One year later: How proof of stake has changed Ethereum

Energy consumption has been reduced by 99.95%

In proof of work, miners participated in a never-ending rivalry to be the ones to process a block. This rivalry was about computing a string below a target set by the network. The latter was computed using a mathematical function to mostly go through trial and error. This called for immense computational power, in Ethereum’s case, GPUs, using a great amount of electricity. Now, the network randomly chooses a validator every 12 seconds to process a block, so there are no battles for the blocks. The bottom line is that Ethereum has reduced its energy consumption by about 99.95%. This great reduction makes Ethereum much more appealing in a never-satisfied ESG world.

Another advantage of proof of stake is the consistency of 12-second blocks, so they do not fluctuate similar to during Ethereum’s proof of work era. This makes the network more predictable and easier to utilize for various protocols. The shift from average blocks of 13 seconds during proof of work to consistent 12-second blocks has also made Ethereum slightly more scalable, as block sizes have stayed the same.

Is Ethereum now more centralized?

This is a discussion largely beyond the scope of this piece; however, we will shortly touch upon the most critical considerations. Leaving the matter of decentralization aside for a second, Ethereum has certainly archived greater security by proof of stake. The network now reaches block finalization about 15 minutes after a block has been proposed. This is an extra layer of security not found in proof of work. It says that for a block to be altered or removed after reaching finalization at least 33% of the total staked Ether must be burned, effectively imposing a cost of at least $13bn for doing that. On top of that, the network can slash validators by burning some of their Ether in case they behave dishonestly or against the objectives of the network. In other words, by having collateral in something of great value from validators, in this case, Ether, the network can enforce much stricter rules for strong security.

Decentralization is another matter. This highly depends on who you ask. In our view, it is roughly the same as before the merge, as it is now. The challenge of the present staking distribution is that the largest staker is the liquid-staking provider Lido with around 32.5% network penetration, but still growing slowly. The Ether staked by Lido belongs to thousands of holders and is spread across 31 independent validators by smart contracts, so it is considerably better than if it was a single entity. The challenge, however, is that Lido may capture the consensus layer of Ethereum if it continues to grow, so the governance token of Lido suddenly decides much of the future of Ethereum. You had a somewhat similar situation during proof of work, as miners mingled their computational power to form so-called mining pools to enhance their chances of creating a block.

In both instances, the market operates with strong economies of scale. For mining pools, there are scale economies, as the capital flows to few but large mining pools to boost the chances of proposing a block. In proof of stake, there are no such advantages, but instead, large liquid-staking providers attain an upper hand in terms of liquidity. This enhances the ability of users to buy and sell the given liquid staking token without much price impact. The fear is that if Lido is not limited sooner rather than later, then it will continue to devour Ethereum with ever-increasing advantages for users by choosing Lido over other much smaller liquid staking providers.

Another challenge facing Ethereum in proof of stake is that its staking ratio continues to rise, meaning more and more Ether is staked. Most critically, this may lead to fewer Ether than optimal to be left to be paid in transaction fees to maintain the ecosystem, while liquid-staking providers, particularly Lido, archive damaging network penetration. Ethereum’s core developers decided last week to slow down the acceptance of new validators in Ethereum’s next upgrade to allow the community more time to figure out a proper solution.