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JPMorgan Pins Ethereum’s Centralization Issues on Lido as the ‘Single Point of Failure’

Last Updated October 6, 2023 1:43 PM
Teuta Franjkovic
Last Updated October 6, 2023 1:43 PM

Key Takeaways

  • According to JPMorgan, the recent growth in ETH staking has led to higher centralization.
  • Lido is considered a better alternative to centralized staking platforms, but concerns about its centralization persist.
  • Centralization risks in Ethereum, including concentrated liquidity providers, could threaten the network’s integrity.

The Merge upgrade was a significant step forward for the Ethereum network. This update occurred in mid-September 2022, signifying the network’s transfer from the Proof of Work consensus process to the Proof of Stake consensus mechanism.

Since then, the ship has been sailing smoothly, and its energy usage has fallen by 99%. However, according to JPMorgan  analysts led by Nikolaos Panigirtzoglou, the network has become more centralized since the overhaul.

“The rise in Ethereum staking since the Merge and Shanghai upgrades has come at a cost as the Ethereum network became more centralized and the overall staking yield declined,” the report said.

According to JPMorgan, the primary contributors to staking growth are liquid staking providers. The company says the top five liquid staking providers control more than half of the staking on the Ethereum network. In reality, Lido accounts for over one-third of the total.

 

lido market share in staking
Credit: Dune Analytics

The ETH ‘Yield’ Appeal Has Been Ruined

Many members of the crypto community believe that Lido, a decentralized liquid staking platform, is a better alternative to the centralized liquid staking platform.

Analysts, on the other hand, claimed that Lido and other such decentralized solutions “involve a high degree of centralization.” Nonetheless, Lido has been adding additional node operators to solve this specific difficulty.

JPMorgan asserted that centralization by any entity or protocol poses risks to the Ethereum network because a concentrated group of liquidity providers or node operators could act as a single point of failure, be attacked, or collaborate to form an oligopoly that would advance their interests at the expense of the community’s interests. For example, a controlling entity could censor specific transactions or front-run end users’ transactions.

Another risk associated with the emergence of liquid staking, according to JPMorgan, is rehypothecation. This entails using liquidity tokens as collateral across multiple DeFi protocols simultaneously.

“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,” the company said .

Furthermore, the increase in staking has harmed ETH’s appeal from a “yield perspective.” The total staking yield has fallen from 7.3% before Shanghai to 5.5% now. The paper emphasized that the outlook is more grim in the face of rising yields on traditional financial assets.

Challenging Centralization in Ethereum Staking

In the world of Ethereum staking, there are different approaches. The simplest is “home staking,” where you manage assets using a small, energy-efficient PC with Ethereum software. However, some people prefer not to do this for various reasons.

One group lacks the technical skills or time to set up the required PC, while another group seeks higher returns and is willing to take more risks than the 3% to 6% dividend from staking. These two groups entrust their staking tokens to a third party to manage on their behalf. They provide a service and take a portion of the rewards in return.

Third-party staking providers have pros and cons. They make staking more accessible but also introduce issues, acting like middlemen, which goes against the decentralized nature of crypto.

Ethereum’s Shanghai hard fork allowed long-term stakers to withdraw, causing a rush into staking. Many people are joining, but few are leaving, which can risk network stability and centralization. This has led to a negative perception of third-party providers, with Lido being a prominent one.

Lido’s actions pose a risk to Ethereum’s core principle of decentralization. To address this issue, Ethereum researchers need more time to find solutions. They are working with top tech experts to tackle the centralization challenge and develop ways to mitigate it.

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