[Keynotes] Possible futures of the Ethereum protocol, part 3: The Scourge

Ethereum’s move to proof-of-stake (PoS) has raised concerns about potential centralization, primarily due to economic incentives that favor large-scale stakers. As larger actors can operate more sophisticated algorithms and offer liquid staking tokens (LSTs), they gain significant advantages over smaller stakers, who may then join large staking pools rather than participating independently. This centralization could lead to various risks: 51% attacks, transaction censorship, and a concentration of value extraction power, where a small group captures profits at the expense of Ethereum’s user base.

Key Areas of Centralization Risk

1. Block Construction: Large stakers with advanced MEV (Maximum Extractable Value) algorithms can extract higher revenue from each block by prioritizing profitable transactions and optimizing the block construction process. This requires specialized tools, which small stakers may not have, causing a natural aggregation of power among larger participants.
2. Capital Provision and Staking Pools: Larger actors provide LSTs, allowing them to release capital to other investors while maintaining a presence in staking. This favors larger stakers who can absorb the capital-locking cost more easily than smaller, independent stakers, further centralizing Ethereum’s staking structure.

Proposed Solutions

To counter these risks, Ethereum researchers are exploring technical and design innovations to balance centralization with security and usability:

1. Inclusion Lists and FOCIL (Fork-choice-enforced Inclusion Lists): Here, transaction inclusion is restructured so that proposers (stakers) decide which transactions must be included, while builders can only order these transactions and add a few of their own. This solution aims to keep transaction control decentralized among stakers while allowing builders to focus on block sequencing, minimizing MEV-driven centralization.
2. Multiple Concurrent Proposers (MCP), such as BRAID: MCP schemes allow multiple proposers to submit transaction lists, which are then ordered according to a set algorithm (e.g., based on transaction fees). This approach attempts to make revenue generation achievable with only moderate resources, discouraging large-scale centralization among block producers.
3. Encrypted Mempools: These protect user transactions by keeping transaction details hidden from block builders, preventing large actors from exploiting specific transactions before they’re included in a block. Transactions are submitted in encrypted form and only revealed later, reducing the chance for MEV-driven centralization while enhancing user privacy.

Challenges and Future Directions

Each of these solutions involves trade-offs. For instance, while inclusion lists and FOCIL limit centralization, they still permit some MEV activity, which could incentivize collusion among proposers. BRAID, while more decentralized, depends on encrypted mempools to maintain privacy and prevent attacks that target the highest-priority transactions. The encrypted mempool itself is technically challenging, requiring robust design to ensure timely transaction inclusion without adding undue complexity.

Broader Impact and Next Steps

Addressing centralization in block construction and staking pools interrelates with Ethereum’s broader PoS roadmap. By reducing the 32 ETH staking minimum, decreasing hardware requirements for validators, and tackling staking pool dominance, Ethereum’s network could become substantially more decentralized. The article suggests that addressing one area (e.g., block construction) enhances efforts in others, creating compounded gains in decentralization and security.

The Problem with High Staking Levels

Currently, around 30% of Ethereum’s supply is staked, which is more than enough to secure the network. But if nearly all ETH were staked, it could introduce various issues:

1. Compulsory Staking: Staking would shift from a specialist task to a necessity for all ETH holders, leading many to simply choose the easiest, centralized staking option.
2. Weakened Slashing Mechanism: If almost all ETH is staked, slashing penalties become less credible as a deterrent.
3. Single Liquid Staking Token Dominance: If a single liquid staking token (LST) gains popularity, it could threaten ETH’s own role as a currency and cause a concentration of power.
4. Excessive Issuance: If staking becomes widespread, Ethereum could over-issue ETH as rewards, and much of this could end up captured by one large LST.

Proposed Solutions

To manage these risks, two main approaches have been suggested:

1. Encouraging Decentralized, Low-Risk Staking Tokens: One idea is to cap staking penalties (e.g., at 1/8 of staked ETH), making 7/8 of it unslashable and thus eligible for a trustless, neutral LST. Alternatively, a two-tiered staking approach could separate high-risk, slashable staking from low-risk staking that everyone could join.
2. Reducing Rewards as Staking Increases: Another approach is to limit staking by adjusting Ethereum’s issuance curve, where rewards decrease sharply if staking reaches a certain level, discouraging excessive staking.

However, each option has trade-offs. The two-tiered approach is complex and would require setting separate reward curves for “basic” and “risk-bearing” staking. Reducing rewards is simpler but could also lower incentives for security.

Managing MEV (Maximum Extractable Value)

MEV, which stakers earn by ordering transactions in blocks, presents several challenges:

• It is a volatile income source, pushing small stakers to join pools for stable returns.
• It can drive excessive ETH staking even if rewards are capped.

One solution is for Ethereum to make MEV revenue “legible” to the protocol, potentially through MEV smoothing (pooling MEV income to spread it across stakers) or auctioning off block proposer rights, allowing MEV to support security without centralizing stakers.

Policy Options and Trade-offs

Ethereum’s developers are still debating the best path forward. The main policy options include:

1. Doing Nothing: This would keep the current system but may lead to LST centralization risks.
2. Stake Capping via Issuance Adjustment: Lowering issuance as staking grows could effectively cap staking, though it could also centralize the remaining set of large stakers.
3. Two-Tier Staking: Separating low-risk from risk-bearing staking would spread participation but is technically complex and might centralize the high-risk tier.

Aligning with Other Roadmap Goals

High staking costs today make solo staking less attractive, especially with the $60 monthly VPS costs for running nodes. Reducing these costs, as planned in Ethereum’s “Verge” phase (which aims to reduce storage and operating expenses), will keep solo staking viable even if returns decrease. Additionally, MEV burn could make staking returns more stable, helping smaller stakers remain competitive.

Application-Level Solutions to Boost Decentralization

Beyond protocol changes, application-level solutions could strengthen decentralization:

• Specialized Staking Hardware: Companies like Dappnode sell dedicated hardware for easy staking node setup, which could potentially offer users other privacy-focused services like decentralized VPNs.
• Squad Staking: Solutions like Obol allow groups to stake together, reducing risks for solo stakers.
• Airdrops for Solo Stakers: Projects could incentivize solo stakers with airdrops or other rewards, promoting decentralization.
• Decentralized Block Builders: By creating decentralized entities that bid in block-building auctions, Ethereum could better protect privacy and resist censorship.
• MEV Minimization on L1: Applications designed to minimize MEV leaks, such as Cowswap, can reduce the centralizing effects of MEV by offloading work from L1 or auctioning the right to execute faster transactions.

You can read the full article on Vitalik Buterin website.