Ethereum went through a key network upgrade on Sept. 15, shifting from its proof-of-work (PoW) mining consensus to a proof-of-stake (PoS) one. The key
Ethereum went through a key network upgrade on Sept. 15, shifting from its proof-of-work (PoW) mining consensus to a proof-of-stake (PoS) one. The key upgrade is dubbed the Merge.
The Merge was slated as a critical change for the Ethereum network that would make it more energy efficient, with later improvements to scalability and decentralization to come.
A little over a month later, however, some industry observers fear the PoS transition has pushed Ethereum toward more centralization and higher regulatory scrutiny.
The Merge replaced the way transactions were verified on the Ethereum network. Instead of miners putting in their computational power to verify a transition, validators now pledge Ether (ETH) tokens to verify those transactions. The issue with this system is that validators with a higher number of Ether have a larger say, given they have a larger percentage of validator nodes or staked ETH.
To become a validator on the Ethereum network, one must stake a minimum of 32 ETH. Thus, whales and big crypto exchanges have staked millions of ETH to have a larger portion of the validator nodes.
Current staking activities look very centralized, with the leading liquid staking protocol Lido and leading centralized exchanges such as Coinbase, Kraken and Binance accounting for over 60% of the staked ETH.
RA Wilson, chief technology officer of crypto and carbon credits exchange 1GCX, told Cointelegraph that the Merge has enabled large holders of Ether to gain mass control of the network, making it significantly more centralized and certainly less secure and explained:
“Many ETH holders stake their crypto on centralized exchanges such as Coinbase, which allows these platforms to become dominant holders on the network, contributing to stakeholder centralization.”
The centralization aspect was quite evident right after the Merge, as 46.15% of the nodes for storing data, processing transactions and adding new blockchain blocks could be attributed to just two addresses.
Arcane Crypto analyst Vetle Lunde told Cointelegraph that while the PoS transition was important for Ethereum’s long-term goals of energy efficiency and scalability, one should be aware of the trade-offs:
“The largest validators being exchanges represent a potential long-term risk. Exchanges already find themselves in a difficult regulatory landscape, and precautionary rejections of transactions may conflict with one important core principle in the crypto ethos, censorship resistance.”
While Ethereum proponents claim that anyone with 32 ETH can become a validator, it is important to note that 32 ETH, or around $41,416, is not a small amount for a newbie or common trader, added to the fact that the lock-in period is quite long.
Slava Demchuk, CEO of Web3 complaint platform PureFi, told Cointelegraph that the centralization and complexities involved in staking would make centralized entities like Coinbase more powerful:
“Most people will be staking with custodians (such as Coinbase) due to the simplicity and the fact that they don’t have 32ETH. This way, large companies will have a majority share of the network, making it more centralized. It means that entities with more ETH will have more control.”
The fear of regulatory scrutiny
Earlier in 2018, the SEC claimed that Ether is not a security, owing to its decentralized development and expansion over time. However, that may change with the move to PoS, which has complicated the relationship between the Ethereum blockchain and regulators.
Gary Gensler, Chair of the United States Securities and Exchange Commission (SEC), testified before the Senate Banking Committee on the day of the Merge, stating that revenue from “expectation of profit to be derived from the efforts of others” would include proof-of-stake digital assets.
Gensler also mentioned that staking from large centralized exchanges looks “very similar” to lending, calling out high-yield products that caused the recent crypto market meltdown and lumping these products into the financial instruments under the scrutiny of the SEC.
Furthermore, in an SEC lawsuit filed just a week after the Merge, the SEC claimed jurisdiction over the Ethereum network as the majority of nodes are concentrated in the United States.
While the SEC’s claims raised some eyebrows and with many criticizing the regulator for its approach, some believe Ethereum has had it coming, as Gensler has already stated that moving to PoS could trigger securities laws. Ruadhan, the lead developer of PoW-based mining token developer Seasonal Tokens, told Cointelegraph:
“The argument that many of the validators are located in the U.S. is weak because it’s not even a majority. However, this move does show an intent to regulate, and it would cause a major disruption to the economy if Ethereum were to be classified as a security. Centralized exchanges would need to de-list Ethereum. The world economy is currently very vulnerable, and Ethereum’s market cap is so…
cointelegraph.com