Ethereum’s Centralization Concerns Rise Post-Merge and Shanghai, Says New Report

Is Ethereum becoming more centralized after two major upgrades?

A recent research analyzes the effect of The Merge and Shanghai. JPMorgan’s new report shed light on Ethereum’s greater centralization after The Merge and Shanghai, the two major upgrades of the network in a year.

According to the insight, the transition from Proof-of-Work to Proof-of-Stake has seen a surge in Ethereum staking. However, this has led to a decline in the overall staking yield and the growing centralization.

People don’t want highly centralized systems, but it looks like Ethereum is going in that direction.

Greater Centralization, Less Yield

As reported, the total staking yield for Ethereum has decreased to around 5.5%. Before the Shanghai upgrade, this figure stands at 7.3%.

Lido Finance is a go-to alternative for interested people who want to stake Ethereum without relying on a centralized entity. The protocol additionally has taken steps to mitigate centralization concerns by adding more node operators.

However, despite Lido’s efforts, there are still centralization risks. Lido currently accounts for “almost one-third” of staking on Ethereum.

The report noted that a, “concentrated number of liquidity providers or node operators could act as a single point of failure or become targets for attacks or collude to create an oligopoly that would promote their own interests at the expense of the interests of the community.”

Apart from centralization, rehypothecation was also a highlighted risk in the bank’s study. This is a common practice in traditional finance where an asset or collateral is used as collateral for multiple loans or other financial transactions simultaneously.

While rehypothecation can reduce the cost of borrowing and increase liquidity in financial markets, it can also amplify risks, especially during periods of financial stress. A recently known example of this risk is the collapse of Silicon Valley Bank.

Ethereum’s Co-founder Warns of Liquid Staking

Liquid staking offers a multitude of advantages to both users and the broader blockchain ecosystem. When users stake their tokens, they help make the network safer and earn extra rewards.

Plus, these users retain the flexibility to actively engage in various projects within the decentralized finance (DeFi) space. But it comes with high risks.

Lido Finance, while not the only platform offering ETH staking through its model, stands out with a substantial million ETH staked, representing approximately one-third of the total ETH staked on the Ethereum consensus layer.

However, amassing such a significant portion of staking power raises concerns about increased risk.

The primary driver behind Lido’s extensive ETH staking is its exceptionally high yield. With various options delivering attractive returns, investors are flocking to stake their ETH on the Lido platform. This influx can lead to an imbalance, particularly when a crisis hits.

Ethereum’s co-founder, Vitalik Buterin, has raised concerns about the dominant role of liquid staking protocols, particularly Lido and Rocket Pool, in the Ethereum staking ecosystem.

He believes that although there are many validators, these two protocols still pose risks. To address this, he suggests changes to Ethereum itself, including giving more governance power to a small group of stakers.

Buterin also discussed the idea of integrating certain protocols and features directly into Ethereum’s source code instead of keeping them separate. He highlighted ERC-4337, an account abstraction standard, as a priority but cautioned that this could be a complex process with potential challenges.

Debates around PoS consensus have circled in the crypto community even before The Merge. Some express concerns that this shift, while aiming to enhance scalability, may compromise the security and decentralization valued in PoW.

Previously, censorship was a major concern during the transition. Ethereum is now poised for its next major upgrade, called Dencun, anticipated in early 2024.