A Good Summary of Ethereum in the PoS Era

As discussed earlier, Ethereum has been running a Proof of Stake (PoS) protocol for a year now, which has exposed some unanticipated side effects  It’s an exciting experiment, though I’d worry about having a lot of money at risk. 

As an old Illiac IV programmer used to say, “the fun of software is finding out what it does.”

So how is Ethereum doing, overall?

Margaux Nijkerk and Sam Kessler have a good summary in Coindesk’s Consensus Magazine [1].

First of all, the entire point of the exercise was to cut power consumption and emissions.  In this, PoS is a smashing success: “Ethereum’s energy consumption has fallen 99.9%” [1]  Whatever else happens, Ethereum is no longer a ridiculous energy hog that it once was.

Second, like most Nakamotoan cryptocurrencies, Ethereum was highly “centralized”, with a handful of large operations dominating the execution of the PoW protocol. This is not what Nakamoto envisioned, and, worse, isn’t all that different from the bad-old conventional financial systems.  (Except Nakamotoan cryptocurrencies are vastly less scalable than conventional currencies….)

The new PoS has a different mechanism, but has ended up equally “centralized”.  A handful of large operations do most of the validations. So, PoS is “no change” on this dimension.

It’s beginning to look like distributed systems naturally tend to become “centralized”. Who would have expected that?  (Every network scientist in the world.)

But there is more. PoS adds some wrinkles that PoW doesn’t have, because the validators are charged with organizing incoming transactions into blocks, which are submitted for validation.  This process can be optimized in various ways, and sure enough, validators have been optimizing for their own profits. 

This “maximum extractable value”, MEV, process isn’t an official part of the protocol, but it has become ubiquitous.   Worse, it appears that one company has a de facto monopoly on the process.

And worse yet, the sorting and sifting is also an opportunity for “censorship”, and, sure enough, this mechanism has been used to implement US sanctions.  This is definitely not what Nakamoto intended!

A fourth trend is a side effect, the emergence of a large market in third party staking.  I.e., the staking process has been securitized, letting people buy tokens that fund the actual staking process.  This isn’t formally part of the protocol, but it is a pretty predictable outcome.  I mean, if there is anything Etherheads understand, it is tokenization! 

 I’m not enough of an economist to really guess exactly what risks and benefits this extra-protocol layer may have.  But it is true that the basic protocol demands a large minimum stake, which I think is supposed to filter out speculators.  By contrast, the liquid staking tokens have no such filter, which means they enable mass speculation is Ethereum staking.  For better or worse.

Perhaps it is worth noting here that in the original PoS protocol it was difficult to cash out your stake, and these third party tokens were a lot more liquid.  The protocol was updated to make withdrawals easier, but the change had little effect on the liquid staking tokens. People seem to like speculating without the need to do any work in return!

And finally, the PoS protocol not only ties up Ether in stakes, it actually deliberately shrinks the supply of tokens (down .24% in the year).  This was supposed to be “deflationary”, raising the exchange rate of Ether against other assets.  The exchange rate against the USD has been largely unchanged over the period.   Once again, Nakamotoan economics hasn’t actually worked. 

So, the score in this list is, 1 absolute win, 2 major unexpected side effects, and 2 unchanged/no effect.

As is often the case, optimizing for one feature (reducing power consumption) has had unanticipated effects on many other features.

The good news is that Ethereum is so useful that most users have just carried on, regardless of the fiddling with the basic protocol. I’m pretty sure that most people never thing about validation, or for that matter, power consumption.

I guess the bad news is that the side effects are a warning that there may be unexpected gotchas in the future.

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1. Margaux Nijkerk and Sam Kessler (2023) The State of Staking: 5 Takeaways a Year After Ethereum’s Merge. Consensus Magazine,  https://www.coindesk.com/consensus-magazine/2023/09/25/the-state-of-staking-5-takeaways-a-year-after-ethereums-merge/

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