Ethereum 2.0 Upgrade Spurs Centralization Concerns

Ethereum’s recent Ethereum 2.0 update saw a surge in staking activity, signaling a shift in the blockchain landscape. While staking, which involves locking up cryptocurrencies to support network operations, offers benefits, there is another side – centralization.

The crypto community has traditionally favored decentralized liquid staking platforms like Lido over centralized alternatives. For example, Lido expanded its node operators to prevent any entity from gaining excessive control over staked Ether (ETH) to address centralization concerns. Threats of centralization remain, however, as a concentration of liquidity providers or node operators could create a single point of failure or even work together to create an oligopoly, potentially undermining the interests of the wider Ethereum community.

JPMorgan raised concerns about Ethereum’s increased centralization following the Merge and Shanghai upgrades. The report also highlights the concept of rehypothecation, where liquidity tokens are reused as collateral across multiple decentralized finance (DeFi) protocols. This practice can become problematic if the value of the staked asset plummets or faces security breaches or protocol errors, which can lead to a cascade of liquidations and threaten the stability of DeFi.

Additionally, the rise in stakes has reduced Ethereum’s appeal from a yield perspective, especially since traditional financial assets offer higher yields. Total betting returns decreased from 7.3% before the upgrade in Shanghai to around 5.5%.

However, there is a silver lining. Ethereum’s reduced energy consumption due to the September 2022 Merge upgrade is in line with global efforts to reduce the environmental impact of blockchain technologies. To address these concerns and optimize staking, the Ethereum core developers introduced the Ethereum Improvement Proposal (EIP-7514) as part of the upcoming Dencun upgrade, which is scheduled to be activated in October 2023. The goal of this proposal is to slow down the rate of Ethereum staking, allowing the Ethereum community more time to develop a practical system of rewards for stakeholders in the network.

Ethereum’s evolving environment illustrates the complex balance between centralization and decentralization as stakeholders and developers strive to maintain a secure, sustainable, and decentralized ecosystem.