The ban on the Tornado Cash mixing service by the US Treasury Department continues to raise many questions in the crypto cosmos. For some, the sanction is seen as an intrusion into privacy.
Another debate has now flared up in the Ethereum community, in which the danger of increasing centralization of the Ethereum blockchain has come to the fore. Ethereum’s resistance to censorship is subsequently questioned.
Ethereum 2.0: Censorship at the protocol level?
Fear of violating U.S. Treasury Department sanctions drove some developers and other crypto sector figures to cut all ties with Tornado Cash and clearly distance themselves from the platform. Wallets that interacted with the Tornado Cash protocol, for whatever purpose, lost access to much of the Ethereum infrastructure. Stablecoin operators also shut down funds, drawing attention to the huge influence of centralized stablecoin companies in the Ethereum ecosystem.
A short time later, it was revealed that Ethermine, the largest mining pool operator on Ethereum, was boycotting Tornado Cash transactions on block creation. With this, Ethermine may have set a precedent for on-chain censorship on Ethereum.
This goes well beyond denying access to the front-end of many crypto platforms. It is about the selective exclusion of those blocks that go against a government regulation. One might think blockchain neutrality would be undermined by blocking transactions of a branded protocol.
Other miners are currently still processing corresponding blocks. However, given Ethermine’s influence on the network, they may soon find themselves compelled to follow suit. And it turns out that this problem will not be limited to the proof-of-work version of the Ethereum blockchain.
Centralization on Ethereum
Block production after the Ethereum merge in mid-September will no longer be taken over by miners, but by validators. By staking 32 ETH, you become a validator of transactions on Ethereum. A considerable amount of tokens that many smaller investors do not have. In order to stake nevertheless, they can join an Ethereum staking pool. There are almost 417,000 validators in total. Still, some statistics point to strong centralization.
Almost 60 percent of the total Ethereum stake is spread across four pools. Three of these can be assigned to the large centralized exchanges Binance, Coinbase and Kraken. The danger of a 51 percent attack, for example by collusion between the centralized operators, is an open question. The share of the provider for liquid staking “Lido Finance” is striking at 31 percent.
Lido allows smaller investors to put their ETH on the protocol and earn returns from it. Here it is being staked without requiring 32 ETH to set up a node for validation. Instead, the protocol further delegates these deposits to larger validators, which are themselves capable of running nodes and confirming transactions.
It is important here that the Lido Community continuously determines the node operators by voting. Accordingly, it would be possible that certain validators could be voted out. For example, those that violate upcoming regulations of OFAC or other authorities. Like Ethermine, these validators would then probably be forced to block certain transactions. Otherwise, in addition to the loss of income due to the ejection from the pool, there may even be criminal consequences.
The high concentration of staking shares in Ethereum thus represents a potential weak point in the system. In the event of further sanctions, there could be a chain reaction of peer pressure.
Lido in focus
Lido’s high stake in ETH is a concern. But there is still room for growth. With the successful implementation of ETH 2.0, it is conceivable that the demand for ETH staking will also increase among smaller investors. Especially since an increase in staking interest rates is in prospect. Lido’s share might even grow to more than 50 percent. This would give the staking pool decision-making power over the development of the Ethereum blockchain.
Because with the majority of validators, they would be able to refuse block production or, like Ethermine, censor transactions of certain platforms.
The main thing is to dissolve the centralized shares in the Ethereum Stake. For example, by introducing upper limits for individual providers. Such a proposal for self-regulation had already been put to the vote in the Lido community. The sobering result: 99 percent of those entitled to vote were against such a specially imposed upper limit.
One possible reason: the majority of the Lido Governance Token (LDO) and thus the right to vote is apparently in the hands of large US venture capitalists.
These are subject to the regulations of the US supervisory authorities and, in extreme cases, would either have to decide to give up the lucrative staking business or use their power in the project to force it to tolerate censorship. In that case, immutability and freedom from permission would be over.
What are the Ethereum stakers doing?
This scenario confronts the relevant stakeholders with a decision. Are they enforcing network censorship under pressure from regulators? Or are you abandoning your staking ambitions?
Coinbase CEO Brian Armstrong has already advocated censorship by authorities resignation of its staking service to “preserve the integrity of the network”. As determined as the announcement sounded, in the midst of this debate, Coinbase launched its own ETH staking token (cbETH). This suggests that the staking business should be further expanded.
Kraken was even more reserved. One is aware of “the importance of censorship resistance and permissionlessness for crypto”. As one of the leading ETH validators, “we are closely monitoring the current discussion and the potential implications of the Tornado Cash sanctions for validators,” a spokesman for the exchange said on request.
The Tornado Cash case shows that the US authorities see themselves as authorized to declare a DeFi platform illegal on the basis of national security. And centralized structures on Ethereum can be used for censorship. Where there is a way, there could also be a will.
Meanwhile, the Ethereum community is discussing possible solutions. Founder Vitalik Buterin confessed to so-called social slashing. Any staking rewards for censorship-tolerant validators will be destroyed here. However, small investors who delegate their ETH to those validators via Lido would also lose money. “The less bearish scenario,” says Ethereum Influencer Anthony Sassano.
It also remains to be clarified who carries out the slashing and whether there is a risk of abuse. Can censorship be fought with censorship?
There would probably also be one or more hard forks. These could split Ethereum into a blockchain of compliant and defiant validators. The second largest network in crypto space would threaten to dismember. A new “Classic” version that adheres to the creed of immutability and one that is legitimized by conformity.
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