Pledge Status 5 Key Points After One Year of Ethereum Merge

5 Key Points of Ethereum Merge Pledge Status after 1 Year

Authors: Margaux Nijkerk, Sam Kessler, Consensus Magazine; Translation: Song Xue, LianGuai

It has been over a year since the largest smart contract blockchain, Ethereum, switched its old energy-intensive Proof-of-Work (PoW) model (used by blockchain such as Bitcoin) to Proof-of-Stake (PoS).

This transition, known as “The Merge,” introduced a new way of adding and approving transaction blocks on the blockchain called “staking.”

Under the Proof-of-Work mechanism, miners compete to add blocks by solving cryptographic puzzles. Now, under the PoS mechanism, Ethereum validators stake 32 ETH (about $50,000) on the network and are randomly selected to add blocks. In both models, miners and validators receive ETH rewards if their blocks are added to the blockchain.

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Through staking, Ethereum has greatly reduced its environmental impact, but it still faces a series of challenges regarding centralized power, censorship systems, and the exploitation of certain infrastructure intermediaries. Here are five key points learned from the Ethereum ecosystem in the past year since the merge:

Ethereum’s Energy Consumption Decreased by 99.9%

(Digiconomist)

The merge completely overhauled Ethereum’s consensus mechanism – the system used by the decentralized community of network operators to secure the network and process transactions. The old model, Proof-of-Work, used an energy-intensive “mining” system where network operators essentially compete by consuming computational power to process blocks (and receive rewards).

The transition from cryptocurrency mining to staking is expected to significantly reduce Ethereum’s energy consumption – completely eliminating the energy-intensive system previously used to generate blocks and protect users.

Ethereum’s energy consumption prior to the merge was roughly equivalent to that of a small country, and its energy usage statistics were a major focus of early NFT and DeFi critics. According to the Cambridge Bitcoin Electricity Consumption Index, Bitcoin still uses a Proof-of-Work system to power its network, consuming energy comparable to that of Singapore.

“Significant decrease in Ethereum’s new energy consumption.”

One year after the merge, Ethereum’s new emissions have sharply decreased. The new Proof-of-Stake system consumes 99.9% less energy than the old mining-based system. Regardless of whether the upgrade is successful or not, it is now difficult to portray Ethereum as environmentally harmful.

Staking Distribution Fuels Centralization Concerns

(Dune Analytics)

In addition to criticism for its high energy costs, Ethereum’s old consensus model has also been criticized for centralizing power in the hands of a small number of crypto mining groups – these groups have the funds, specialized hardware, and expertise to build large-scale crypto mining facilities. Prior to the merge, only three mining pools dominated the majority of Ethereum’s computing power – this is the metric that measures the collective computing power of all miners.

When the merge action transforms Ethereum into PoS, the network abandons mining in favor of staking. The new system eliminates the hardware requirements and computational costs of PoW, in part to open the doors for more people to participate in operating the network.

However, a year after the merge, centralization remains one of the biggest challenges Ethereum faces. To stake on Ethereum, validators need to lock up 32 ETH in the network, approximately $50,000 – these funds can earn stable interest, but if validators make mistakes or engage in dishonest behavior, these funds may be revoked. Setting up validator nodes for staking on the network can also be a complex task, meaning economic penalties may be imposed if not properly set up.

Due to the costs and technical barriers of setting up nodes, intermediary services have emerged – from companies like Coinbase and decentralized collectives like Lido – allowing users to pool their ETH together to create 32 ETH for a validator. These intermediaries take on much of the heavy lifting: they take ETH from users, stake on their behalf, and extract a portion of the rewards earned from operating validators.

Even before the merge, some anti-PoS advocates were concerned that staking could increase centralization in Ethereum – meaning a small portion (or even a single entity) of these intermediaries could gain disproportionate control over which blocks are added to the network.

This scenario seems to be unfolding: currently, the largest staking provider is the largest decentralized staking pool, Lido. Lido currently holds 32.3% of the total staked ETH, close to the 33% threshold that raises concerns about centralization, as developers suggest that this threshold may lead to security issues.

MEV and the Governance System

(mevboost.pics)

(mevwatch.info)

After the merger, Ethereum validators have successfully obtained significant additional profits through a practice called Maximum Extractable Value (MEV). This is sometimes seen as an “invisible tax” where validators and builders can charge users for these taxes by strategically inserting or reordering transactions before adding them to the network.

When MEV becomes an unexpected carrier of centralization and censorship on the network, third parties intervene and attempt to address some of the more harmful side effects of this practice.

Flashbots, an Ethereum research and development company, invented MEV-boost, which is software that validators can run to reduce the negative impact of MEV. However, Flashbots’ solution to the MEV problem is controversial. While some believe that MEV should be completely eradicated, Flashbots introduced MEV-Boost, which makes this practice ubiquitous.

Currently, about 90% of blocks on Ethereum go through MEV-Boost, which optimizes the way transactions are organized into blocks for validators to maximize profits.

The widespread adoption of MEV-boost has become a focal point of network debates. As mentioned earlier, MEV is seen by some as an unfair tax on users. Flashbots’ central role in the Ethereum MEV market has been criticized: the majority of blocks assembled through Flashbots software are either “relayed” or passed on to validators by Flashbots itself.

This centralization is seen by some as a potential carrier of censorship: when the US Treasury Department approved certain Ethereum addresses related to the mixer program Tornado Cash, Flashbots stopped adding these transactions to the blocks sent to validators. This move has disgusted Ethereum builders, who believe that the infrastructure level occupied by Flashbots should be completely neutral – to avoid the entire network becoming more like centralized payment processors such as Visa.

Since the early stages of the merger, the Ethereum community has been working to reduce censorship by configuring MEV-Boost to use non-Flashbots relays. Currently, 17.3% of blocks rely on Flashbots relays to extract MEV, and the censorship rate has dropped to 35%, a huge reversal compared to the high point of 78% in November 2022.

Liquidity Staking Tokens Have Taken Over the ETH Market

(https://defillama.com/lsd)

After the merger, liquidity staking has emerged in the Ethereum ecosystem.

Anyone can participate in Ethereum’s security system and earn rewards through the staking process, which involves locking ETH tokens in addresses on the Ethereum blockchain in exchange for a stable interest flow. However, there is a problem: once tokens are staked, they cannot be bought, sold, or used in DeFi (such as collateral for loans) – which limits the appeal of staking for investors interested in maximizing their investment value.

The third-party liquid staking service provides an alternative solution to traditional staking. Users who stake through services like Lido can receive a derivative ETH token representing their staked assets, called Liquid Staking Token (LST).

LST earns interest just like regular staked ETH, but it can be bought and sold like any other cryptocurrency, making it an attractive investment for DeFi traders who want to participate in ETH staking easily. As an additional benefit, LST offers users exposure to staking without requiring them to lock in the minimum amount of 32 ETH.

Before the Shapella upgrade in April 2023, it was not possible for stakers to withdraw their staked ETH. This led people to initially turn to liquid staking to earn staking rewards without the risk of locking tokens for an unknown period of time. Once staked ETH can be withdrawn, eliminating one of the main risks of staking but eroding one of the added values of LST, some people thought that the liquid staking market might shrink and support traditional staking instead. However, this is not the case.

“The impact of short-term macroeconomic factors may be greater than changes in supply.”

Currently, the liquid staking market is valued at nearly $20 billion and is rapidly growing, primarily due to the widespread presence of LST in DeFi and its ease of access compared to traditional staking. Lido’s token stETH holds the largest share in the LST market, accounting for approximately 72.24% of the total LST supply.

Decrease in ETH Net Supply

(Ultra Sound Money)

(Ultra Sound Money)

The merge update made some adjustments to the tokenomics of Ethereum, the rules supporting the blockchain’s native token.

Most notably, this upgrade introduces “deflation” to ETH for the first time, meaning that the overall supply of the token is now decreasing instead of increasing. Today, the circulating supply of ETH is 0.24% lower than a year ago. The decrease in supply is partially attributed to EIP-1559, a network upgrade implemented approximately a year before the merge. This upgrade started “burning” some ETH in every transaction on the network, but it is only after the merge that the net contraction of new ETH supply occurs.

As the supply of ETH continues to grow year by year, some investors are concerned that their token holdings will depreciate over time. Some hope that deflation will help make ETH more valuable. So far, it’s hard to say if this has happened. In the months since the merger, the price of Ethereum has not changed significantly, and the short-term impact of macroeconomic factors may be larger than the changes in supply.

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