In its latest report, JPMorgan warns of Ethereum’s Centralization Risk!
What are they talking about? Let’s take a look at what centralization risks Ethereum’s recent upgrades may pose and why.
JPMorgan “Staking Volumes Increase…Ethereum’s Centralization Risk Grows”
ETH staking volumes have increased significantly since the Mersey upgrade last September, which switched to PoS, and the Shanghai upgrade in April, which enabled ETH unstaking. This has increased the centralization risk of Ethereum, according to JPMorgan.
What is centralization risk in blockchain protocols?
JPMorgan pointed out
1. Increases the network’s exposure to attacks
Higher staking volumes increase the likelihood that the network will be attacked.
2. Minority node operators can collude for profit
If a small number of node operators collude, the community suffers.
3. It reduces Ethereum’s price advantage.
Increased staking volume reduces Ethereum’s price attractiveness.
4. The risk of re-collateralization increases.
As liquidity staking in Ethereum increases, so does the risk of re-collateralization. As the amount of re-collateralization increases, the value of staked assets could plummet or the protocol could be hacked. This could lead to a chain liquidation. We can call this a big risk.
Let’s take a look at the four points one by one.
1. The network is more vulnerable to attack
What does this mean for the network’s vulnerability to attack?
As a decentralized blockchain platform, Ethereum can face various network attack vulnerabilities. These possibilities can include the following key security considerations related to the Ethereum network:
– Smart contract vulnerabilities: Smart contracts are one of the core features of the Ethereum network; however, vulnerable smart contracts can be exploited, which can result in loss of funds. When developing and deploying smart contracts, security vulnerabilities should be carefully reviewed and validated.
– 51% Attack: Blockchains like Ethereum rely on distributed nodes to validate transactions by voting. However, if an attacker controls more than 51% of the hash power on the network, they can use it to manipulate or cancel transactions. To prevent such attacks, cryptographic algorithms that require high hash power are used, and constant monitoring is required to maintain security levels.
– Spam and transaction congestion: Spam attacks, where malicious users overuse the network and cause transaction congestion, can slow down Ethereum’s performance and increase fees. To prevent this, fee mechanisms and network resource management need to be improved.
Skill flow attacks: A skill flow attack on a smart contract means that the contract is executed in an unexpected way. To prevent skill flow attacks, you need to ensure the safety of your smart contract code, perform tests and code reviews.
– Network upgrades and hard forks: Ethereum regularly undergoes upgrades and hard forks. However, these changes must be agreed upon by the community and developers, and can introduce security and compatibility issues.
Centralized staking: Centralized staking services are on the rise during the transition to Ethereum 2.0. Centralized staking platforms can increase the centralization of the network, which can increase the potential for attack exposure.
To reduce this risk, it’s important for the Ethereum developer and user community to continue to implement security updates, identify vulnerabilities, and adhere to security best practices. It’s also important to emphasize the decentralized nature of Ethereum and have an emergency response plan in place in case of an attack.
2. How can minority node operators profit?
Importantly, the activities of node operators can affect the decentralization and centralization risk of the network. Maintaining decentralized participation and transparency plays an important role in minimizing centralization risk and ensuring the health of the network.
Even after the Ethereum network’s recent Shanghai and Mudge upgrades, node users can still fulfill various roles and earn revenue. These roles and monetization methods include
– Full Node Operators:
Maintain the network: Ethereum full node operators provide network nodes by downloading and maintaining the entire blockchain. This contributes to maintaining the decentralization and stability of the network.
– Smart Contract Developers:
Develop and deploy smart contracts to earn fees for their execution. Smart contracts are utilized in DeFi, NFTs, gaming, and many other fields.
– DeFi Participants:
Provide liquidity: Provide Ethereum and related tokens to liquidity pools on DeFi platforms, and earn fees and interest for doing so.
– Staking: You can stake funds in a DeFi protocol to contribute to the operation of the protocol and earn rewards.
– Stakers and Validators:
Staking: In Ethereum 2.0, you can stake ether and get rewarded for performing block validation. This helps maintain the security and performance of the network.
– Data Providers:
Provide blockchain data: Collect blockchain data and make it available to users and projects through APIs, allowing you to get paid for your data.
– Digital Asset Holders:Increase asset value: Hold Ethereum and related digital assets and benefit from the increase in asset value when the market value increases.
– Smart Contract Users:
Interact with smart contracts: Use smart contracts to perform various tasks, and pay fees for executing those contracts.
– Network Fee Collection:
Transaction fees: Node users can collect fees for transactions that users submit to the network.
– Network Development and Consulting:
Network Development and Consulting Services: Node operators and developers can monetize by providing services on network development, security, upgrades, and management.
Ethereum continues to evolve, providing opportunities to contribute to and benefit from the network in a variety of ways. These roles are utilized in various sectors of the blockchain ecosystem and play an important role in contributing to the user and developer community.
3. Ethereum’s price advantage will diminish.
There are several factors that contribute to why Ethereum’s price attractiveness decreases as the supply of Ethereum staked increases.
Increased supply: Staking is the process of bundling and holding Ethereum, which limits the supply of Ethereum in the market, reducing the available supply of Ethereum. Ethereum held in staking is temporarily taken out of circulation and not used on exchanges or in the market. Therefore, increased staking activity can reduce the circulating supply of Ethereum, resulting in less Ethereum in the market.
– Price stability: Staking allows ETH holders to earn a steady return, which has the potential to keep the price of ETH more stable. Stable prices can reduce price volatility, which can reduce price attractiveness.
– Investment and transaction burden: Staking is an investment method that can yield a steady return, which some ETH holders may prefer. This may tend to keep ETH out of short-term trading or speculation, which can limit its price appeal.
– Stifles economic activity: Staked Ethereum is locked up for a period of time, making it unavailable for use in smart contracts, more DeFi projects, or other economic activities. Because of this, staking can suppress economic activity on Ethereum.
For this reason, an increase in staking volume can impact Ethereum’s pricing power and is one of the key factors in maintaining the health and price stability of the Ethereum network.
4. Increased re-collateralization risk.
As liquidity staking in Ethereum increases, re-collateralization risk increases for the following reasons
– Duplicate tokens: Ethereum tokens used in liquidity staking can be used as collateral in multiple decentralized finance (DeFi) protocols at the same time. This means that a single Ethereum token can be used for lending and staking on multiple DeFi platforms at the same time.
– Declining value and security threats: When staked Ethereum tokens are used in multiple DeFi protocols, the value of the Ethereum tokens used as collateral may decline due to a sharp decline in the price of Ethereum or security threats. This can increase the likelihood of automatic liquidation and losses in lending and staking protocols.
– Liquidity risk: Ethereum tokens used in many DeFi protocols can be subject to liquidity risk. This means that short-term price fluctuations or malfunctioning of smart contracts can cause Ethereum tokens to be liquidated or suffer losses.
– Attack risk: Ethereum tokens used in multiple DeFi protocols can have multiple targets, increasing the likelihood of being targeted by malicious actors or hackers. This can expose them to a variety of security threats.
Collateralization risk is an important consideration in the DeFi ecosystem, and smart contracts and protocols need to be carefully managed to minimize it.
Ethereum’s proposed Shanghai (hard fork) and Merge upgrades in 2021 are one of the important steps towards the transition to Ethereum 2.0. These upgrades aim to improve the security and efficiency of Ethereum’s network, and there may be varying views in the community regarding centralization risk.
Below are some of the main views related to centralization risk that may emerge within the Ethereum community:
– Centralization of staking: Staking plays an important role in the Ethereum 2.0 upgrade, and some community members are expressing concern that large staking service providers are becoming centralized. This could lead to the centralization of the network, and some argue that decentralized staking services are needed to prevent this.
– Difficulty with private staking: Ethereum 2.0 staking is open to regular users, but requires a significant amount of ether to be held. This can make it difficult for regular users to participate in private staking, which can be considered a centralization risk.
– DeFi centralization: Ethereum plays a central role in DeFi (decentralized finance) projects. However, the success of DeFi platforms is dependent on a few key projects, which can increase centralization risk. Efforts are needed to promote decentralization in the DeFi ecosystem.
Upgrade-related risks: The Shanghai and Mudge upgrades introduce technical changes to Ethereum, and there is a chance that errors or security issues may occur during these upgrades. This could lead to increased reliance on centralized developers or administrators.
These views on centralization risks are being debated within the Ethereum community, and it’s important to find solutions to manage these risks while maintaining the safety and decentralization of the network. Ethereum developers and users continue to discuss and work on ways to minimize these risks and enhance its decentralized nature.
(Content created on Web3 Builders is copyrighted by Web3 Builders. Please credit the source when quoting. You are advised to conduct your own research before making any investment decisions. Use provided information at your own risk.)