Post-Merge Emergent Trends
It’s been a year since Ethereum underwent The Merge, a significant network upgrade that transitioned Ethereum from the energy-intensive Proof-of-Work (PoW) consensus mechanism to the more sustainable Proof-of-Stake (PoS). In the PoW system, miners engaged in a competitive race to find a valid nonce for each block, collectively consuming around 70 TWh per year, equivalent to the Czech Republic’s annual energy consumption. The Merge has drastically reduced Ethereum’s energy consumption by ~99.95%.
Ethereum’s shift to PoS represents a fundamental change in the network’s security and ETH issuance model. Post-Merge, the daily issuance of ETH has plummeted by nearly 90% compared to the PoW era. The total ETH supply has decreased from ~120,520,000 on the day of The Merge.
In this article, we will dissect three key trends that have emerged as a consequence of The Merge: liquid staking, MEV, and validator set count.
Rising Popularity of Liquid Staked ETH
Node operators must lock up 32 ETH to validate Ethereum, making their ETH illiquid. However, shortly after the launch of the Beacon Chain, Lido Finance introduced a solution. They enabled users to stake any amount of ETH and unlock the liquidity of their staked assets by creating a token representing them. This token can be utilized across various DeFi protocols while the original ETH remains staked for Ethereum’s validation.
Lido operates under the governance of the Lido DAO, comprising LDO token holders. The DAO oversees crucial tasks like protocol development, deployment, updates, and parameter determination. Additionally, it manages node operators, involving the selection of initial DAO-approved operators, scouting and accrediting new ones, and penalizing those slashed due to chain rule violations.
Over time, liquid staking, pioneered by Lido, has gained significant popularity. Lido now holds a substantial market share of total staked ETH, approaching the critical consensus threshold of 32.32%. In a theoretical extreme scenario, this could lead to cartel-like behavior, with the protocol generating disproportionately high profits through block space monopoly. Staked ETH might be discouraged from participating elsewhere due to the significantly higher rewards within the protocol, further consolidating its dominance in the staking ecosystem. This would also impact decisions regarding the inclusion or removal of operators in the network.
Encouraging the entry of additional liquid staking protocols into the market and advocating for diverse liquid staking providers is crucial. This strategy mitigates the risk of any single provider growing excessively large and posing systemic risks.
However, as Vitalik suggests, relying solely on moralistic pressure may not provide a stable long-term solution. There may be merit in formalizing specific aspects of the liquid staking mechanism while leaving others open to user determination.
Liquid staking is currently the largest DeFi sector with over $20B TVL, and it carries a significant impact to the supply and circulation dynamics of ETH.
A New Paradigm for Maximal Value Extraction
In PoW, block building and mining were managed by the same network actors, primarily mining pool operators. However, The Merge altered this dynamic. Now, validators have taken on the role of both proposing and constructing blocks. Nevertheless, the influx of new validators post-Merge has resulted in some lacking the expertise to optimize blocks as miners once did.
This transformation has given rise to a novel category of network participants known as block builders. These specialists actively compete in a real-time marketplace to construct blocks on behalf of validators. Ultimately, this separation is formalized as proposer/builder separation (PBS), currently implemented through a protocol sidecar called MEV-Boost. Since The Merge, MEV has been consistently present in most blocks, with a total of over 322,353 ETH extracted.
MEV searchers identify profitable MEV opportunities and employ bots to automatically submit these transactions to the network, often times bypassing the public mempool. An example is jaredfromsubway.eth, which has generated millions of dollars in profit this year.
Block builders and relays introduce trust assumptions to the network, potentially enabling them to censor certain transactions from the public mempool. Ongoing research is exploring solutions such as inclusion lists and encrypted mempools to address this issue.
MEV-Boost maximizes validator profits by creating a market for block builders and relays, utilizing advanced hardware to optimize bids. However, this competition among high-end machines for last-second MEV extraction within the 12-second block time can lead to centralization.
MEV has prompted the development of solutions like MEV Blocker and Flashbots Protect to shield users from MEV-hungry bots.
To reduce trust assumptions concerning builders and relayers, protocol researchers are actively exploring methods to integrate MEV mechanisms directly into the protocol. Additionally, the concept of MEV burn, expected in the future, is seen as a potential solution. While MEV is considered a solved research problem, practical implementation is still under evaluation.
Growing Validator Set Count Post-Staking Withdrawals
Since the implementation of the Shapella upgrade, staked ETH can now be withdrawn through either full or partial withdrawal methods, with a limit of 16 withdrawals per block. This upgrade has sparked heightened interest in staking ETH, resulting in a surge of staked validators compared to those opting for full withdrawals. This surge in participation has, in turn, driven an increase in the churn limit, allowing more validators to join the network.
However, the expanding validator count raises potential concerns about latency, particularly as each epoch requires additional attestations for chain progression. In May 2023, Ethereum faced network disruptions that delayed transaction finalization due to issues related to software client logic. These problems were exacerbated by the rapid growth in Ethereum’s validator set at that time.
As the validator set continues to grow, operators will require advanced hardware to accommodate higher bandwidth and internet speeds, potentially centralizing the network if left unchecked. Besides, Ethereum may end up supporting a smaller theoretical-maximum validator count in order to achieve Single Slot Finality (SSF), as discussed by Vitalik in “Paths toward single slot finality”.
Notably, the recently launched Holesky testnet has demonstrated support for 1.4 million validators, marking it as the largest public PoS testnet. Originally planned for 2.1 million validators, the testnet was scaled back due to networking issues during simulations, which led to delayed attestations and block proposals. Should the churn limit continue to rise unchecked, it could surpass this threshold.
Addressing this issue, EIP 7514 has been proposed as a temporary measure, capping the maximum churn limit per epoch at 8, down from the current 12.
Assuming the deposit queue remains at capacity, it’s possible that we may reach a point where 50% of all ETH is staked (approximately 2 million validators) by May 2024. Without a solution, this could result in the aforementioned networking issues. Lowering the churn limit now should provide core developers with the necessary time to devise long-term strategies.
While we’ve witnessed a decrease in the number of validators in the entry queue, the rising popularity of liquid staking solutions, which reduce the barriers to entry for many users, presents a unique challenge. This issue of a burgeoning validator set is likely to intensify over time if left unaddressed.
One promising long-term strategy to mitigate these challenges is increasing the maximum validator effective balance. This adjustment would allow validators to accrue higher rewards by staking more than 32 ETH, up to 2048 ETH, with a minimum balance of 32 ETH. This simplifies infrastructure for large staking providers, eliminates the need for multiple validator activations, and encourages solo-staking with auto-compounded earnings. However, this proposal involves more complexity and is being worked on by the core devs.
In Conclusion
The post-Merge landscape of Ethereum is characterized by dynamic shifts and emerging trends that continue to shape the network’s evolution. While liquid staking has successfully unlocked liquidity for staked ETH, the challenge of maintaining decentralization remains prominent. Additionally, MEV extraction can enhance network efficiency, sparking both innovation and concerns about centralization tendencies. Meanwhile, the growing number of validators requires careful management to mitigate centralization effects, making it an ongoing effort to preserve decentralization across the Ethereum stack.
Two intriguing areas of development on the horizon include Distributed Validator Technology, which enables a node to operate with multiple operator clients, and Secret Single Leader Election, designed to ensure the anonymity of upcoming proposers. These innovations hold the potential to further strengthen the Ethereum network while addressing critical concerns.
