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On Thursday, September 15, Ethereum successfully merged its execution and consensus layers, becoming a Proof-of-Stake blockchain.
The Merge may have been one of the most impressive endeavours in the history of open-source software: changing one of the key elements of a blockchain – its consensus – while it was running, was no small issue. It required a lengthy planning, masterful coordination of dozens of developer teams and researchers… but it all went as good as one could have imagined, earning Ethereum and its developers even more of the industry’s respect.
This paints a bright picture for the second-biggest blockchain and its plans for the future, still very ambitious (Vitalik Buterin still considers Ethereum complete at only 55%).
However, the Merge has also brought forward new problems, like centralization and risks of censorship, and a growing part of the crypto community is worrying how those might turn out.
Transition to the PoS consensus not only reduced Ethereum’s energy consumption, but also paved the way for further improving of its efficiency, accessibility, capacity to evolve…
Now that the Merge is done, the next stages will include the surge, the verge, the purge and the splurge (yes, giving cool names to serious software is one of the perks of the crypto space). Here’s what these are about:
The surge will allow Ethereum to scale from the actual 15-20 transactions per second to 100’000. It will achieve it with sharding, which is basically splitting the blockchain into 64 mini-blockchains, or “shards”.
The verge will allow users to become network validators without having to store the whole blockchain (which is getting pretty heavy) on their computers. This step, which will rely on the so-called “Verkle trees”, a type of mathematical proof, and “stateless clients”, is supposed to help bring down technological barriers to entry and help decentralize the network.
The purge will push further the above effort, aiming at simplifying the protocol over time and dispense the nodes from storing its history.
Finally, the splurge is about “all the other fun stuff”, as Vitalik Buterin put it.
Decentralization is the main raison d’être of the blockchain. It is the cornerstone of its security, censorship-resistance, community governance… Keeping a blockchain decentralized is vital, albeit not easy: as it grows, it naturally attracts bigger players.
Bitcoin has often been criticized for the concentration of its miners: first within China (65% of the world hashrate up until 2021), then within mining pools (73.7% of the hashrate is now produced by 4 mining pools). However, the massive miner exodus from China only proved the industry’s flexibility and resilience, and the same qualities apply to mining pools. These associations pool their members’ computing power to compete for block production, splitting the reward proportionally. Miners act on their own will, which means that even in case a pool decides to conduct a malicious operation, its members can swiftly stop supplying their hashrate to it, for they have powerful incentives to see Bitcoin prosper.
Ethereum stakers are also motivated to see Ethereum succeed, but they have no say in what their staking services do. Once a user has locked their ethers in such service, they relinquish all control, and this makes Ethereum staking centralization tendency worrisome. It is especially dangerous now that ethers cannot be un-staked – a situation that is supposed to change after the Shanghai fork, expected to happen sometime in 6-12 months.
At the moment, out of 13.8 million of staked ETH, over 60% is controlled by only four entities: Lido (30.2%), Coinbase (14.5%), Kraken (8.3%) and Binance (6.6%).
So, what are the actual risks of centralization and passing to the PoS?
⏸️ Validators could collude and rewrite the chain, which would hurt the counterparties that have received funds in the transactions that have been overridden (scenario known as double-spending). However, we can hardly think of a transaction that could be so valuable that it would incite the malicious validators to lose their stake.
⏸️ The colluders could also halt the blockchain, hurting everyone transacting on it and bringing down the price of ETH. This scenario is profitable for those who would bet beforehand on the price decline, by opening short positions on derivatives platforms and stock exchanges. However, once again, in order for this to have an actual economic interest, the amount of shorts would have to be so big, it would not go unnoticed, and the plan would fail.
⚠️ There’s one risk that is quite real, though, and this risk is regulatory. The companies that run staking services control both the staked ethers (to the extent at which Ethereum allows to un-stake them) and the tokens that they give to their clients as an IOU. If the authorities of these companies’ respective jurisdictions decide to outlaw staking, Ethereum, or individual wallets, the companies will be required to comply. Now, decentralized services like Lido, which need a DAO vote to make changes to the protocol, are less likely to mess with their clients, but centralized ones like Coinbase, Kraken or Binance, will be obliged to do whatever the authorities request, even if it means censoring the blockchain.
This risk is much higher for Coinbase and Kraken, for they are incorporated in the US, and the recent Tornado Cash affair showed just how reckless the Federal agencies can be when it comes to crypto.
In an attempt to reassure its clients, Coinbase’s CEO Brian Armstrong said last month that the company would rather shut down staking services than impose protocol-level censorship, if it ever was requested to do so. However, the smart contract for the wrapped staked ETH (cbETH) that Coinbase gives the stakers in exchange for their ethers, does have a blacklist option, pretty much like the stablecoins do. This option would allow the company to freeze customers’ funds if it believed that their wallets were violating its user agreement or if the law required it. Furthermore, it is hard to imagine the company un-staking its clients’ ethers and shutting down the service after a regulatory crackdown, which is often enforced immediately.
⚠️ Now that Ethereum is operated and governed by the “tokenholders”, it is likely to get more attention from the financial authorities. Regulators could decide to tax the staking gains, or officially liken ethers to securities, with all the bureaucratic hurdles this entails. Gary Gensler, the Chair of the SEC, has been circling around the PoS blockchains for a while already, and Ethereum joining their ranks is exposing itself to this new risk.
The Merge has marked a new era for Ethereum, and as often, it brought about new opportunities and new threats. Ethereum is now off the radar of ”ecological” attacks, but on the radar of the financial and AML policies, which now have a mean to influence the blockchain via centralized staking services. The crypto community is split into Ethereum-believers, thrilled by the success of the Merge, and Ethereum-sceptics, who say that the blockchain has lost its independence and fell into the arms of “big finance”.
It is difficult to draw the line, but in the “blockchain trilemma”, a notion coined by Vitalik Buterin and describing competing qualities of decentralization, scalability and security, Ethereum has privileged scalability at the expense of decentralization. Time will tell if that was the right bet.