The Merge has been hailed as one of the significant milestones in the crypto world, as the Ethereum network transitioned from Proof-of-Work to Proof-of-Stake.
While its environmental impact has been significantly reduced, there have been concerns that this consensus mechanism has made Ethereum more centralised.
Here’s an overview of on-chain censorship of Ethereum, and whether it could really become a possibility.
It all started with Tornado Cash
Tornado Cash is an open-source project, where it acts as a mixer to ‘break the link between the on-chain source and destination address of a transaction’.
This was the first time that any code was sanctioned, and it has raised concerns about OFAC censoring free-speech.
As many of you are aware, the recent Tornado Cash sanctions pose an existential threat not just to DeFi, but to free speech and privacy rights. It has sparked intense debate and had an immediate ripple effect across crypto and DeFi. (1/8)
— LeXpunK_Army (@LeXpunK_Army) August 14, 2022
Furthermore, some wallet addresses were included in the sanctions as well.
After these sanctions, Circle, the company behind USDC, blacklisted these wallet addresses, and froze around $75k worth of USDC.
Multiple DeFi applications like Aave, Uniswap and Balancer chose to ban users who interacted with Tornado Cash.
— H.E. Justin Sun🌞🇬🇩🇩🇲🔥 (@justinsuntron) August 13, 2022
All of this shows that even in decentralised finance, there are still some centralisation risks!
Why is Ethereum becoming more centralised?
With the shift to Proof-of-Stake, Ethereum relies on validators to approve transactions, instead of miners when it was utilising Proof-of-Work.
Validators are important as they decide which transactions go into each block, and the order that they are included as well.
To become a validator, you will need at least 32 ETH to start processing transactions, so this initial investment can be rather high.
Pooled staking has now become the most popular way for users to stake their ETH, where you delegate your stake to a validator, and they will charge a commission for providing this service.
Lido is one such example of a pooled staking provider, and it now holds 4.3m out of the 14.4m of total staked ETH.
Other big validators include Coinbase, Kraken, and Binance, and all of them are centralised exchanges.
This means that majority of ETH is currently staked by centralised entities, and this goes against the concept of decentralisation.
Even though ETH has around 450,000 validators, 40% of the network’s blocks were added by Coinbase and Lido in the hours after the Merge!
With transactions being processed by only a few validators, this could pose risks where some transactions deemed as ‘illegal’ may be censored.
Transactions on the Ethereum network can be censored too
Furthermore, validators are looking to maximise the revenue they earn for processing a block on Ethereum, and one such way is by using maximal extractable value (MEV) boosts.
When validators run this boost, this will “maximise their staking reward by selling block space to an open market of builders”.
There are a few companies that run these MEV-boost relays, with the most prominent one being Flashbots.
You can find out more about MEV here.
The problem with Flashbots is that their MEV-boost relays are OFAC-compliant.
flashbots censorship confirmed pic.twitter.com/zTaz20PFFy
— banteg (@bantg) August 17, 2022
This means that any validators that use the MEV-boost relay will not process any transactions that are involved with OFAC-blacklisted wallet addresses.
One such example would include those wallet addresses that are involved with Tornado Cash.
Flashbots is the biggest player in this space, and most validators are using their technology.
A website known as MEV Watch has been monitoring the number of blocks that are OFAC-compliant post Merge.
At the time of writing, about 40% of all blocks since The Merge have been OFAC-compliant.
Flashbots has since made its code open-source, and hopefully, this will reduce its dominance in the block production market.
Why does this matter?
Given these 2 factors, Ethereum may not be as decentralised as it seems.
This is because:
- Only a few validators have control over a large amount of all staked ETH
- Transactions on the Ethereum network could be censored if the wallet addresses are blacklisted by OFAC
Censorship challenges the idea of a blockchain, where Ethereum is no longer ‘neutral’, and could be prone to regulatory pressure.
A decentralised blockchain should allow anyone to participate in the network, regardless of who they are.
However, regulators are trying to control blockchains, and are forcing centralised entities within the crypto space to comply with their rulings.
In response to this, Coinbase’s CEO Brian Armstrong mentioned that he would rather shut down Coinbase’s liquid staking service than comply with regulations to censor certain transactions.
It's a hypothetical we hopefully won't actually face. But if we did we'd go with B i think. Got to focus on the bigger picture. There may be some better option (C) or a legal challenge as well that could help reach a better outcome.
— Brian Armstrong (@brian_armstrong) August 17, 2022
However, this is just one opinion, and other centralised entities may choose to comply with these regulations, instead of preserving the integrity of the network.
As blockchain networks are starting to be scrutinised by regulators, the possibility of a fully decentralised network may not be achieved.
There seems to be a degree of centralisation that exists in every network, which could be exploited for certain motives.
In Ethereum’s case, the presence of liquid staking providers with a high concentration of staked ETH, and the use of OFAC-compliant MEV-boost relays pose a risk to it being controlled by a central entity.
We can only hope that Ethereum’s community is fully committed to maintaining a ‘neutral’ stance!
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