The historic Merge upgrade that took place in September 2022 marked a significant transition for Ethereum. It shifted the network’s consensus mechanism from proof-of-work (PoW) to proof-of-stake (PoS). However, this upgrade had unintended consequences, leading to a decline in compliance with the standards set by the Office of Foreign Assets Control (OFAC).
OFAC compliance within the Ethereum ecosystem involves censoring certain transactions to adhere to regulatory requirements. In August 2022, OFAC sanctioned Tornado Cash and several Ether (ETH) addresses associated with it due to the platform’s ability to mask and anonymize transactions. This move by OFAC had a negative impact on the neutrality of the Ethereum ecosystem.
Before the Merge upgrade, Ethereum’s compliance with OFAC regulations had been increasing exponentially. Many entities, including crypto exchanges, chose to run censoring MEV-Boost relays on their validators to ensure compliance. However, popular platforms such as Binance, Celsius Network, Bitfinex, Ledger Live, Huobi (HTX), and Coinbase were among the top offenders when it came to censorship, according to data from MEV Watch.
Despite the initial increase in OFAC compliance, the overall compliance level of Ethereum blocks has significantly declined. In November 2022, 78% of Ethereum blocks complied with OFAC regulations. However, as of September 27th, the compliance rate dropped to 30%, resulting in a 57% reduction overall.
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To counter OFAC compliance issues, operators need to use relays that do not censor transactions according to OFAC requirements. There are seven major MEV-boost relays commonly used, including Flashbots, BloXroute Max Profit, BloXroute Ethical, BloXroute Regulated, BlockNative, Manifold, and Eden. However, only three of these relays do not censor transactions based on OFAC compliance requirements, as reported by MEV Watch.
It is important to note that not all blocks built by OFAC-compliant relays are censoring blocks. However, they will censor transactions when non-compliant transactions are broadcasted to the network.
Although OFAC regulations primarily target organizations based in the United States, validators outside the US must also consider running non-censoring relays for the benefit of the entire network.
In response to the reduced OFAC compliance, Grayscale, a prominent cryptocurrency investment firm, made the decision to abandon all rights to PoW Ethereum tokens (ETHPoW). This decision was mainly due to a lack of liquidity in the market. Grayscale stated in an official announcement that it was not possible to exercise the rights to acquire and sell the ETHPoW tokens, prompting them to abandon these assets on behalf of the record date shareholders.
On the other hand, some cryptocurrency investment firms, such as ETC Group, have attempted to launch dedicated EthereumPoW exchange-traded products (ETPs). These products aimed to provide investors with exposure to Ethereum’s PoW ecosystem even after the Merge upgrade.
It is clear that the Merge upgrade brought about significant changes for Ethereum, including the transition to PoS and the subsequent decline in OFAC compliance. The Ethereum community will need to find ways to address these compliance issues while maintaining the network’s credibility and neutrality.
