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.

---

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/

Cryptocurrency Thursday

Ethereum Wrestling With The Censorship Demon

This fall, Ethereum reached a widely noted milestone, in which 51% of it’s transactions passed through nodes that comply with US OFAC regulations.

Specifically, this means that many processing nodes refuse to handle transactions involving Tornado Cash, which is banned for violating US sanctions.  Tornado Cash transactions are still on the blockchain, but they are treated as second class citizens.

It is estimated that if about 2/3 of validaters comply with sanctions, Tornado Cash will effectively be ousted.

This apparently effective US government action has provoked a great deal of hand wringing and fiery rhetoric about “censorship” and Nakamotoan values.   As Sam Kessler notes, there has been considerable difference of opinion between the “core community”—Nakamotoan fundamentalists—and “new folks”—interested in conventional finance [1]. The former absolutely will not tolerate this regulation, the latter consider it normal and probably essential.

The 51% milestone presumably indicates that a lot of the new “validators” are coming out of conventional finance, or are organized in the US.  These folks are already regulated, and, in fact, benefit from regulation.

On the other hand, as Kessler suggests, the vast majority of users—most of who are not paying to run validators—do not want regulation, and use Ethereum in part to avoid regualtions.

This split may matter, because the only conflict resolution method available in Nakamotland is forking.  In this case, the fork would create an OFAC compliant Ethereum and an OFAC non-compliant Ethereum. 

What could that possibly mean?

I’m pretty sure this would not be “two versions of the chain: one regulated, one not.” (per Kessler), but rather two there would soon be two competing systems.  And I predict that it won’t be possible to support two branches for very long.

The question is, if and when this happens, who will win? Which branch will be the “official” Ethereum? 

We know what the US government will say, but what about Vitalek and friends?  What about the users and the big money say?

The non-compliant branch might have more users initially.  But the Ethereums’s PoS depends on stakes and validators, and there is a lot of money that wants or needs to be OFAC compliant.  So, it isn’t clear whether bodies or dollars will matter more.

---

This fork may be inevitable.  Forking away from problems is the way Nakamotoland does things.

But I have to think it will not work the way the fundamentalists hope.  Aside from the inconvenience of dealing with two different Ethereums, the two chains will formalize compliance in a way that is extremely convenient for the US government.  If you use the OFAC compliant branch, it’s fine.  Otherwise, you are non-compliant and we treat you as sanctions busters.

I’ll also note that Ethereum just spent years branching to PoS.  Just how much time and effort are available for this OFAC compliance fork?  I mean, if it takes a year or more, it may not actually matter by the time it’s done.

We’ll stay tuned.

This story certainly puts Ethereum in the running for CryptoTulip of the Year!

---

1. Sam Kessler (2022) Will Censorship Fork Ethereum? Coindesk,  https://www.coindesk.com/tech/2022/10/19/will-censorship-fork-ethereum/

Cryptocurrency Thursday

More “Innovation” in Nakamotoland

Nakamoto’s Happy Kingdom is supposed to the the home of “disruption” and “innovation“.

I’ve commented before on the completely predictable security problems of crypto “bridges”, which have been subjected to massive thefts in the past year. 

This month saw yet another heist from yet another “bridge” [1].  This appears to be due to a goof, when–wait for it–“a recent update to one of Nomad’s smart contracts made it easy for users to spoof transactions” [1].  Like that’s never happened before. Sigh.

This week we learn that this oopsie was at least partially a “crowdheist”.  After the thieves lobbed a brick through the window, a bunch of bystanders rushed in and pilfered what was left [2].  This was a “brilliant” and “innovative” attack, accomplished by a simple process: “copy the attacker’s code, add their addresses and broadcast the changed code”.

---

Several thoughts occur to me.

First: why do people put money into these shoddy systems? Just how many times does this have to happen before people stop throwing money away?

Anyway.

Second, it is clear that these huge hacks are hardly feats of technical wizardry.  So-called “smart contracts” are, by definition, programs that are published for all to read.  Moderately clever people can find bugs and exploit them.  And, as this case shows, it doesn’t take a lot of technical savvy to hear that a heist is in progress and simple copy the nefarious code with your own address.

Very “innovative”.

(Actually, there is one “innovation” here: “smart contracts” are (a) unfixable by design and (b) executed without checking anything. “The code is the law” means that bugs are, by definition, features.

To a software engineer, this design is pure madness.

Anyway. )

Third, this incident suggests that the ethos of the crypto “community” may be fraying.  For many years, crypto users have been remarkably cooperative and supportive of each other.  The idea is, “we don’t trust banks or governments; we trust the code and the spirit of common good.”  So users work together to deal with bugs and thefts, and to prevent attacks and exploitation.

Unfortunately, the code was never really trustworthy, and now we see that some users will happily loot if the opportunity arises.

Tsk.

If you can’t trust “a bunch of guys on the Internet”, who can you trust? : – )

---

1. Sam Kessler and Brandy Betz (2022) Crypto Bridge Nomad Drained of Nearly $200M in Exploit.  https://www.coindesk.com/tech/2022/08/02/nomad-bridge-drained-of-nearly-200-million-in-exploit/
2. Shaurya Malwa (2022) Copycats’ Stole $88M During Nomad Exploit by Copying Attacker’s Code: Coinbase. Coindesk,  https://www.coindesk.com/tech/2022/08/11/copycats-stole-88m-during-nomad-exploit-by-copying-attackers-code-coinbase/

Cryptocurrency Thursday