You are reading an excerpt from our free but shortened abridged report! While still packed with incredible research and data, for just $40/month you can upgrade to our FULL library of 60+ reports (including this one) and complete industry-leading analysis on the top crypto assets.
Becoming a Premium member means enjoying all the perks of a Basic membership PLUS:
- Full-length CORE Reports: More technical, in-depth research, actionable insights, and potential market alpha for serious crypto users
- Early access to future CORE ratings: Being early is sometimes just as important as being right!
- Premium Member CORE+ Reports: Coverage on the top issues pertaining to crypto users like bridge security, layer two solutions, DeFi plays, and more
- CORE report Audio playback: Don’t want to read? No problem! Listen on the go.
Introduction
As Ethereum continues to mature and expand its ecosystem, discussions around its technological roadmap and monetary policy become increasingly pivotal. These deliberations delve deep into the nuances of Ethereum's future, focusing on key themes such as rollup-centric strategies, validator incentives, and the broader implications of its monetary policies. The landscape of Ethereum's Proof of Stake system is becoming increasingly complex due to the rise of liquid staking and restaking, the introduction of spot Ether ETFs, regulatory developments related to staking, and potential changes to validator and issuance dynamics. These factors will significantly influence the future trajectory of Ethereum’s PoS system.
As Ethereum’s staking ratio surpasses 28% of the total supply and the number of validators exceeds one million, the community and researchers are exploring adjustments to Ethereum’s issuance curve and the potential for increasing validators' maximum effective balance. These discussions are driven by concerns over ETH’s rising staking ratio and the centralization tendencies within staking pools, where incentives favor liquid staking tokens over plain ETH. One proposal is to raise the maximum effective balance for validators from 32 ETH to 2048 ETH to manage the rapid expansion of the validator set and reduce the consensus layer's overhead.
The Shift to a Rollup-Centric Ethereum
A fundamental shift in Ethereum's development trajectory is the move towards a rollup-centric architecture. This strategic pivot is designed to enhance scalability and efficiency by encouraging transactions and smart contract interactions to occur on secondary layers (layer 2 rollups) rather than directly on the Ethereum mainnet (layer 1). The rationale behind this transition is to alleviate congestion on the main chain, thereby reducing transaction fees and improving transaction throughput.
The implications of this architectural shift are profound. By reducing the dependency on the base layer for transaction processing, Ethereum can significantly scale operations without compromising on security or decentralization. However, this also raises questions about the role and utility of Ether (ETH) as the native cryptocurrency. If layer 1 becomes less congested due to the adoption of layer 2 solutions, the demand dynamics for ETH could shift, potentially impacting its value proposition as 'pristine' collateral within the ecosystem.
Monetary Policy and Network Upgrades
A pivotal area of discussion revolves around Ethereum's approach to monetary policy, particularly how it manages issuance and staking rewards. Ethereum's monetary policy is not static; it evolves based on network upgrades and changing economic conditions. For instance, the transition to PoS from proof-of-work (PoW) significantly altered the network's economic model, reducing overall energy consumption and laying the groundwork for future scalability enhancements.
The complexity of managing a digital currency's monetary policy, akin to how central banks manage fiat currencies but in a decentralized context, is highlighted. The balance Ethereum seeks to strike through mechanisms like EIP-1559, which introduced a fee burn mechanism, showcases efforts to make ETH more deflationary, potentially increasing its attractiveness as a store of value.
Rethinking Validator Incentives and Security
The discussion also steers towards the critical aspect of validator incentives under Ethereum's proof-of-stake (PoS) model. The concept of minimum viable issuance (MVI) seeks to find the optimal balance of new ETH issuance necessary to incentivize validators sufficiently while minimizing inflation. This concept is crucial as it directly impacts the economic sustainability of Ethereum, affecting both validators and token holders.
The debate extends to the 'staking endgame,' which examines the long-term implications of staking dynamics, particularly focusing on the potential overpayment for network security. Currently, Ethereum compensates validators through block rewards, which are determined by the amount of ETH staked and the total number of validators. The concern here is whether this model could lead to excessive issuance, creating downward pressure on ETH's price.
Lowering the target stake ratio could result in a concentration of staked ETH with CEXs, especially if ETFs use platforms like Coinbase as custodians. Significant capital inflows could drive validators away from decentralized alternatives due to lower yields. This scenario underscores the importance of balancing staking incentives to avoid excessive centralization.
Foundations For A Secure Ethereum
Ethereum’s value hinges on Ethereum’s ability to validate state changes transparently, securely, and autonomously. Security is a cornerstone of this value proposition. Without robust defenses against Sybil resistance and double-signing attacks, Ethereum's credibility as a settlement layer diminishes. Equally important is sovereignty, which involves defending against 51% attacks and resisting coercion by state actors.
Decentralization ensures a broad distribution of power within the system, protecting users from arbitrary exercises of power by recognized authorities, such as validators, and external authorities, such as governments. Effective decentralization requires:
- Client Software Diversity: Running various validator software types to avoid concentration risks from bugs.
- Node Operator Diversity: Independent entities operating validator software to prevent excessive control by any single operator.
- Geographic and Jurisdictional Diversity: Different infrastructure levels are capable of influencing node operators, such as internet connectivity, power supply, and legal jurisdictions.
Stakers can be categorized into three main groups:
- Retail and Institutional Participants: These users delegate their staking to centralized exchanges (CEXs).
- On-Chain Actors: These include decentralized staking middleware (DSM) such as Liquid Staking Tokens (LSTs), decentralized pools, Liquid Restaking Token protocols (LRTs), and Centralized Staking Providers (CSPs).
- Solo Stakers: Individuals who choose to run validators independently.
Contributions to decentralization vary among these groups, with solo stakers offering the highest contribution by adding additional validators.Solo stakers play a vital role in Ethereum’s network security, yet they face higher fixed costs and lower adaptability to low issuance rates compared to larger node operators. Centralized staking providers, despite their risks, often offer more stable and efficient validation due to their resources and professional management.
DSMs efficiently distribute delegated stakes among many parties, enhancing decentralization. In contrast, centralized staking providers and CEXs risk aggregating large amounts of stakes, potentially undermining decentralization.
Conclusion
Reevaluating Ethereum’s monetary policy through the MVS framework highlights the need for a strategic shift towards maximizing security. This approach addresses the complexities of maintaining decentralization, defending against coercion, and ensuring robust security incentives. By focusing on long-term security and sustainability, Ethereum can strengthen its position as a trusted and autonomous settlement layer in the global capital markets.
