Centralization Remains a Big Challenge for Ethereum

The Ethereum blockchain reached a significant milestone in its history on September 15, 2022. During the event tagged the "Merge," the network migrated from proof-of-work (PoW) to a more eco-friendly proof-of-stake (PoS) consensus mechanism.

The Ethereum network had previously relied on specialized hardware (read: high-end GPUs and ASICs) to verify transactions and mine new blocks. The Merge switched the network to a less energy-intensive and efficient proof-of-stake protocol. Now anyone can become a validator on the Ethereum network by staking a minimum of 32 ETH.

Roughly a year after, the network now enjoys improved scalability and security — two key tenets of blockchain systems — alongside cheaper transactions. However, the risk of centralization on the Ethereum blockchain network remains problematic.

What Is Centralization in Crypto?

By definition, centralization arises from singular points of failure in a system's architecture. Any time there is a choke point in the technology stack, centralization occurs.

Indeed, the crypto space remains in a dilemma on centralization; some propose that absolute decentralization is the way to go, while others prefer a better user experience — think faster transactions and near-zero fees.

Centralization risk is real. For one, there is centralization of capital, highlighted in the collapse of 3AC and FTX in 2022. Even more, blockchain systems also possess inherent centralization risks, and Ethereum is no exception.

Larger mining pools can earn more profit due to economies of scale in concentrated voting power. Nodes can also have centralized clients or be hosted on centralized cloud providers. Sadly, the fatal result of centralization is censorship.

According to Cointelegraph , "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."

Censorship-resistance is a prominent feature of blockchain systems, so it's necessary to guide against elitist gatekeeping and favoritism in network transactions and addresses.

Centralization Risks in Ethereum

Blockchain security company Trail of Bits conducted a study on blockchain decentralization in 2022, pointing out various classes of centralization risks. These include governance, consensus, motivational, topological, network and software centrality.

Some of these six vectors have been major talking points for Ethereum. For instance, governance and consensus centralization risks have risen with the switch to PoS consensus.

Liquid staking derivatives (LSDs) are the latest DeFi trend, which enable users to stake ETH to earn rewards. However, unlike traditional staking, liquid staking does not lock up staked ETH but instead automatically mints the stake into an LSD token.

As it stands, liquid staking platform Lido and the top three CEXes: Binance, Coinbase and Kraken hold about half (~47%) of the staked ETH.

Top 10 ETH stakers. Source: Dune Analytics

According to the Dune dashboard, Lido currently has a TVL of over $11 billion, the highest on Ethereum. In comparison to their next competitor Coinbase, Lido is 5X their total value locked at about $2.33 billion. Lido currently owns 32% of all ETH staked and 72.9% of the liquid staked ETH market share.

No doubt, these are eye-popping numbers (at least for Lido stakers), but they raise several red flags. Most notably, a single organization holding a large quantity of ether is a serious threat to Ethereum's decentralization.

Ethereum Foundation researcher Danny Ryan warned in a recent essay that a 1/3 centralization attack may occur if Lido's network control exceeds 33%. This attack vector is a common drawback of Proof of Stake consensus.

Regulatory Scrutiny and US Dominance

Lido acts as a validator, allowing anyone to stake their ETH and earn some staking rewards. Although Lido's staking power is technically delegated, it's easy to take control by staking more tokens. Almost like a cartel of sorts, especially with the rising trend of MEV — maximal extractable value .

Finally, there are two bottlenecks that further increase the risk of centralization: validator clients and node hosting diversity. Over 76% of Ethereum's nodes utilize one execution client (Geth), while two companies (Prysm and Lighthouse) provide a majority of nodes with consensus clients. Even now, AWS hosts the majority of validator nodes.

Validator clients and node hosting could be sources of centralization. Source: Messari

Although these bottlenecks aren't that critical, it's now becoming clear that Ethereum is not fully decentralized — only nominally. Granted, stakers are dispersed across various geographical regions, but voting power is "aggregated" into central points of failure (i.e., staking pools).

And perhaps even worse, the PoS transition has shone a brighter regulatory spotlight on the network. SEC Chair Gary Gensler stated that ETH staking from large centralized platforms looks "very similar" to lending, meaning their financial instruments fall under the SEC's purview.

The SEC also filed a lawsuit claiming jurisdiction over the Ethereum network, since the majority of nodes are in the US. However, Buterin is already planning to tackle Ethereum's centralization challenges with the next stage of its roadmap, "the Scourge."

Mitigating Centralization Risks in Ethereum

The Merge was the first step in Vitalik Buterin's vision to build Ethereum into a "decentralized world computer." The upgrade event changed the Ethereum network's consensus mechanism and reduced energy consumption by 99.9%, a significant drop by all standards. However, issues abound and there is much left to do in achieving true decentralization.

Thankfully, the Ethereum developer community is aware of these setbacks.The Scourge event in the Ethereum roadmap is designed to effectively tackle these challenges.

According to the updated roadmap tweeted by Buterin, the Scourge is designed to ensure reliable, fair and credible transaction inclusion, and solve MEV issues. It will incorporate extra-protocol MEV markets to keep the transaction marketplace as fair as possible.

In other words, the Scourge will make the network more censorship-resistant and decentralized. Hopefully, the update will roll out sooner rather than later.