Ethereum’s staking pool market is still relatively young. But it has now reached a critical milestone of maturity with Shapella.
And as this liquid staking market has grown, it has shown itself to be vulnerable to winner-takes-most dynamics, with the top players potentially destroying the decentralization that makes Ethereum valuable in the first place.
With Shapella (the combo of the Shanghai and Capella upgrades), liquid staking will take another critical step towards maturity, making now a critical time to steer the industry in the right direction — toward more decentralization instead of less.
The threat of liquid staking monopoly
The amount of ETH locked in liquid staking pools has soared in the past two years to hit 7.6 million, representing more than 40% of the total staked ETH amount.
While this might seem like a large number, the total stake is only 15% of ETH’s total supply — a very small fraction compared to the ~50% to 75% staking participation rates seen in other proof-of-stake blockchains where withdrawals are already implemented.
Having a single dominant liquid staking protocol — or even a single centralized staking service provider — does offer some advantages. A singular protocol makes it easier to trade staked ETH while also preventing liquidity from being split across too many staking tokens. As they say in traditional finance, liquidity begets liquidity.
But at a certain point, this dominance becomes damaging. Node operators that are bound together — either operationally, politically, or through a liquid staking governance token — are more likely than not to act as a single unit that holds outsized influence over the network.
If this single protocol controls less than a third of staked ether, then it may not become a threat. But if it verges over this safety threshold, that means that a singular protocol could effectively influence the entire blockchain.
A centralized entity is more likely to succumb to pressure to censor transactions, or to establish a stranglehold on the network and reap an outsized share of MEV opportunities. Passing these superior returns on to their users (or even retaining the value extracted for themselves) would then further cement the protocol as the market leader, creating what ETH researcher Danny Ryan called “outsized cartel rewards” discourage prospective stakers from choosing other protocols.
Even disregarding the misaligned incentive structure, a smart contract bug or mistake leading to a large slashing event at a dominant staking provider could lead to outsized losses, making it more likely to shake confidence in the entire Ethereum ecosystem.
These reasons and more are why multiple Ethereans — including the likes of Vitalik Buterin and SuperPhiz — have argued that a single staking protocol should never control any more than 15% to 33% of staking activity.
Creating a healthy liquid staking market
In an ideal world, ETH holders looking to earn yield through staking would set up their own validator infrastructure and “solo stake” independently for maximum network security.
But in reality, the majority of holders don’t have the technical capability or the requisite 32 ETH to solo stake. They are instead likely to opt for third-party solutions such as liquid staking protocols, which knock down the barrier to entry and give them liquid rewards to deploy elsewhere in DeFi.
To help create a liquid staking market that doesn’t damage Ethereum’s diversity or decentralization, these liquid stakers should do two things:
First, turn away from centralized and permissioned solutions and toward those that are more aligned with Ethereum. This means trust-minimized, non-custodial protocols that use diversified and resilient node operator sets, especially those that are seeking to employ innovations that aid decentralization.
Take distributed validator tech (DVT) as an example, which allows a single Ethereum validator to be split across multiple nodes, improving network resilience and reducing the risk of slashing. This creates less risk of centralization even if a single staking provider becomes dominant.
Second, liquid stakers should stake with the values of Ethereum in mind. The qualities of decentralization, diversity and censorship resistance are ultimately what gives ETH value, and the best way to uphold them through liquid staking is to avoid contributing to the outsized dominance of a single staking provider.
The time to preserve network neutrality is now
Ultimately, taking the overall ethos of Ethereum into consideration will help create a diverse staking market composed of multiple providers that each have a relatively small slice of market share, all competing on a level playing field.
As the withdrawal of staked ETH is unlocked with Ethereum’s Shanghai upgrade, the boom in liquid staking protocols will naturally accelerate — and if left unchecked, the potential threat of these protocols centralizing Ethereum along with it.
All we need to do is make sure that people understand the stakes when choosing what to do with their ETH.
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Source: https://blockworks.co/news/stakers-shanghai-centralize-ethereum