Why did Etherium make the switch to PoS

Since its launch in July 2015, the Etherium network has operated on a proof-of-work consensus algorithm, or so-called Proof-of-Work (PoW). This means that the creation of transaction blocks and their subsequent addition to the blockchain was handled by miners, who competed against each other and thus secured the network.


Although Ethereum ended up running on PoW for just over seven years, the developers had planned from the beginning to move it to a Proof-of-Stake or Proof-of-Stake (PoS) algorithm. Accordingly, such dramatic changes last fall were always seen by developers and the community as the next logical step in the development of the largest cryptocurrency since Bitcoin. It came as a surprise only to those who have not been following the blockchain developments.


As we have already noted, the role of miners in PoS networks is played by validators. The latter send 32 ETH to the stack, thus guaranteeing their bona fides, and run the validator client. The network then pseudo-randomly selects validators, who get a chance to propose a block for further validation. Members of the network are rewarded for this and validating other blocks. And if they break the network’s rules or want to harm it in other ways, they are punished by reducing their total deposit.

In general, Etherium’s move to a Proof-of-Stake algorithm is needed to further scale the blockchain, i.e. its ability to handle more transactions per second. PoW blockchains have traditionally been unproductive because they require a huge amount of resources to validate blocks by miners. The PoS update was therefore another step towards increasing the bandwidth of Etherium in the future.


So far, the performance of the Ethi network with stacking is almost the same as it was on Etherium with mining. The only difference is the block creation time. Whereas in the PoW version of Etherium a block was created in about 13.3 seconds, now it takes about 12 seconds. That means for now, the PoS-based Etherium is at best 10 percent faster.

As previously reported by Ethereum creator Vitalik Buterin, full integration of so-called sharding will allow the blockchain to process as many as 100,000 transactions per second. At the moment, that figure is at 13 transfers per second. However, judging by the current pace of development, it would take more than a year to implement sharding for such a large-scale project.


Barring a major advance in network development, Ethereum’s upgrade to PoS immediately brought two important improvements:

• reduced power costs: since the PoS network does not need video cards or ASICs to run, it is a more energy-efficient alternative compared to PoW blockchains. In the case of Etherium, its upgraded version now consumes 99.9 per cent less electricity than before. And, as the developers of Eth noted, the Fall 2022 update reduced total global energy consumption by 0.2 percent;
• reduced issuance: the PoS version of Etherium involves significantly less cryptocurrency issuance per block. A PoW-based blockchain would issue 2 ETH per block created, which would go to the miner. On the other hand, in PoS blockchain, the reward is calculated using a complex formula and is dynamic. For example, it can be as low as 0.002 ETH, as was the case with block number 17018165.

Actually, it was the combination of low issuance and active burning of ETH as a commission that allowed ether to become a deflationary asset.

How ether (ETH) became a deflationary asset

A deflationary asset is an asset whose supply gets smaller over time. For example, Bitcoin is an asset with a limited maximum supply of 21 million coins. Although the cryptocurrency’s issuance rate halves approximately every four years due to so-called halving, BTC is still an inflationary asset.

Bitcoin’s inflation rate is currently at 1.77 per cent annually, which is how much the cryptocurrency’s total supply increases per year.

Etherium has a different situation at the moment. Each transaction on the cryptocurrency network ends up destroying a certain amount of ETH used as transaction fees. In the case of the already mentioned block 17018165, we are talking about burning 0.49 ETH. Here is the relevant data.

When the load on the network increases, transaction fees go up as users are forced to increase their rates to get their transaction done before others due to the limited technical capabilities of the blockchain. This leads to an overall increase in transactions, which at times can reach completely silly levels.


For example, we once had to conduct token exchanges on the decentralised exchange Uniswap for more than a hundred dollars. Of course, after actively using Solana network such experience would be forgotten soon.


So, the increase in commissions leads to more ethers being burned in the Eth network within a certain blockchain than being created. Consequently, the total supply of the cryptocurrency becomes smaller, which characterizes it as deflationary.

You can see the volume of burns on the Ultrasound Money platform. In the last week, for example, the total supply of ethers has decreased by almost 7,000 coins.

And what about the total period since Etherium switched to PoS in September 2022? Click on the date to get this data.

As you can see, the total number of ethers in circulation since September 15, 2022 has decreased by almost 83 thousand units. Accordingly, there is not more ETH, but rather the opposite: the amount of ETH in the world has become less in six months. Just think about it, because you hardly know another cryptocurrency like that.

The funny thing is that if the blockchain had continued to run on the PoW consensus algorithm with its high issuance, the total cryptocurrency supply would have increased by more than 2.3 million coins over the same period. Here is a relevant simulation of the situation.

That is, this amount of coins would go to the miners, who would probably sell the cryptocurrencies to pay for electricity, buy video cards and maintain the equipment in place, which would create what is known as seller pressure in the market.

Validators also need to pay for electricity to run a node computer around the clock, but such costs are nothing compared to the activity of the miners.

The actual rate of return on staking on the Etherium network is at 6 per cent. You can find out other blockchain’s rates of return if you need to here.

Why they call Etherium a centralised cryptocurrency

There is a stereotype in the cryptocurrency world that PoS blockchains are supposedly more centralised by default. The argument in favour of this theory is that the validator who has more money to buy ETH, run more validator nodes and gain more capacity in the blockchain respectively will validate the blocks.


However, the same is true for PoW blockchains. Still, somehow richer miners are able to buy more video cards or ASICs and by exactly the same logic get a bigger role within the blockchain.


Parsing the topic without stereotyping, there are indeed visible signs of centralisation in Ethi Blockchain. These arise from two factors – steaming pools and regulator activity like the US Treasury’s Office of Foreign Assets Control (OFAC). Let’s deal with each separately.

The problem of stacking pools of Etherium

As mentioned above, it requires 32 ETH to run a validator node. At today’s exchange rate, that amount translates to the equivalent of $59,000, which many investors may not have. What about holders of at least 1 ETH, who want to put them to work and earn some passive income?

This is where so-called stacking pools come to the rescue. We’re talking about platforms that pool cryptocurrency from many users, run validator nodes, and then distribute an appropriate share of the total earnings, while charging a certain commission.

This scheme is very popular. Specifically, there are just over 18 million coins in the Etherium stack today, as confirmed by the Beacon Chain platform.

Well almost 33 per cent of this amount is accounted for by the Lido platform, which is the largest stacking pool for Etherium. The data on the platform’s page allows us to draw this conclusion.

And Lido is not the only stacking pool platform – Coinbase, Kraken and Binance also offer similar services. As of the end of January 2023, 70 percent of all staked ethers were sent to the stack through intermediaries. And this creates centralization risks because, for example, the validator nodes in a particular case will not be managed by a notional 10,000 individual people, but by a single Lido platform to which these people have put their own coins at their disposal.


It is important to understand that when coins are sent to the pools, the user loses control over them, although they do receive stETH-like synthetic assets in exchange. Accordingly, all power in this case goes to the intermediary platform, which is not conducive to decentralisation of a particular blockchain.


Since 33 per cent of zastakaniyi ethers today are managed by the Lido platform, that means it gets a corresponding probability to approve transactions and create blocks. And if we add other centralised intermediaries to this, we get a huge chance that it will be one of them that adds a block to the existing blockchain. And since validators can choose which transactions to add to the block and which to ignore, this also creates certain risks of censorship.

Can transactions be blocked on the Etherium network

The censorship mentioned above is indeed present on the Etherium network. Remember when the US Treasury’s Office of Foreign Assets Control imposed sanctions on a blockchain mixer called Tornado Cash in August 2022? Because of this, the platform’s smart blockchain itself and its associated addresses ended up on the so-called SDN list from that agency, OFAC. This list contains those entities with which it is forbidden for US citizens to interact in a business context.

It turns out that the validator, represented by the same cryptocurrency exchange Coinbase, which was established in the US, is not allowed to validate transactions on the Etherium network related to the Tornado Cash platform. That is, the transaction in question will be confirmed later in the blockchain, which is not subject to validators who are subject to US laws and regulations.

According to the MEV Watch platform, about 30 per cent of validators on the Etherium network today have to comply with OFAC agency instructions. Which means they are bound to ignore a transaction involving the same Tornado Cash mixer and not include it in their blockchain.


It is important to understand that in such a case, the transaction will be included in one of the next blocks that will be offered by another validator, and this will happen soon enough. Be that as it may, it is censored.


The platform mentioned even has an anti-rating of companies that cause transactions to be blocked more often than others. Here’s that list, ordered by the number of such actions.

To address the problem, platform representatives recommend engaging with those organisations that are not involved in transaction blocking and censorship.

Which cryptocurrencies are more centralised?

The above-mentioned problems of Etherium have led to a low estimate of the level of decentralisation of this blockchain, according to the so-called Nakamoto Coefficient. This is a metric that determines the number of validators or nodes that must collude to create problems for the blockchain. In this case, it is about slowing down or even stopping the blockchain from functioning properly.


The higher the ratio, the safer the blockchain is in terms of decentralisation and independence.


Given the huge role of centralized stackers in the Ethereum network, its decentralization score is only 2, with a minimum score of 1. Among popular PoS networks, Solana has the best score with 33 points.

Is it true that Ethers are a security

After Etherium’s move to the PoS consensus algorithm, various regulators started talking about the cryptocurrency’s supposedly being a security. In particular, SEC Chairman Gary Gensler called all digital assets, with the exception of Bitcoin, securities.


Bitcoin's special position is ensured by the fact that the cryptocurrency was launched without a pre-sale phase of the asset. Moreover, it was created by an anonymous developer, whose identity remains unknown.


However, it’s not all so clear-cut here. First of all, Gensler cannot decide for himself which cryptocurrencies are securities and which are not. Such a ruling can only be made by a court, so there is no point in paying attention to Gary here.

Second, the SEC is already trying to prove that Ripple’s XRP token is a security, and has been doing so since December 2020. As can be guessed from the length of the proceedings, the SEC is having trouble proving its own position. In addition, the day before Ripple CEO Brad Garlinghouse stated that he expects the case to end as early as 2023, with Brad himself clearly admitting to winning the case.

Finally, thirdly, in a recent lawsuit against cryptocurrency exchange Binance, another regulator, the Commodity Futures Trading Commission (CFTC), explicitly called Bitcoin, ETH, LTC, USDT and BUSD commodities, not securities. Accordingly, one should not count on the SEC to be right here, as even its colleagues from another agency disagree with it.

What will happen to Etherium after the Shapella/Shanghai update


The PoS branch of Etherium called Beacon Chain was launched in December 2020. Since then, validators have been sending Ethers into steaming and in doing so have been unable to return them. Accordingly, they were prepared for the risk of long-term asset lock-ups and a drop in value, but decided to help the blockchain anyway.

This approach is due to a high level of trust in the developers of Etherium. Imagine this: you send $32 ETH of $3,000 each to the stack in 2021 and don't know when you'll be able to get it back. As you can see now, the developers have still lived up to their trust.


Now the Shapella/Shanghai update is waiting on the night of April 12-13 on epoch number 194048, which will allow ETH to be withdrawn from stacking. Which means everyone – and that includes those who sent ethers to work back in 2020 – will be able to get them back.

Back then, ETH was valued at around $500, which is several times lower than today’s rate. It would seem that hardly every staker would want to withdraw the crypto as soon as possible and get rid of it, which in theory could supposedly drop the exchange rate of ethers almost tenfold, right?

Not really. First of all, many stakers have bought ethers at a much higher price and are now at a loss. At the beginning of March 2023, CryptoQuant analysts noted that owners of about 60% of all ethers in stacking at that time were in the red, meaning they bought ETH more expensive than the current rate. Well, in such an environment, running out and selling cryptocurrencies – even though there are more of them – at a loss is rather foolish. Including the prospect of the end of the bearish trend and the onset of a new growth phase.

Today, according to analysts at Glassnode, the total amount of ether stackers is $4.7 billion in the red. That means the average purchase price of ETH before they are sent by validators to stackers is noticeably higher compared to the current rate. So counting on a massive cryptocurrency drain after this week’s update is unlikely.


Separately, it should be noted that it will not be possible to withdraw all coins from stacking in one day. As clarified earlier, the maximum amount of coins withdrawn from stacking in a day will be 43,200 ETH. This means that a full withdrawal of the current 18 million ETH from the stacking would take over a year.


We think that the withdrawal feature will just catch the attention of ether owners who were previously afraid to send them to staking due to the uncertainty of the issue. Now they know for sure that they will be able to get their coins at any time – even if it is just for a few days.

To illustrate, here are the statistics from early April 2023. It shows what percentage of the total supply of different cryptocurrencies is in stacking.

Etherium has just 15 percent, while Avalanche, Cardano and Solana exceed the 60 percent mark. Accordingly, stacking is in demand among coin owners because it allows for additional income in cryptocurrency terms.

That is to say, we can assume that there will now be a lot more people willing to send ethers to be steamed. This is especially true for those investors who do not trade, but simply wait for the bull run to sell coins. They are primarily interested in increasing the volume of cryptocurrency and are not paying attention to rates yet.

Conclusions

Since the move to PoS, ether has become a more attractive investment for the medium and long term. In 2023, the cryptocurrency’s supply has started to gradually decline, rather than increasing by millions of units per year as before. Also, the power consumption of the blockchain has dropped by 99.9 per cent, making the network less vulnerable to pressure from the government and environmental organisations.

Now, those who wish to do so will also be able to not only send coins to the stack, but also withdraw them from there. And that adds to the certainty of what’s going on, because if anything happens, it will be able to get their investment back relatively quickly.

Finally, the developers of Etherium, who have done a Herculean job of migrating such a vast network to PoS and now continue to improve the blockchain, deserve a special commendation. Yes, ETH remains the second most capitalised cryptocurrency today, but the developers are pushing the coin industry forward more actively than they are pushing Bitcoin. And that’s another argument for trusting developers. And to believe in a bright future for the ether as well.

Stay tuned for an update on our cryptochat. So let’s talk about the Etherium update and more.