A recent proposal aimed at curbing the rapid growth of Ethereum’s approximately $56 billion liquid staking sector has sparked debate.
Proponents argue that reducing the issuance of new Ether would mitigate this growth. However, critics, including some representing liquid staking projects, contend that such a move could have unintended consequences and jeopardize solo stakers.
Debate Over Ethereum’s Liquid Staking Regulation Proposal
These solo stakers are crucial for maintaining the blockchain’s decentralization. This is a fundamental characteristic of a system intended to serve as an accessible distributed world computer. Staking plays a role in Ethereum, similar to mining in Bitcoin. It involves creating new ETH, confirming and ordering transactions, and providing economic security against potential attacks on the blockchain.
Concerns have long existed regarding the potential dominance of liquid staking protocols, which lock or stake users’ Ether on their behalf, potentially granting them significant control over circulating Ether and, consequently, the blockchain itself.
In response to these concerns, researchers at the Ethereum Foundation recently proposed a subtle yet significant adjustment: a reduction in the issuance of new ETH. They argue that this change would help address the growing concentration of staked ETH and its potential adverse effects on decentralization.
However, some critics contend that this proposal could have the opposite effect. Reducing the staking rewards might deter smaller stakers while favoring larger and more sophisticated operators, thus aggravating centralization rather than alleviating it.
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Staking data firm Rated hailed solo staking as “the backbone of Ethereum” estimating that it constitutes approximately 6.5% of all staked Ether. Ethereum.org, a community-driven platform dedicated to the blockchain, lauds solo staking as the “gold standard.”
However, staking independently can be costly and technically complex, requiring 32 Ether (~$124,000). Liquid staking protocols offer a convenient alternative by staking users’ Ether on their behalf. Moreover, these protocols typically allow users to deposit any amount of Ether, which is then aggregated into increments of 32 ETH, as the blockchain requires.
Source: X
Additionally, liquid staking protocols address the opportunity cost by issuing IOUs for staked Ether, known as liquid staking tokens or derivatives. These tokens can be utilized across DeFi platforms instead of Ether. This presents a mutually beneficial solution for Ethereum and users who are reluctant to lock away tokens when potentially more lucrative opportunities are available.
The popularity of staking has surged since last spring. This followed a blockchain upgrade that enabled the withdrawal of staked Ether, mitigating the primary risk associated with staking. Currently, over 25% of circulating ETH is staked, with 38.1% using protocols like Lido and Rocket Pool. According to DefiLlama data, Ethereum has more than thirty liquid staking protocols.
Source: DeFillama
Many argue that it may not be long before most Ether is deposited into liquid staking protocols. Should this occur, liquid staking tokens such as stETH or rETH could replace Ether as the asset with the highest liquidity on Ethereum.
However, skeptics caution against this scenario. They compare it to the 2007 financial crisis, where layers of intermediaries obscured underlying risks.
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