Will a proof-of-stake Ethereum lead to more centralization?

Will a proof-of-stake Ethereum lead to more centralization?

Lido's staking protocol now holds 33% of all deployed Ether.

Lido is the most widely used protocol for liquid stakes. According to data from Nansen and Etherscan, it accounts for one-third of all ETH wagers on the Beacon Chain, Ethereum's proof-of-stake blockchain.

This article originally appeared in Valid Points, CoinDesk's weekly newsletter that focuses on Ethereum 2.0 and its far-reaching impact on crypto markets. Subscribe to Valid Points here.

When Ethereum eventually moves from its current proof-of-work method to a proof-of-stake (PoS) consensus mechanism, it will rely on validators rather than miners to validate transactions on the Ethereum blockchain. To run a validator (and earn staking rewards), participants will need to stake 32 ETH (about $65,800 at current prices).

Lido is a Staking-as-a-Service provider that allows users to deposit any amount of ETH to earn Staking rewards on the Beacon Chain. Lido users are not required to deposit the full 32 ETH to run a Validator node and are not responsible for the technical maintenance required to manage a Staking node.

In exchange for accepting ETH deposits, Lido issues stETH to stakers, its derivative token that "represents the value of the Ether staked in Lido and combines the value of the initial deposit and staking rewards," according to Lido. Lido stakers can hold their stETH, sell them on the open market, or deposit their stETH in various DeFi (decentralized finance) platforms such as Curve, Aave, and 1inch to generate additional returns.

This access to liquidity is attractive to some stakers who want to be able to access their deployed ETH before the merge; otherwise, they would not be able to touch any of that deployed ETH (or any rewards they may have earned in the meantime) until after the merge, which will not happen until later this year.

Currently, 10.6% of the circulating Ether supply is deployed in the Ethereum Beacon Chain, or just under $26.4 billion, or 12.6 million ETH.

Of the 12.6 million ETH, approximately 4.2 million have been deployed via Lido by 73,369 stakers, making Lido the most used staking pool on Ethereum.

Lido, Coinbase, Kraken and Binance, the four largest validator node operators on Ethereum's PoS beacon chain, accounted for 54% of all ETH deployments, according to Nansen. The dominance of Lido, which controls about 33% of all ETH deployments on Ethereum's PoS blockchain, has led to concerns about centralization and the long-term health and security of Ethereum.

While there are more than 70,000 stakers, Lido has 22 Ethereum node operators who handle the technical side of running the validator node software. Moreover, it doesn't help that the top 100 holders of LDO, the governance token for the Lido DAO, own 93.1% of the total LDO supply, data from Etherscan shows.

Danny Ryan, senior researcher at the Ethereum Foundation, pointed out on Twitter the problem of Lido's concentration in terms of deployed Ether: "Lido passing ⅓ is a centralization attack on PoS," he tweeted.

By controlling a significant portion of deployed Ether and taking over more than 90% of the liquid deployment market, Lido's centralization problem increases the risk of adverse events such as validator slashing, governance attacks, and smart contract exploits.

On the other hand, in the run-up to Ethereum's decision to move to proof-of-stake, there were concerns that centralized exchanges like Coinbase would take the lion's share of the staking pools. Lido was created in itself as an alternative to these centralized juggernauts. The fact that Lido has surpassed Coinbase, Kraken, and Binance could be taken as an encouraging sign that the ecosystem will be able to maintain some level of decentralization in the future.

Pulse Check

The following is an overview of network activity on the Ethereum Beacon Chain over the past week. For more information on the metrics presented in this section, see our 101 Explanations of Eth 2.0 Metrics.

Disclaimer: All profits from CoinDesk's Eth 2.0 staking venture will be donated to a charity of the company's choice once transfers are possible on the network.

Validated Stakes

Portugal plans to impose taxes on the exchange and sale of cryptocurrencies.

  • WHY IT MATTERS: Portugal was previously considered a tax haven for cryptocurrency investors, but Finance Minister Fernando Medina indicated that cryptocurrencies will be subject to taxation. The new policy does not go into detail about how staking or yield farming will be affected, but a capital gains tax will be imposed. "Many countries already have systems in place, many countries are building their models around this issue, and we will build our own," Medina said. Read more here.

Ratings giant S&P Global Ratings has formed a DeFi strategy group.

  • WHY IT MATTERS: S&P Global's DeFi Strategy Group is designed to help build the company's decentralized market framework for investors. Having rated Compound Treasury a B-, S&P Global hopes its strategy group will build its analytical and risk assessment capabilities for both traditional finance and DeFi clients. Read more here.

Ernst & Young partnered with the Polygon Network to unveil its blockchain-based supply chain manager.

  • WHY IT MATTERS: Ernst & Young's Supply Chain Manager on the Polygon Network aims to solve bottlenecks and chokepoints along supply chains by combining product traceability with inventory management. Currently available in beta, EY OpsChain Supply Chain Manager represents the first joint project between the accounting firm and the Ethereum scaling platform. Read more here.

China is still a significant contributor to global bitcoin mining.

  • WHY IT MATTERS: According to the Cambridge Centre for Alternative Finance, China was the second largest contributor to the Bitcoin mining network after the United States from September to January. Although the Chinese government banned bitcoin mining last year, the latest data shows that China's share of bitcoin mining increased from 0% in July to around 20% in October. Read more here.

Robinhood Markets plans to launch a new crypto wallet for "advanced" crypto users.

  • WHY IT MATTERS: By the end of 2022, the trading firm plans to launch a new crypto wallet focused on DeFi for customers who want to participate in the crypto economy. Unlike Robinhood's previous wallet, the new Web 3 crypto wallet will allow users to lend, deploy, farm and buy non-fungible tokens (NFTs). "We want to give [users] the last missing piece to access the Web 3 space," said Johann Kerbrat, Robinhood's chief technology officer for cryptocurrencies. Read more here.

Trivia of the week

Open Communications

Valid Points incorporates information and data about CoinDesk's own Ethereum validator into its weekly analysis. All profits from this staking project will be donated to a charity of our choice once transfers are activated on the network. For a full overview of the project, please see our announcement post.

You can check the CoinDesk Eth 2.0 validator activity in real time via our public validator key, which is:

0xad7fef3b2350d220de3ae360c70d7f488926b6117e5f785a8995487c46d323ddad0f574fdcc50eeefec34ed9d2039ecb.

Search for it on any Eth 2.0 block explorer page.