Ethereum is regarded as the most decentralised Layer1 blockchain in all of crypto. However, recent developments from OFAC threaten to undermine the integrity of Ethereum’s censorship resistance. For starters, the Office of Foreign Assets Control (OFAC), an enforcement agency of the U.S. Treasury Department, sanctioned Tornado Cash and several other Ethereum addresses associated with it. Regulated US entities and various DeFi applications quickly complied with these sanctions, and blacklisted the addresses specified by OFAC.
The Ethereum transition to Proof-of-Stake (PoS) has concentrated ETH staking among four key players: Lido, Coinbase, Kraken, and Binance. These centralised players need to comply with US regulations and submit to requests from OFAC, such as censoring addresses. These developments greatly undermine the integrity of Ethereum decentralisation, raising valid concern amongst the crypto world.
The problem with centralised ETH Staking Market Share
One key centralisation metric on Ethereum is Provider staking market share. Irrespective of OFAC, a concentration of market share amongst large staking Providers creates the possibility for collusion. Dominant bad actors colluding can change the ordering of new transactions, and censor specific blocks or addresses. Concern over concentration of ETH staking Provider market share is valid as Lido, Coinbase, Kraken, and Binance account for 58.8% of total staked ETH market share.
On August 8, 2022, the U.S. Treasury Department added privacy protocol Tornado Cash to its sanctions list, arguing cybercriminals used the crypto project for money-laundering purposes. Centralised exchanges like Coinbase, Kraken, Binance and other centralised entities quickly complied with the sanctions and blacklisted Ethereum addresses associated with Tornado Cash. While centralised entities need to comply with regulations, the Tornado Cash sanctions highlight centralised entities potential for control over Ethereum. This begs the question, what would prevent these companies from using their dominant staking market share to further censor transactions on Ethereum’s base layer if the Treasury ordered them to?
One of the absolute core purposes for blockchains such as Ethereum is to provide neutrality and censorship resistance. A threat to Ethereum’s censorship resistance is a threat to the core premise of decentralisation.
To understand the full extent of possible censorship, you need to ask which validators are OFAC compliant, or which validators use relayers that are OFAC compliant?
A large % of validators run a relay service called ‘MEV-Boost’. In short, MEV-boost allows PoS Validators to outsource block production duties to the highest bidder, effectively increasing Validator APR. MEV-boost increases Validator APR by as much as 70%, making it hard for validators to ignore.
The chart above tracks the percentage of blocks built by OFAC compliant MEV-boost relays since the Merge (as a percentage of MEV-boost proposed blocks or all blocks). 63% of Post-Merge blocks produced on Ethereum are OFAC compliant. This means if the OFAC compliant validators would stop attesting to non-censoring blocks they would eventually form the canonical, 100% censoring chain.
The most popular relay is developed by Flashbots, which is OFAC compliant. Currently, Validators can choose from eight relayers:
Flashbots (OFAC Compliant)
Eden Network (OFAC Compliant)
Block Native (OFAC Compliant)
BloXroute Regulated (OFAC Compliant)
BloXroute Max Profit (Non-OFAC Compliant)
BloXroute Ethical (Non-OFAC Compliant)
Manifold (Non-OFAC Compliant)
Relayooor (Non-OFAC Compliant)
Of the validators that have MEV-Boost activated, 94% of blocks relayed through MEV-Boost are enforcing OFAC Compliance. This means there is censorship at the protocol level, which is not good for decentralisation.
A valid argument can be made that Tornado Cash could aid bad actors in anonymity and thus the associated addresses are rightfully blacklisted. However, this ignores all the good actors using Tornado Cash for privacy reasons. What is most concerning is the power of OFAC to decide what is and isn’t compliant, and forcing the hand of compliant entities are complying. OFAC compliance puts the network in a precarious position where validators are submitting to the requests of a nation state (Centralised entity) - thus threatening a core feature of Ethereum, decentralisation.
The defence mechanism: Social Slashing
Vitalik Buterin and other developers have argued that Ethereum still has an ace up its sleeve: the possibility of implementing user-activated soft forks (UASFs) - a form of social slashing. In his blog, Vitalik describes how UASFs protect against 51% coalition attacks with intent for censorship. A UASF is a mechanism by which blockchain nodes activate a soft fork (a network update) without needing to obtain the usual support from the chain’s block producers (Validators in Proof-of-Stake).
In the event of a UASF, the attacker's funds are largely destroyed (in Ethereum, this is done via the "inactivity leak mechanism"). No explicit ‘hard fork to delete coins’ is required; with the exception of the requirement to coordinate on the UASF to select a minority block, everything else is automated and simply follows the execution of protocol rules.
Hence, attacking the chain the first time costs the attacker an absurd amount of money, and Ethereum smoothly resumes within days. Attacking the chain again requires the attacker to acquire new coins to replace burned coins. If they were to attack again, it would cost them a lot of money…again (You get the idea). The game is very asymmetric, and not in the attacker's favoUr.
What would a UASF look like on Ethereum?
Social slashing is not a process that is built into the protocol following the migration to Proof-of-Stake, hence the need for a UASF. Ethereum restricts slashing offences to very specific actions. Any movement to implement protocol-level standards for additional slashing offences would need to take place via further upgrades to Ethereum. The basics of the UASF go like this:
A validator complies with OFAC and starts to censor transactions
The Ethereum community disagrees and the validator is slashed
The validator either reverses its behaviour or leaves the network
Now think about US entities like Coinbase/Kraken, these companies have to comply with OFAC regulations if they want to operate their staking services in the US. In a situation where ETH users attempt a UASF to combat OFAC censorship, US compliant Validators like Coinbase/Kraken validators will need to comply with OFAC. In such a scenario Coinbase or Kraken Validators get slashed. The conundrum is that Coinbase and Kraken are running staking pools which hold ETH deposits from…the users that activated the UASF.
The black flag
he black flag movement across some Ethereum users declares a willingness to support a manual fork (UASF) to counter Validators that engage in attempts to achieve system-wide censorship.
On the contrary, ecosystem participants don’t want to slash centralised entities like Coinbase since it’s retail money. However, censorship should be take as seriously as double-spending - If you double spend you will get slashed and if you censor, you will get slashed. UASFs are arbitrary and not codified or automated and rely on human decisions. What type of censorship merits aggressive slashing of centralised entities in custody of user tokens? UASFs are arbitrary and not codified or automated and rely on human decisions. What type of censorship merits aggressive slashing of centralised entities in custody of user tokens? The controversy of social slashing lies herein.
To add to the intricate and convoluted situation, the Ethereum community cannot rely on a single leader like Vitalik to initiate a UASF. Relying on a “Overlord of the network” leads to another form of centralisation. .
Moving forward, the Bitcoin UASF is an example of a successful UASF. The core developers of the Bitcoin network did not actually support a Bitcoin UASF, but rather took a backseat and allowed the community to decide. It comes down to the community to push a social slashing fork. The only way UASF works fairly is through a grassroots approach.
A lesson from SWIFT (Yes, the centralised banking network)
Erik Wall highlights that Swift does not apply OFAC regulations on messages passed within its network. SWIFT is a cross-jurisdictional messaging network for banks. If you have to abide by every single jurisdiction's OFAC laws and regulations, you cannot have a cross-jurisdiction messaging layer like Swift. You simply cannot comply with every single jurisdiction at the same time, which is why you cannot have network level censorship for a global system. It just doesn’t work. If not even SWIFT complies with OFAC at the base layer, then why should Ethereum?
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