Power over Eth2 could become concentrated. Here’s why developers aren’t too worried

Earlier this month, Ethereum finally took the first step toward its long-awaited transition from a proof-of-work-based consensus model to one that uses proof-of-stake.

But although Ethereum 2.0 (Eth2) advocates say the system is designed to maximize decentralization, the network already faces a legitimate risk that power over it could become concentrated in the hands of commercial staking service providers.

Eth2 developers say they are indeed concerned about the possibility. But they argue that while this kind of centralization risk may be difficult to avoid in the short-term, in the long-term, there are measures they can take to minimize it.

In the meantime, the protocol’s rules will deter attacks, developers say.

Power in numbers

Instead of relying on proof-of-work miners, Eth2 has validators that earn their position by locking up, or staking, a set amount of ether (ETH). The current minimum stake to become a validator is 32 ETH.

Already, within just one month since the launch of the first phase (Phase 0) of the transition, more than $1 billion worth of ETH has been staked.

The figure seems to reflect excitement for Eth2. But on the other hand, most of it is staked via centralized entities such as crypto exchanges and standalone staking service providers, according to early statistics tracked by The Block Research via the Ethereum blockchain.

Two crypto exchanges — Kraken and Binance — currently account for more than 20% of the network's total stake.

Source: Ethereum blockchain, The Block Research

Besides Kraken and Binance, Coinbase, Bitfinex, OKEx, Huobi, and Gemini have announced support for Eth2 staking. Some have already enabled staking services, while others are set to go live in the coming days and weeks.

Kraken and Binance are the only exchanges so far that have their Eth2 staking addresses public, making it possible to track how much they are staking. When reached, the other exchanges either did not respond or did not comment on their Eth2 staking deposits received so far.

In some ways, it would not be a surprise to see exchanges play a dominant role in Eth2 staking. After all, they hold around 23% of all the ETH in circulation.

At these venues, users can simply choose to stake their ETH with the click of a few buttons and then let the exchange do the rest. The exchange maintains the validator node infrastructure. Users don't even have to stake a minimum of 32 ETH. In return, exchanges often charge a commission on staking rewards.

'Resistant to World War III'

In the worst-case scenario, a few companies with enough power over the network could collude to disrupt or attack the network. To halt the chain, a single validator only needs to amass a third of the network’s stake. Two-thirds is needed to gain control over the blockchain.

In this context, an important distinction should be drawn between the types of staking services. Unlike the exchange-based services, standalone staking service providers such as Staked.us and Stake.fish are non-custodial.

“The advantage of having control of your keys is that you can pull your funds out if you think your stake is being used to pull off an attack,” said Jun Soo Kim, strategy and operations lead at Stake.fish.

Either way, Eth2 has been designed to withstand all kinds of catastrophic events, Justin Drake, an Eth2 researcher at the Ethereum Foundation, told The Block. "We have tried to design the Eth2 protocol to be resistant to World War III."

Centralized entities becoming the dominant Eth2 validators is possible, and that scenario would be "definitely suboptimal," said Drake. But it “is not the end of the world at this point in time.”

To begin with, Eth2's design has a mechanism in place that incentivizes good behavior and punishes malicious actors. So if a handful of centralized entities were to act in a way that is not in the best interest of the network — at least according to the protocol’s rules — they would be penalized via a process called slashing.

Slashing entails forcing a validator to exit the system and forfeit a portion of their stake, which is then destroyed.

According to Drake, Eth2’s Phase 0 has all the infrastructure required for the protocol to be "extremely decentralized."

He also drew a distinction between Eth2 and other proof-of-stake protocols, such as Polkadot and NEAR, in terms of the way the networks rolled out. When those two networks were launched, Drake said, they had a handful of validators and were basically like "centralized private blockchains." Only over time have they started to become more decentralized, he said.

Eth2 is also “much more resilient to centralization risks than Bitcoin or proof-of-work chains in general,” argued Tim Ogilvie, CEO of Staked.US, which is currently the third-largest Eth2 validator.

Ogilvie contended that it is easier for a few mining pools to gain control of a proof-of-work network than it would be for validators to gain a third of Eth2's stake. And if they do, they risk losing their entire stake if they choose to attack the network, he said.

An 'ongoing area of study'

Overall, reducing centralization is "always going to be an ongoing area of study," Collin Myers, an Eth2 contributor and head of global product strategy at ConsenSys, told The Block.

Eth2 is the "best attempt at mitigating centralization at the base layer — there is no doubt about that," Myers said. But he added that the technology underlying decentralized networks is "still very, very greenfield."

To further decentralize the Eth2 network, Myers and Mara Schmiedt, an Eth2 contributor who also works at Bison Trails, are collaborating with the Ethereum Foundation on a system called secret shared validators (SSV).

SSV would allow validators to work together to share responsibility for block production as well as the right to validate the Eth2 chain. So, if someone is using a provider, they are actually using multiple providers at once which is "kind of the next step of decentralizing," said Myers. He said SSV should be production-ready by the first half of 2021.

Meanwhile, Drake said the Ethereum Foundation eventually hopes to lower the barrier to entry for becoming a validator from the current 32 ETH. That would require cryptography advances that make it possible to reduce the cost of verifying signatures, he said.

Over the next one to two years, Drake expects centralized entities to become the largest Eth2 validators. "But I'm very optimistic that over the long term, all of this will not be a real concern."