October 6, 2023 at 09:46 GMTModified date: October 6, 2023 at 09:46 GMT
October 6, 2023 at 09:46 GMT

JPMorgan warns of Ethereum’s increasing centralisation post Merge and Shanghai

JPMorgan’s Thursday research report called attention to Ethereum’s increasing centralisation.

JPMorgan warns of Ethereum’s increasing centralisation post Merge and Shanghai

In a Thursday research report, JPMorgan highlighted the issue of Ethereum’s increasing centralisation happening as a result of a rise in Ether ($ETH) staking since the Merge and Shanghai upgrades.

The Ethereum Merge, which was executed on 15 September 2022, shifted the Ethereum blockchain from a proof-of-work (PoW) consensus mechanism to a proof-of-stake (PoS) model.

As a result, the Ethereum network started securing itself via staked cryptocurrency. Instead of expending computing energy to solve a puzzle, the nodes validating new transactions now stake their own value as collateral.

On the other hand, the Shanghai Upgrade, which was executed on 12 March this year, gave validators the ability to withdraw staked coins. This eventually spurred institutional investors’ interest in staking.

According to OKLink data, around the time of the Shanghai upgrade, the amount of staked $ETH was approximately 18.01 million. By 18 May, this figure had risen to 21.30 million.

Therefore, there has been an evident increase in Ether staking. Further leading to centralisation, this has created many risks for Ethereum because a concentrated number of liquidity providers or node operators could easily be vulnerable as a single point of failure.

The report added that this could also: “…become targets for attacks or collude to create an oligopoly that would promote their own interests at the expense of the interests of the community.”

Analysts led by Nikolaos Panigirtzoglou then wrote about the better alternatives that were tackling this issue efficiently. One such example was that of Lido ($LDO), which is a liquid staking solution for proof-of-stake cryptocurrencies launched in 2020.

“Many in the crypto community had seen Lido, a decentralised liquid staking platform as a better alternative compared to the centralised liquid staking platforms associated with centralised exchanges.”

The network had also launched a decentralised autonomous organisation (DAO) to facilitate decentralised protocol governance. The DAO makes all key decisions on the protocol’s operations, facilitating the protocol to remain aligned with its stakeholders’ best interests and maintain decentralisation and transparency.

In order to address centralisation issues, Lido has also been adding more node operators to contain the number of staked Ether being controlled by any single operator, said the report.

The banking behemoth also talked about rehypothecation, which is an added risk from the rise of liquid staking. This is a practice where banks and brokers use assets that have been posted as collateral by their clients. As a result, liquidity tokens are reused as collateral across numerous decentralised finance (DeFi) protocols at the same time.

According to the analysts: “Rehypothecation could then result in a cascade of liquidations if a staked asset drops sharply in value or is hacked or slashed due to malicious attack or a protocol error.”

On top of this, the rise in staking has also made Ether unpopular from a “yield perspective”, especially given the backdrop of rising yields in traditional financial assets, said the report. The total staking yield has dropped from 7.3% before the Shanghai upgrade to about 5.5%.

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