Did the 'Merge' Create a Centralized Ethereum PoS System ?

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It's time to look at the numbers folks !

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A market intelligence platform, Santiment, provides both on-chain and social metrics for more than 2,000 cryptocurrencies. "Santiment’s analysis shows that 46.15% of Ethereum PoS nodes are controlled by just 2 addresses. Hours after The Merge, the first address validated about 188 blocks, or 28.97% of the nodes, and the second address validated 16.18%, or 105 blocks. On Twitter, the data became a controversial topic as users debated The Merge’s impact on the centralization of the world’s largest crypto network" [Baxter, A. Santiment data shows that more than 40% of Ethereum PoS nodes are under the control of 2 addresses. (Accessed September 18, 2022)].

"Ahead of the Merge, the blockchain analytics platform Nansen released a report showing fiv entities holding 64% of all staked Ether, with Coinbase, Kraken and Binance accounting for nearly 30% of staked ETH. Reports also showed that the majority of 4,653 active Ethereum nodes are in the hands of centralized web service providers like Amazon Web Services (AWS)" [Pereira, A. 40%+ Ethereum PoS nodes are controlled by 2 addresses says Santiment data. (Accessed September 18, 2022)].

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"Since the successful completion of The Merge, the majority of blocks – around 40% or more – have been created by two addresses owned by Lido and Coinbase. It’s not ideal to see more than 40% of blocks being solved by 2 providers, especially one that is a centralized service provider (Coinbase),” explained Ryan Rasmussen, cryptocurrency research analyst at Bitwise. And he added: 'That’s not ideal. However, I think Lido will struggle to maintain that market share as more staking service providers and Lido’s competitors enter the space, and as solutions like Rocket Pool become more popular' [Baxter, supra].

Since PoS rewards those with a higher token supply over those with a lower one, it is frequently thought to promote centralization. For instance, the Ethereum blockchain’s new consensus mechanism relies on validators, rather than miners, to validate transactions. Participants must stake 32 ETH, which at the time of publication is equivalent to about $48,225, in order to run a validator and be rewarded. Supporters of PoS, however, contend that the technique is safer and more environmentally friendly than PoW. Vitalik Buterin, the co-founder of Ethereum, predicted that the transition would not only reduce energy consumption by about 95% but also help scale the network, with features that are anticipated to take place in the second half of 2023. Transaction processing is expected to match that of centralized payment processors.

[Shashikumar, A. Ethereum PoS nodes being centralized? 2 addresses dominate 40%+ nodes. (Accessed September 18, 2022)].

As well, pre-Merge "mining data reveals Ethereum’s heavy reliance on Flashbots — a single server — for building blocks, raising concerns over a single point of failure for the ecosystem. Flashbots is a centralized entity dedicated to transparent and efficient Maximal Extractable Value (MEV) extraction, which acts as a relay for delivering Ethereum blocks. Data from mevboost.org show that there are six active relays currently delivering at least one block in Ethereum, namely Flashbots, BloXroute Max Profit, BloXroute Ethical, BloXroute Regulated, Blocknative and Eden" [Sarkar, A. Flashbots build over 82% relay blocks, adding to Ethereum centralization. (Accessed September 18, 2022)].

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"As shown above, out of the lot, 82.77% of all relay blocks have been found to be built by Flashbots alone — contributing heavily to Ethereum centralization" [Id].

In a blog dated May 6, 2022, BitMEX examined Flashbot's mining and transaction selection system relative to Ethereum.

Flashbots is a potential mitigation against the so-called MEV problem. Over 90% of Ethereum miners subscribe to the Flashbots centralised and trusted service and we discuss the implications of this and the degree to which this contributes to Ethereum centralisation. We conclude by asserting that Flashbots may have saved Ethereum, as although it is a trusted and centralised system, the alternative could have been far worse. We go on to look at ETH 2.0 and explain why Flashbots or a similar system needs to be constructed again from scratch. A further complication for 'the merge' [...] In Ethereum lingo, the value of these rewards is called MEV (Firstly “Miner Extractible Value” and then “Maximal Extractible Value”).

[BitMEX. Flashbots. Accessed September 18, 2022)].

This blog goes on to explain:

As Defi has become popular on Ethereum, the value of MEV has been growing and this has led to a somewhat degraded user experience and “unfair markets”. The consensus view in Ethereum appears to be that there is nothing that can be done about this aspect of the problem. This is said to be an inevitable consequence of decentralised systems and users need to accept it or modify their behaviour if they don’t like it.

In order to extract the MEV, block producers/searchers may be required to engage in several burdensome processes:

1. They need to analyse and understand most of the Defi activity occurring
2. They may also need significant capital to exploit such opportunities

Therefore, block producers and searchers require complex systems similar to those of a sophisticated trading house, like Alameda Research or Jump for example. This can therefore result in significant centralisation pressures for block producers, with smaller less sophisticated block producers being unable to compete.

However, even in the above scenario, the situation may not be totally devastating for Ethereum, just more centralisation pressure and some clever entities making some nice profits.

[Id].

Specifically regarding Flashbots, the blog explains:

In Ethereum, as of May 2022, it is believed that over 90% of miners are connected to the Flashbots server. One can determine this by observing that over 90% of blocks contain Flashbot transaction bundles. Adoption from 0% to around 90% occurred almost entirely within 2021. Flashbots should therefore be considered very significant from an economic perspective when analysing Ethereum [...]

Flashbots is a single centralised entity. It is funded by Fred Ehrsam’s crypto VC firm Paradigm, although it appears that this funding could be altruistic. Searchers send there MEV transactions to the server with the address https://relay.flashbots.net/ and the server is currently located in Ohio in the United States of America.

The Flashbots entity must also be trusted to sensitively and securely handle the information in the MEV transaction bundles. If Flashbots acted nefariously, it could outbid and front run other searchers themselves. Flashbots is therefore a trusted and centralised system, not ideal as a long term solution to the MEV problem.

In order to prevent spam, searchers are required to be authenticated prior to the submission of MEV transactions and can build up reputation.

[Id]

The blog concludes (please remember this blog was written in May when PoW was still utilized):

The Flashbots system is integrated into the current Proof of Work (PoW) mining system on Ethereum. When the Merge happens and PoW mining is switched off, Flashbots adoption will reset to zero again. In order to mitigate against the MEV problem a new Flashbots infrastructure will need to be built up and staking agents will need to adopt this new system. This was not in the ETH 2.0 roadmap and may be an additional complication related to the upgrade to ETH 2.0.

Fear not, proponents of Flashbots argue. The Flashbots system is a DAO and will eventually become decentralised itself. This is a similar analogy to Lido here. Lido is a staking pool that accounts for around 29% of all Ethereum staked in ETH 2.0. To avert claims of centralisation, Lido itself says it is or will become a decentralised DAO, just like Flashbots. To “Bitcoin maximallists”, this logic may sound ridiculous. It is merely obfuscating the centralisation into more layers and complexity, such that the centralisation is harder to see, they could argue. However, we do see some limited merit in adding more layers. The benefits of this could be that the centralisation is harder to spot, which can improve the resilience network against some adversaries over some periods. At the same time centralisation can be more easily shuffled around between the layers, confusing any adversary.

[Id].

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