'Fiat-Like' Proof-of-Stake Chains Favor Centralization & Rich Players
The threat of the financial system’s ability to acquire an unlimited stake shouldn’t be neglected. Buying up ETH doesn’t give validators or stakers unilateral control over the network. The largest existing holders will grow even richer with PoS.
In crypto, consensus often results in controversy. Sure, consensus mechanisms themselves obviously result in agreement concerning transactions, yet when it comes to picking the ideal mechanism for a particular chain or cryptoasset, the crypto community as a whole is very often in disagreement.
One of the most debated mechanisms now is proof-of-stake (PoS). While its supporters argue that it avoids the eye-watering energy consumption associated with proof-of-work (PoW) networks such as Bitcoin (BTC) and Ethereum (ETH), those on the other side of the debate claim it results in centralization and helps the rich get richer.
In fact, at least one prominent industry figure has recently argued that proof-of-stake isn’t substantially different from how the current fiat monetary system works, with the largest stakeholders having a near-monopolistic control over the overall system. This is an assessment that numerous other commentators agree with, although few would go so far as to agree that we’ll soon have actual (central) banks buying up control of the Ethereum 2.0 blockchain, as it aims to start using PoS.
Posting to Twitter, Pavol Rusnank, co-founder of Satoshi Labs, the manufacturer of the Trezor hardware wallet, declared that “proof-of-stake is how fiat works.” As he explained, the actors with dominant stakes determine how the system functions, with responsibility for controlling how transactions are verified and how much new money is created.
Rusnak was replying to an earlier tweet from Bitcoin developer 'grubles', who claimed that banks will love Ethereum 2.0 since they’ll be able to print indefinite amounts of fiat currency to buy more ETH, which they can then use to control the blockchain.
For other Bitcoin developers and supporters, the possible involvement of financial institutions is a tangible risk.
“Definitely a big risk and the reason why PoS doesn't work. It's essentially paying rich people to be rich and it's a permissioned system and therefore not decentralized,” said Bitcoin educator, author and developer Jimmy Song.
For those who aren’t so closely associated with Bitcoin, the actual risk of banks buying up control of Ethereum 2.0 (or any other big PoS chain) is very remote right now. Nonetheless, critics mostly agree that centralization is a serious concern for proof-of-stake.
“The problem with PoS is there is no real-world anchor, as the block validation is entirely intrinsic,” said Trezor Ambassador Josef Tětek.
However, he added that, for now, the idea that financial institutions would buy up large amounts of ETH sounds “far-fetched.”
“Far bigger current risk is a centralization of stake at exchanges and other custodians, that’s fueled by minimum stake requirements. But over a longer time horizon, the threat of the financial system’s ability to acquire unlimited stake in the system shouldn’t be neglected,” he told Cryptonews.com.
Incentives, disincentives & and the power of the rich
Other analysts suggest that, while possible, severe centralization of Ethereum 2.0 and other proof-of-stake networks isn’t likely, given the incentives and disincentives involved.
“It’s possible, if not likely, that institutions and banks will see ETH as a viable investment vehicle. But buying up ETH doesn’t give validators or stakers unilateral control over the network,” said Wilson Withiam, Senior Research Analyst at Messari.
As Withiam went on to explain, Ethereum doesn’t have on-chain, token-weighted governance, so owning more ETH doesn’t give a single user greater control over every aspect of the network.
“Also, attacking the network or acting maliciously will result in getting slashed or could cause price (and the attacker’s holdings) to free-fall in an extreme situation. The economic incentives in place prevent validators from easily profiting when acting outside of the defined rules of the platform,” he told Cryptonews.com.
But while ‘attacking’ a network is one thing, using a position of power to influence the direction of a blockchain and platform may be another.
“It [Ethereum] is definitely centralized, so there's no risk of it becoming centralized, it already is! I suspect exchanges will basically be the controllers of such coins. This is similar to how the current central-bank backed fiat money system works in that banks have undue influence over money,” said Jimmy Song.
This is a view with which Josef Tětek largely agrees, arguing that PoS has centralization tendencies built into it, with exchanges likely to be the biggest beneficiaries.
“With minimum stake requirements (such as Ethereum’s 32 ETH per validator), small holders will look for ways to also participate — and exchanges are the obvious providers of pooled staking services. This is already happening with existing PoS systems, where exchanges are the major stakeholders,” he said.
Another reason for centralization, according to Tětek, is the positive feedback loop whereby having lots of coins usually equals earning lots more coins.
“The largest existing holders will grow even richer with PoS, without undergoing any tangible risk,” he added.
While he claims the prospects of a bank-led violation of Ethereum 2.0 are very low, Wilson Withiam agrees that PoS has “an almost unavoidable” rich-get-richer problem.
“Those with initial allocations have a perpetual claim on seigniorage at the expense of non-stakers. It’s also subject to economies of scale, as professional staking providers can run more validators, and exchanges (services with multiple revenue streams) can offer staking at a near-zero cost to users,” he said.
Both factors can lead to a concentration of stake, he added. But on the other hand, he noted that no consensus mechanism is perfect, with Ethereum having two main counterarguments in its favor:
“Its six years of PoW emissions have enabled it to have a more equitable distribution. Its distribution and holder base is more diverse compared to newer PoS networks. Decentralized staking pools allow users with any amount of ETH to participate in staking and receive inflation rewards,” he said.
Centralization tendencies and improvements
There are some, such as Jimmy Song, who claim that no amount of tinkering can decentralize proof-of-stake chains.
“Decentralization is not a feature you can just bolt on. It's something that is inherently very hard to get and altcoins like ethereum simply are not, no matter how much they proclaim otherwise,” he told Cryptonews.com.
Even Trezor Brand Ambassador Josef Tětek argues that PoS chains will have to learn to live with centralization, and that they aren't compatible with decentralization.
“When you give up the real-world anchor that is PoW, you open the system up to centralization tendencies. PoW through specialized devices like SHA256 ASICs [mining hardware] is much harder to control — ASICs are already dispersed around the globe, they require a lot of ongoing maintenance,” he said.
But ending on a more positive note, Wilson Withiam suggests there are at least three improvements PoS chains can make to limit stake concentration:
- baked-in incentives to encourage stakers to stake with smaller validators (examples include Cardano (ADA)'s k parameter and Polkadot (DOT)'s Nominated PoS design);
- adjust reward yields based on a predetermined lock-up period; stakers could receive more rewards and voting power for locking up their holding for a longer period (examples include the Internet Computer);
- implementing an equitable initial distribution; avoid overly large team and insider allocations.
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