- Switch to the proof-of-stake model is raising questions about Ethereum’s (ETH-USD) future.
- Investors need to understand the fundamental reasons for and pros and cons of the switch.
- The Beacon chain represents the same risks inherent in the proof-of-work model.
Source: Filippo Ronca Cavalcanti / Shutterstock.com
As Ethereum (ETH-USD) continues its move toward becoming a full proof-of-stake (PoS) network, questions have begun to arise. The choice had been earlier lauded for its environmental benefits. But now larger questions about centralization have begun to crop up. However, the risks inherent to Ethereum aren’t very different than they were under the outgoing proof model.
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Why Is ETH Switching?
Ethereum comprises a network of nodes that validate transactions. One thing to understand about these so-called nodes is that they aren’t fixed in number. According to Etherscan, in the last month, there have been between 1,000 and 3,000 nodes, usually around 2,500. The nodes themselves are groups of people attempting to validate a block. Validate a block, and get rewarded with valuable ETH. That’s one reason nodes exist. The work of validating blocks is vitally important.
It’s also vitally important to understand how that work is done. Ethereum began operating under a proof-of-work (PoW) model. In that model, nodes cluster together massive computing power in order to solve complex mathematical computations. Those that do are rewarded with ETH.
But that computing power requires massive amounts of electricity. That damages the environment. The media seized on this early last year. At that time lots of articles were published claiming that Ethereum could quickly and easily switch to a PoS model to reduce its environmental footprint.
How Proof-of-Stake Works
In a PoS model, validators have to contribute at least 32 ETH to the network to have a chance to prove the block. Then a validator is chosen at random among those nodes. Prove the stake, 32 ETH, and have a chance to prove the next block added to the blockchain.
Right now Ethereum is running both models with the intent to switch to PoS completely sometime this year. That chain is referred to as the Beacon chain. That switch was once universally lauded primarily based on environmental arguments. But that transition is starting to raise some other valid questions.
Primarily, PoS raises the question of centralization of power on the blockchain. That’s pretty much antithetical to the premise of blockchain and Ethereum.
But as long as a validator can prove that it has a pool of 32 ETH to stake then it can validate a block. One of the arguments here is that a group with enough capital can simply invest money and set up a bunch of valid nodes. It could then simply throw so much money at it that it would have a higher chance to validate blocks and gain influence.
That’s the assertion anyway. I question it to some degree. For one, Ethereum claims to have mechanisms in place to prevent that from happening. Two, how does that significantly differ from the threat mining groups pose under the PoW model? Miners aggregate large amounts of capital to create supercomputing clusters to then mine ETH.
In theory, the same risk of concentrated power exists under POW and POS. That power can be wielded in dangerous ways under either model. So I don’t really believe that the threat is any greater under a POS model.
Betting Big on Ethereum
There are massive bets being made that the POS model will be successful. There’s more than $35 billion staked in the switch to the Beacon chain. $10 billion of that is staked in Lido Staked ETH (STETH-USD).
Pundits are worried that Lido represents a threat because it currently controls a large portion of the Beacon chain’s liquidity. Lido allows users to contribute any amount of ETH to a pool that, once it reaches 32 ETH, is directed to a service Lido chooses to set up a validator. The reason so much capital is accounted for through Lido is that it is liquid. The other $25 billion staked in ETH is locked in until the Beacon chain comes online, ostensibly sometime this year.
Lido controls about 90% of the $10 billion liquid market for staked ETH currently. Most pundits believe that once the switch occurs, ETH is set to rise quickly.
The anxiety is overblown. Most of the risk posed by Lido and the Beacon chain is the same as the risk that existed before.
On the date of publication, Alex Sirois did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
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