. This is preferable to an internecine hyper-competitive warfare for deposits, which would threaten the integrity of the system they’re trying to protect by making the industry less attractive for anyone to participate in.
Currently, liquid staking is quite a competitive market. Operating margins are thin, the stakes are high and the sector as a whole is hostage to the vagaries of total cryptocurrency market cap, which is not typically moored in any computational economic reality. At the time of writing it is declining, and whenever growth turns negative, players start to scramble for what’s left of a shrinking pie.
Despite the context, market participants fortunately haven’t relented in their vigilance to safeguard network security. Lido, for instance, has faced criticism as its market share approached the 30% mark, despite aggregating a highly decentralized node operator set. The intensity of these calls are a reflection of the importance of this market to all participants.
Michael Porter’s book, Competitive Advantage, contains useful frameworks and case studies that are relevant to understanding, for instance, how to navigate the presence of competitors. It sits squarely in the realpolitik world of experience, saddling the monopoly capitalism view on one side and atomized perfect competition on the other. It also might contain guidance that could help bolster the development of the burgeoning ecosystem building around decentralized finance, including liquid staking.
Industry structure can, in certain conditions, benefit from the presence of multiple competitors, who each play positive-sum distinct roles for each other in maintaining the welfare of the overall ecosystem. Porter outlines a few examples of how the presence of the right types of competitors can benefit individual players as well as the liquid staking market as a whole.
Good Competitors Increase Each Other’s Competitive Advantage
- Enhance the ability to differentiate: Lido stEth vs Coinbase cbEth is easier than comparing staking Eth at Coinbase vs staking ETH at Kraken, if consumers have difficulty distinguishing between various options
- Improve bargaining position with regulators: The presence of large institutional players helps educate regulators about the benefits of a healthy liquid staking industry, provided they don’t fall for the temptation to capture them and disfavor decentralized liquid staking
- Lower antitrust risk: The presence of liquid staking competitors reduces the risk of any one player gaining a controlling share of the network and reduces the intensity of PvP warfare among decentralized liquid staking providers
- Increase motivation: A viable competitor can be a powerful motivator for reducing cost and improving products
Positive-sum Competition Improves Liquid Staking Market Structure
- Increase industry demand: If the presence of cbETH on the Coinbase app is a gateway to educate consumers about the benefits of liquid staking, then the industry as a whole benefits
- Reinforce desirable elements of industry structure: As long as all competitors keep catering to a user demographic that values decentralization and network security, product feature development will tend in that direction for all players
Good Competitors Aid Market Development
- Share the costs of market development: Having more staking operators makes it more likely for market trial to be induced, and a lot of the costs of development can be shared through open-source contributions
- Reduce buyer’s risk: Users may be reluctant to enter liquid staked Eth if they see there are only one or two firms minting tokens
Bad Competitors Deterred From Entry
- Block easy entry avenues: Although attracting new players is a desirable outcome for Ethereum staking, it is important that these players share the same values of the ecosystem and are not willing to compromise for a quick scalp on newly referred Eth deposits—the presence of high-quality competitors makes it harder for lower quality offerings to succeed
We make references to a ‘good competitor’, inferring the existence of a ‘bad competitor’. Porter also describes what makes a good competitor, regarding the way in which they focus their resources to achieve their objectives.
A good staking or liquid staking competitor, rather than a bad one, is strategically focused and plays to grow the ecosystem
- Conscious of self-perceived weaknesses: Doesn’t try to be a one-stop shop for all Eth deposits
- Understands the rules: Conscious of the dual profit/good objective
- Operates under realistic assumptions: Never pressured into escalating wars for deposits
- Knows its own costs: Conscious of what margins are sustainable for staking operations or protocol viability
- Follows a strategy focused on improving industry structure: Aware of industry structure dynamics and consciously leaning on peers to play to their strengths
- Knows when to say no: Knows what market segments to ignore and which ones to focus on
- Burns the ships: In it to win it and for the public good, not just a spaceship that landed to farm tokens
Fortunately, the presence of a public good objective (network security) can help align market participants to solve for more than just the growth of their own staking operations–if they want to.