Ethereum’s move to proof of stake has increased concerns about centralization and censorship. The shift to validators instead of miners has reduced energy consumption by 99.99% but has led to the majority of the ETH securing the network sitting with central entities, and these entities have a higher likelihood of being assigned blocks of transactions to add to the chain, allowing them an outsized influence over what is and isn’t allowed on the network. Ethereum staking pools can be centralized or decentralized, depending on how they are operated. Let’s dive into how staking pools work in Ethereum.
What are Ethereum Staking Pools?
Ethereum staking pools are centralized entities that allow individual users to pool their Ether (ETH) together and stake it on the Ethereum 2.0 network. These staking pools are often operated by a centralized entity, which manages the pooled ETH and distributes rewards to the participants.
While staking pools can offer benefits such as reducing the barrier to entry for individual stakers and allowing for more efficient use of staked funds, they also introduce a degree of centralization into the Ethereum ecosystem.
For example, if a significant portion of the ETH supply is staked in a small number of large pools, it could potentially lead to centralization of decision-making power within those pools. Additionally, if the pool operator is compromised or acts maliciously, it could impact the staked ETH and the rewards earned by participants.
To address these concerns, some staking pools have implemented measures such as decentralization of the pool operator or multi-party signing to ensure that no single party can unilaterally control the pool’s funds. Additionally, Ethereum 2.0’s protocol design includes penalties for validators that behave maliciously, which helps to mitigate the risks associated with centralization in staking pools.
At present, about 6.9 million ETH (equivalent to $10.7 billion) is involved in liquid staking pools, which accounts for 42.7% of all staked ETH. With Ethereum’s circulating supply estimated at 120.5 million ETH, the staked amount in pools represents 5.6% of the network’s total supply.
Centralized vs. Decentralized Staking Pools
Centralized staking pools are typically operated by a single entity or organization that manages the pool’s funds and distributes rewards to participants. These types of pools can introduce a degree of centralization into the Ethereum ecosystem, as the pool operator has control over the staked funds and can make decisions about how they are used. Additionally, if the operator is compromised or acts maliciously, it could impact the staked ETH and the rewards earned by participants.
On the other hand, decentralized staking pools are operated using a decentralized governance model, where decisions about the use of staked funds and distribution of rewards are made by a group of stakeholders, rather than a single entity. Decentralized staking pools can be more resistant to centralization and are often seen as more in line with the decentralized ethos of the Ethereum ecosystem.
Ethereum Staking Entity Breakdown
Six pools control more than 70% of the ETH that was staked as Ethereum transitions from proof of work to proof of stake. Lido is responsible for 31% of the entire amount of ETH staked, while Unlabelled controls 23%. Coinbase, Kraken, and Binance account for around 30%, and Staked.us holds 3%.
As the Shanghai upgrade unlocks staked ETH, most stakers are unlikely to sell unless the price of the cryptocurrency surges. Only 18% of all ETH staked is held by stakers who may profit from a sale, according to Nansen, and illiquid stakers like Lido, Coinbase, or Rocket Pool are more likely to sell. Although, the protocol maintains it improves the decentralization of staking.
How to Stake Ethereum?
There are various ways of staking Ethereum, including solo home staking, staking as a service, pooled staking, and centralized exchanges. Each method has varying rewards, risks, and requirements. Solo home staking is considered the gold standard, but it requires 32 ETH and hardware to run the node, and there are risks associated with penalties and liquidity. Staking as a service is similar to solo staking but introduces third-party risks. Pooled staking has the lowest entry cost but carries standard third-party operator risks. Centralized exchanges have the least straightforward setup and offer the least rewards but require no minimum amount of ETH to stake.
The SEC previously said in 2018 that Ether is not a security due to its decentralised development and growth over time. But, with the transition to PoS, which has complicated the interaction between the Ethereum blockchain and authorities, this may change. The SEC claimed jurisdiction over the Ethereum network in a lawsuit filed barely a week after the Merge, claiming that the majority of nodes are centred in the United States. While the SEC’s assertions raised some questions, and many criticised the regulator’s approach, some feel Ethereum was due for a setback.
Ethereum 2 Promotes Centralization Through Custodians
Lido DAO has gathered billions of dollars in staked ETH because of the great benefits of immediate liquidity, automated yields, and the potential to leverage stETH for even larger payouts throughout DeFi. Its deposits have increased 17 times in a year.
Ethereum 2’s liquid staking incentives offer consistent outcomes. For starters, ETH 2 validating power is becoming increasingly centralised. By design, Ethereum users with less than $80,000 in ETH can only hope that centralised custodians like Lido will vote on their behalf. Second, risks are increasing. Users must entrust their ETH to a custodian, which violates the most fundamental principle: “Not your keys, not your coins.”
They are also vulnerable to stETH-to-ETH redemption concerns like as delays, mispricing, and even rejections. Not to mention the hazards posed by hackers, liquidity cascades, and smart contracts. Finally, non-Ethereum initiatives subject them to treasury and governance decision-making risks.
As staking pools become increasingly centralised on the network, the widespread usage of a popular maximal extracted value (MEV) service, Flashbots, indicates that censorship is on the rise.
Additional Read: Is Solana Centralized: An In-depth Study
Word of Advice
ETH holders interested in earning yield through staking should be aware of the differences between centralised and decentralised providers. Users must open accounts and pass KYC/AML checks with centralised providers such as Coinbase. Additionally, customers must first submit their funds to Coinbase, which holds the assets and creates a third-party risk.
Decentralized systems, such as Lido and Rocket Pool, do not save users’ private keys and allow them to stake their assets directly from non-custodial wallets like Metamask or Ledger. These platforms, however, have their own unique risks in the form of smart contract risk, which if exploited, might result in the loss of user funds.