A Breakdown of Ethereum Supply Distribution Since Genesis
The distribution of supply on Ethereum has been a source of criticism and debate since the network's launch in 2015. This is primarily because roughly 50% of total ETH supply was issued through a premine ICO, as opposed to through the public process of proof-of-work (PoW) mining. Despite the controversies surrounding its initial distribution, however, over the last seven years, new coin issuances from PoW mining has succeeded in diluting ~68% of total premined supply, making Ethereum’s native token one of the most distributed, decentralized tokens next to Bitcoin in the entire crypto ecosystem. At an issuance rate of 2 ETH/block, it is estimated to take 5 years to fully dilute the 72 million premine supply under a PoW consensus protocol. However, Ethereum will soon transition away from PoW to a proof-of-stake (PoS) model with the forthcoming Merge upgrade. Under PoS, the issuance of ETH is expected to decline. This reports dives into the breakdown of Ethereum supply distribution today and examines the trends impacting ETH distribution on the network under PoW vs. PoS.
At genesis, roughly 72 million ETH was distributed to early project contributors and investors in Ethereum’s ICO. Since then, 49.1 million ETH has been newly issued and distributed through the process of proof-of-work mining.
According to on-chain data provider Nansen, 10.3 million ETH (41.7% of the premine supply) has been sent to exchanges since network genesis. Conversely, only 1.6 million ETH (~2.3% of the premine supply) ETH has been held unmoved over the same period.
Tracking Ethereum’s supply metrics by account type shows that the top 10 accounts by ETH balance are not typically controlled by individual users, but rather exchanges and smart contracts.
Ethereum’s PoS protocol Gasper is designed to encourage the decentralization of staked ETH supply through individual validator node operators. However, the implementation of Gasper so far has led to the majority of staked ETH being controlled by third-party staking providers such as Lido, Coinbase, and Kraken.
There are several solutions being worked on to ensure that the degree of decentralization that’s been achieved over the last seven years since the Ethereum’s ICO does not degrade post-Merge. These solutions include proposals to decentralize staked ETH supply through smart contract migration, increased competition, self-imposed fees, and distributed validator technology (DVT).
60% of Ethereum’s total supply was pre-allocated to users before the official launch of the network. This fact has long been a source of controversy and criticism against Ethereum. Critics claim that whenever a token’s initial distribution is decided through processes that take place before the public launch of the blockchain, that token distribution will generally have a higher potential of being taken advantage of by early investors and select insiders of the protocol. This can thereby also lead to the centralization of control and power on a public blockchain. These processes, which in general are called a “premine,” include activities such as initial coin offerings and pre-allocation of supply to early project contributors, decentralized autonomous organizations (DAOs), and foundations.
Considering the issuance of coins as the creation of value on a blockchain, a wide distribution of total supply at the launch of a network is indicative of an equal distribution of that value among network participants and stakeholders. Equality in a blockchain’s native token distribution is an important area of analysis when it comes to evaluating the decentralization and censorship-resistance of public blockchains. A wide distribution of ETH on the Ethereum blockchain, for example, suggests vested interests in the success of the network is shared among many participants as opposed to a few centralized stakeholders. On the other hand, an unequal distribution of ETH may be suggestive of a disproportionate amount of power or influence being held by a select group of insiders and/or early investors over a blockchain’s development and operation.
For years, the distribution of ETH on Ethereum became more decentralized over time through the repetition of market cycles, which at various points naturally applied sell pressure on early ETH holders. Decentralization of ETH supply was also spurred by the process of proof-of-work (PoW) mining, which gradually diluted the genesis supply through the issuance of new ETH. However, Ethereum core developers are now making final preparations to radically change the protocol of Ethereum in a forthcoming hard fork upgrade known as the Merge, raising questions about how these protocol changes will impact the distribution ETH on the network going forward. At its core, the Merge transitions Ethereum away from a PoW consensus protocol to a proof-of-stake (PoS) protocol for the purposes of reducing the total electricity consumption of the network by over 99%. (For more information about the motivations for the Merge upgrade, read this Galaxy Digital Research report.) The Merge is expected to activate on Ethereum sometime before the end of 2022.
Once Ethereum has transitioned fully to PoS, the network will directly support on-chain voting for progressing the blockchain and reaching network consensus. The ETH distribution of Ethereum will become a determining factor in evaluating which users can participate in and earn rewards from appending new blocks to the blockchain. The biggest ETH holders on Ethereum will be in the best position to profit after the Merge upgrade as their capital will be able to generate more capital on the network through the activity of staking. And in the case of liquid staking, the capital locked on Ethereum can be rehypothecated into other decentralized finance applications for additional interest. Some predict that the potential for ETH to remain concentrated to the largest ETH holders could be greater under a PoS consensus protocol than PoW because there are no significant operational costs associated with staking like there is with mining.
In addition, PoS creates formal mechanisms through which the ETH holdings of a user on-chain can be directly translated into influence over Ethereum’s consensus building process. This means an unequal distribution of total supply on Ethereum could have unintended consequences on the security of the network. Unlike 51% attacks, which require a majority of mining hash power to initiate, an attack that rewrites the history of the Ethereum blockchain would require a supermajority or two-thirds of staked ETH supply. As such, an investigation into the impacts of transitioning Ethereum from a PoW consensus protocol to a PoS on the network’s supply distribution dynamics is warranted in light of ongoing preparations being made by Ethereum core developers for activating the Merge upgrade.
In this report, we’ll investigate ETH supply through the lenses of several different on-chain metrics including top account balances, network distribution factor, supply equality ratio, and HODLwaves. We’ll also discuss the potential impacts of Ethereum’s transition to Gasper on the current distribution of ETH supply and what solutions are being researched to help distribute supply under PoS.
The Total Supply of ETH
According to blockchain explorer Etherscan, a total of 119,302,785.5 ETH has been issued into circulation since the launch of the Ethereum blockchain in July 2015. The number of coins that have been issued on-chain since genesis is referred to as the total supply of a blockchain. On Bitcoin, calculating and checking the total supply of the network is a simple task that any user running a node can complete. However, on Ethereum, determining the total supply often requires relying on a third-party data service provider. This is primarily because the rules around ETH issuance on Ethereum are complex. In addition to fixed mining rewards, there are rewards distributed to miners for uncle blocks. (Uncle blocks are created when miners have expended energy, also called hash power, to compute a block that does not ultimately make it into the canonical chain.) As of December 2020, a small part of Ethereum’s issuance has been generated on Ethereum’s proof-of-stake blockchain, known as the Beacon Chain. In addition, as of August 2021, a supply burning mechanism introduced by EIP 1559 has started to remove ETH from total supply. (Read more information about EIP 1559 in this Galaxy Digital Research report.)
As such, auditing Ethereum’s total supply is a resource-intensive and time-consuming activity that requires downloading the full chain history of the Ethereum blockchain, even the parts of it that are not part of the canonical history in the case of uncle blocks. It also requires auditing Ethereum’s proof-of-stake Beacon Chain, which is a separate blockchain issuing incremental amounts of ETH to validators. According to BitMex Research, running all the necessary software to track the total ETH balances of all accounts in Ethereum’s unpruned history generates several terabytes of data and takes multiple days to complete. Critics of Ethereum have often pointed to the lack of easy audibility around Ethereum’s total supply as evidence that the network relies too heavily on centralized third parties for accessing basic information about the state of the network. However, as argued by founder of Ethereum Vitalik Buterin, verifying total supply is not a core statistic that all blockchains need or by design can easily support. The verifiability of Bitcoin’s supply is core to supporting the asset’s investment thesis as a store of value with a rigid issuance schedule and supply cap. For Ethereum and its design as a smart contract blockchain, the lack of verifiability around total supply and frequently changing monetary policies do not undermine the network’s value but rather allow it to pursue a different use case.
A Snapshot of Ethereum Supply Dynamics Today
ETH has been issued on Ethereum in a variety of ways. The following chart breaks down the total supply of Ethereum by the type of distribution method through which the ETH was generated. There are four main distribution methods through which new coins have been allocated to users since the genesis of the Ethereum blockchain.
First, 60 million ETH, representing 50% of current total ETH supply, was distributed at the network’s genesis to participants in Ethereum’s initial coin offering (ICO). The ICO sale, which took place a year before Ethereum’s launch, sold coins to the general public at a ratio of 1 ETH:0.0005 BTC for the first 2 weeks and declined linearly to a rate of 1 ETH:0.0007479 BTC for the duration of the rest of the sale. The sale concluded on September 2, 2014 and ran in total for 42 days.
Second, 12,009,990.50 ETH, representing ~10% of current network supply, was also generated at genesis and set aside for early project contributors to Ethereum and the non-profit organization set up to oversee Ethereum development, known as the Ethereum Foundation (EF). These early contributors include Ethereum co-creator Vitalik Buterin, who allegedly received 553,000 ETH as compensation for his contributions. Other known early contributors to Ethereum include: Charles Hoskinson (founder of Cardano), Mihai Alisie (founder of Bitcoin Magazine), Anthony Di Iorio (founder of Decentral), Amir Chetrit, Gavin Wood (founder of Polkadot), Jeffrey Wilcke (founder of Grit Games), and Joseph Lubin (founder of Consensys). It is not known how much of the premine each of these early contributors received or what other individuals may have been considered part of the early contributors group. It has been reported that the 12 million ETH premine supply was split roughly in half between early contributors and the Foundation.
Third, 49.1 million ETH has been newly issued and distributed to miners through the network’s proof-of-work (PoW) consensus protocol, ethash, over the past seven years. Like Bitcoin, Ethereum miners receive newly minted issuance, along with certain transaction fees (see our reports on EIP-1559 for more detail on changes to fee compensation), as compensation for their efforts to process transactions and secure the network. However, unlike Bitcoin, Ethereum miners also receive newly minted issuance for uncle blocks, as explained in the prior section of this report. (As an aside, 2.4 million ETH, which is representative of 2% of total supply, has been taken out of circulation since the activation of EIP-1559 in August 2021.) Finally, 0.005% of ETH supply has been generated through the network’s proof-of-stake consensus protocol known as Gasper, which was activated on a separate blockchain called the Beacon Chain in December 2020.
The initial allocation of supply to ICO participants and early project contributors has been a recurring source of controversy that has shed doubt and incited criticism about the relative decentrality of the Ethereum network, especially as compared to Bitcoin. Critics note that the distribution of coins through processes that take place before the public launch of a cryptocurrency, also called a “premine,” can be manipulated more easily by a few select insiders and thereby lead to more centralization of network wealth than the process of PoW mining. An ICO or premine stands in contrast to a “fair launch,” in which a blockchain’s launch is announced publicly and all participants, including protocol founders, have an equal opportunity to participate in coin issuance from the start. (Notably, as we exhibited in the Initial Token Distribution section of our report Ready Layer One, blockchains that launched with a public ICO tend to have far wider supply distributions than more recently launched blockchains that raise funds through preferred sales to qualified participants or institutional investors).
It is reported that there were rules associated with the ICO to make equitable to all participants. For example, the Ethereum Foundation itself was not allowed to invest in the ICO given their pre-allocated cut of the premine. Early project contributors were also allegedly required to hold on to their ETH for a minimum of a year and could not own more than 12.5% of Ethereum’s 72 million genesis. However, ultimately, there was no way to enforce or verify that these rules were followed on-chain given the pseudonymity of the blockchain and the difficulty in identifying the ownership of accounts by individuals or entities.
According to data from Nansen, 100 of the 8,800 participating accounts received 40% of the ETH issued through the ICO. Some accounts may have bought into Ethereum’s ICO using separate Bitcoin addresses during the sale, including early project contributors who were already allocated a portion of 12m ETH from the pre-mine.
Concerns around the fairness of Ethereum’s premine and its impact on the network’s initial distribution of ETH supply was expected to decline over time as new issuances from mining would gradually dilute the network share of the premined supply. Initially, the block subsidy of Ethereum was set at 5 ETH per block between 2015 and 2017. At this rate, new issuances would have grown annually at a rate of 16.8% of the premined genesis supply and fully diluted the 72 million ETH supply within 6 years. However, the block subsidy on Ethereum has since decreased to 2 ETH/block due to the implementation of various Ethereum Improvement Proposals (“EIP”) impacting the network’s monetary policy over the years. At current rates, it would take an additional 5 years from June 2022 to fully dilute the 72m premine supply with newly issued ETH, assuming average block times of 13 seconds.
Looking ahead, Ethereum is set to transition away from a PoW consensus protocol in a hard fork upgrade before the end of the year. The upgrade, dubbed the Merge, will replace the network’s PoW algorithm, ethash, with a new proof-of-stake (PoS) model known as Gasper. (Read more about the Merge upgrade in this Galaxy Digital research report.) As a result of Gasper, new issuances on Ethereum are expected to decline. Instead of a fixed issuance of 2 ETH/block, Ethereum under PoS is expected to generate new ETH through a dynamically fluctuating interest rate. The interest rate is primarily based on the number of active validators each of which are required to stake 32 ETH on the network.
Factors impacting the interest rate on staked ETH deposits and therefore the network issuance rate include: the percentage of online validators, the churn rate, meaning the number of validators entering and exiting the network, and the total ETH staked on the network. At an estimated total of 15 million ETH staked on Ethereum long-term, with a zero percent churn rate and 100% network participation rate, it is expected to take over 50 years to dilute Ethereum’s premine supply of 72m ETH. Given that the breakdown of Ethereum’s supply types is expected to become more static (i.e. slower to change) post-Merge, it becomes of greater importance to consider how distributed Ethereum supply has become since genesis.
Who’s still HODLing?
The top recipient of Ethereum’s premine was the Ethereum Foundation (EF). Receiving close to 12m ETH from the premine, the Foundation is reported to have distributed half of that amount among 85 early project contributors, and set aside another 3m for roughly 50 Foundation employees as part of a “developer purchase program.” The EF is well-documented to have sold off large portions of the remaining 3m ETH from the 12m premine supply during market peaks in 2018 and 2021 for operational expenses. As of March 31, 2022, the Foundation controls $1.3bn worth of ETH or 0.297% of total ether supply. The EF is also documented to hold roughly $313m other crypto assets and non-crypto savings and investments.
The recipient that received the most amount of ETH from the ~6m ETH distributed to early project contributors was Ethereum co-founder Vitalik Buterin. It is reported that Buterin received 553,000 ETH from the portion of the premine dedicated to early project contributors. Seven other contributors allegedly received 300,000 ETH each, including Joseph Lubin, the founder of Ethereum venture capital studio, ConsenSys. It is difficult to verify these facts using on-chain data because the wallet addresses of most early project contributors are not known. It is also unknown what disbursement schedule was used to reward early contributors, given that some had loaned their funds to the EF at 25% to 50% interest.
On-chain data affirms multiple transactions were initiated between the known accounts of Buterin and the EF over the past seven years. However, these transactions do not show a lump sum payment of 553,000 ETH from the EF at any point in chain history. The four publicly identified accounts of Buterin depict that the Ethereum founder controls about 294,279 ETH in total today.
The ICO distributed 60 million ETH across 8,800 unique accounts. The top receiving address from the ICO received a total of 1m ETH. Outflows from this account reveals that the funds have dispersed through to several externally user owned accounts, centralized exchanges, and smart contracts. Most these flows converge around a tertiary account domain called “virternity.eth” which currently holds 854 ETH. The identity behind this account is not known.
The other top 2 accounts identified to have participated in Ethereum’s ICO each received 935,900 ETH and 933,580 ETH. Over 95% of these funds have since been transferred to centralized exchanges, meaning the funds have been moved off-chain and cannot be traced without further supporting evidence from exchanges themselves. The movement of funds to an exchange generally suggests the funds have been sold or traded. The following is a table of the top 10 receiving entities of ETH from Ethereum accounts that participated in the premine:
Aggregated on-chain data by Nansen shows about 10.3m ETH (41.7% of the premine supply) has been sent to exchanges since network genesis. Conversely, only 1.6m ETH (~2.3% of the premine supply) ETH has been held unmoved over the same period. This analysis suggests there were many investors in Ethereum’s ICO that sold within the first 3 years of the network’s launch. Despite 60% of total ETH supply having been issued through the network’s premine, on-chain data suggests the known balances of early ICO investors and project contributors have not retained much of that supply over the years through market fluctuations and the evolution of Ethereum’s decentralized application (dapp) ecosystem, although movement to centralized exchanges obfuscates some of these flows, as mentioned above.
Ethereum Supply from a Bird’s Eye
Ethereum’s HODLwaves chart, which tracks the duration of time before a coin was last moved or transacted with, also supports the conclusion that there has been a significant decline of ETH supply controlled by early investors and whales (i.e. addresses with > 1,000 ETH) since genesis. The following chart illustrates that more than 75% of the total ETH supply today has been transacted with and moved in the last three years.
The limitation of the HODLwaves metric is that it does not distinguish transfers between accounts owned by the same individual or entity. Concretely, if a user transfers funds from one account they control to another account they control, the coins appear to have moved even though the underlying ownership has not. As such, the analysis can only be viewed at best as a proxy for the distribution of coins among differing users and smart contract accounts over time.
In addition to tracking the lifespan of coins, on-chain data can also be used to compare the simple distribution of coins across all Ethereum accounts. The chart below illustrates how most of the total ETH supply remains held in whale accounts with a balance of >1,000 ETH. However, that percentage has declined from 98% to less than 80% today, which is a positive trend marking the growing proportion of ETH supply held in accounts with smaller balances.
The supply equality ratio (SER) developed by Coin Metrics is another on-chain metric that shows the growth of ETH supply distribution to accounts with smaller balances. SER is calculated by dividing the cumulative supply held in accounts (or address) with a balance of less than one ten millionth of total supply by the cumulative supply held by the top one percent of accounts by balance. Since May 2019, Ethereum’s SER has increased from 0.03 to 0.055, indicating increases in supply dispersion over that time. By comparison, Bitcoin’s SER, which has consistently ranked higher than Ethereum’s SER, has also grown from 0.075 to 0.088 over the same period.
One other on-chain metric that also illustrates an improving distribution of supply away from large entities is the network distribution factor (NDF). NDF is calculated by aggregating the supply held in accounts holding more than 0.01% of total supply and dividing that figure by the total circulating supply. The higher the NDF, the more concentrated coin supply is to accounts holding at least 0.01% of total supply. Ethereum’s NDF has declined since 2015 from above 0.85 to now below 0.65. However, there has been an uptick in supply concentration since December 2020, which was when the Ethereum’s proof-of-stake blockchain the Beacon Chain was launched.
This uptick in NDF around the time of the Beacon Chain contract launch and the persistently high percentage of supply still locked among whale accounts trending at just below 80% can both be misleading figures. Deeper analysis of Ethereum’s on-chain metrics shows that the biggest whales on Ethereum are not accounts controlled by a single individual or entity. Tracking Ethereum’s supply metrics by account type shows that the top 10 accounts by ETH balance are not technically users, but rather exchanges and smart contracts.
Since 2015, the development and adoption of the network has led to a significant growth in the amount of ETH locked up in smart contracts, where it currently stands at an all-time high of 31.2m ETH or 26% of the supply. In contrast, the percentage of supply held on exchanges has been rapidly declining and is trending at multi-year lows. This is indicative of growing confidence in Ethereum’s dapp ecosystem and the adoption of ETH as the fuel to power dapps.
To be clear, the majority of total ETH supply, roughly 74 million ETH, is still held in externally owned accounts (EOAs) operated by pseudonymous users and entities, rather than smart contracts and exchanges. However, the accounts with the largest balance, that is the highest concentration of wealth, on Ethereum are not usually EOAs. Five out of the top 10 accounts on Ethereum holding the largest amount of ETH are smart contracts. This data disproves the assumption that the wealthiest accounts on Ethereum are owned and operated by early investors or protocol founders. On the contrary, the wealthiest accounts on Ethereum are operated by centralized and decentralized applications (dapps) holding ETH on behalf of thousands of individual users. It is still possible that certain users and entities may own extremely large quantities of ETH across different EOAs, exchanges, and dapps. However, this is difficult to prove or track using on-chain data given the pseudonymity of Ethereum accounts and the fact that some transaction activity occurs off-chain on centralized exchanges.
*Data as of May 24, 2022. The 6th account on this list has been identified by data provider Nansen to be an account controlled by cryptocurrency exchange Binance.
The top account by ETH balance is the Ethereum 2.0 Deposit Contract, which holds over 10% of total ETH supply. The Ethereum 2.0 Deposit Contract is a one-way bridge for spinning up validators on Ethereum’s proof-of-stake (PoS) blockchain, the Beacon Chain. To create a validator on the Beacon Chain and earn staking rewards, a user must deposit of 32 ETH into this contract. Other smart contract accounts within the top 10 accounts by ETH balance include decentralized lending protocol Compound and Layer-2 bridge Arbitrum. Half of the accounts in the top 10 belong to centralized exchanges. Only one account in the top 10 appears to be unidentified and externally operated by either an individual or entity: the address with the ENS domain “sendmesomeethplease.eth”. Transaction activity from this account suggests it could be an account managed by a large market maker or trading entity.
On-chain metrics aggregating the distribution of supply by balance and time held both suggest that Ethereum as a PoW protocol has been trending towards wider levels of supply distribution over the past seven years. The analysis also suggests that the amount of supply controlled and operated by decentralized smart contracts has also grown significantly over time, surpassing by some metrics even the amount of supply controlled by centralized exchanges. Looking ahead, not all known whale accounts on Ethereum are guaranteed to convert their holdings of ETH into stake post-Merge. Even under PoS, it is likely that market fluctuations will continue to trigger selling activity by ETH holders, small and large alike, which will still be a force encouraging the distribution the supply of ETH over time.
Risks of Supply Centralization Under PoS
Despite improvements in the distribution of ETH supply since genesis, there remains risks of supply centralization on Ethereum post-Merge as a result of third-party staking services. As mentioned in the analysis above, the largest account on Ethereum by balance is the Ethereum 2.0 Deposit Contract. To activate a validator on Ethereum’s PoS blockchain, also called the Beacon Chain, 32 ETH must be locked into the Deposit Contract through a user interface known as the Ethereum Launchpad. This process of activating a validator will not change post-Merge. Individual stakers and staking providers spinning up their own infrastructure for running a validator will need to use the Ethereum Launchpad and deposit 32 ETH into the Deposit Contract. As such, the ETH supply locked in the Deposit Contract is likely to continue growing the closer core developers become to activating the Merge, especially given that after the Merge staked ETH withdrawals will still not be enabled and returns for operating a validator will be higher due to the addition of rewards from priority fees and maximal extractable value.
Once Ethereum transitions away fully from PoW to a PoS consensus protocol, the security of the blockchain will depend largely on the total amount of ETH deposited into the Deposit Contract and staked on the Beacon Chain. Higher amounts of ETH staked leads to higher issuance rates in general but a lower APR for individual validators. Therefore, the financial incentive for users to stake their ETH declines as the total amount of ETH staked increases. The opposite is true during periods of declining total ETH staked on the network. Given that a constantly high level of ETH staked is imperative for the security of Ethereum as a PoS blockchain, it is also equally important that staked supply on the network is controlled by a diverse and distributed number of users. Unlike the accessibility of mining on Ethereum, which is primarily limited by the available supply of GPU drivers, accessibility to staking is primarily restricted by the minimum stake requirement of 32 ETH (~$64k). As such, staking may exclude smaller retail users, leaving control of the network in the hands of larger, wealthier accounts that are prone to concentration and centralization over time. Said another way, in PoS, capital controls consensus, and it’s easier for capital to congregate and consolidate than for mining machines to centralize under one location.
As background, the Beacon Chain does not natively support stake delegation, which means that users must either operate their own hardware and software to stake their ETH or trust a centralized intermediary to manage their staked ETH for them. This design decision to not permit stake delegations was intended to encourage tech-savvy individuals to stake on their own instead of relinquishing control of their funds to a third-party. The greater the number of validators owned by individuals, the more decentralized and censorship resistant Ethereum becomes. Since the launch of the Beacon Chain in December 2020, nearly 400,000 active validators have joined the network.
(As an aside, a validator on the Beacon Chain is not equivalent to a validator on other major proof-of-stake blockchains such as Avalanche or Solana. A single user or staking provider on Ethereum can run thousands of validators concurrently on a single server. While on other PoS protocols, the number of validators can be equated to the number of full nodes operating on the network, the number of active validators on Ethereum should be confused with the number of computer devices running Ethereum client software.)
So far, the majority of users staking on Ethereum’s Beacon Chain have opted for simpler options of staking that require minimal technical knowledge of the protocol. Trusted third parties including centralized exchanges persist despite the lack of native support for stake delegation. Just over 20% of total ETH staked on Ethereum is controlled by cryptocurrency exchanges Coinbase, Kraken, and Binance.
The liquid staking market
The single largest controlling entity of staked ETH is liquid staking protocol Lido Finance. One of the primary reasons why Lido is beating out centralized exchanges and other staking provider platforms when it comes to the delegation of users’ stake is because the protocol issues the most liquid staking derivative token traded on Ethereum today. As a liquid staking protocol, Lido has the added benefit of offering users who stake with their platform a liquid staking derivative token, stETH, which represents the underlying staked ETH locked in the Beacon Chain. stETH can be used within other DeFi apps on Ethereum for earning additional yield.
Though there are other liquid staking protocols live on Ethereum, none have amassed as many staked ETH deposits as Lido has. Lido retains its dominance in terms of liquid staking market share because it was one of the earliest protocols to launch on the Beacon Chain and has become the most capital efficient for node operators to participate in today. Vetted node operators by Lido earn rewards for operating validators and managing stake exclusively on users’ behalf. In contrast, Rocketpool, a competing liquid staking protocol, requires node operators to stake half of the initial 32 ETH deposit from their own personal funds. Rocketpool node operators only rely on the pool of ETH committed by Rocketpool users for the other 16 ETH. This ensures that Rocketpool node operators have skin in the game and their own wealth to lose if a validator is mismanaged and staked funds are slashed.
As such, the growth of the Rocketpool protocol is limited by the number of node operators that can post up 16 ETH, worth roughly $28,800 at the time of writing. In other words, the number of users staking on Rocketpool can only scale and increase in proportion to the amount of ETH staked by node operators. This is not the case in Lido where node operators have free rein to continue to spin up as many validators as there is increments of 32 ETH staked by users into the protocol. That said, Rocketpool differentiates its liquid staking protocol as a fully decentralized alternative to Lido that allows users to stake their ETH exclusively through smart contracts. For users and node operators who want to support the decentralization of Ethereum, Rocketpool is an attractive alternative.
In addition, there are other liquid staking protocols being built for the target audience of institutions and regulated entities that are required to collect information about their counterparties. Liquid staking protocol Alluvial is currently building a protocol with support from Coinbase and staking service Figment to become the institutional and enterprise-grade version of Lido.The success of Alluvial will depend heavily on how much staked ETH liquidity the protocol can amass through partnerships with centralized exchanges and staking providers. At present, Lido’s stETH token represents over 90% of total ETH deposits into liquid staking protocols on Ethereum. As such, it is by far the most liquid ETH staking derivative token and the most rewarding for users to hold. Alluvial’s staked ETH derivative product will not be able to compete with stETH unless it can achieve similar levels of market acceptance and liquidity. While Alluvial has the advantage of catering to an audience of deep-pocketed institutions and professional investors, the protocol may struggle initially to create a competitive use case for its liquid staking derivative token over that of Lido’s widely used stETH token.
Potential Solutions to Decentralize Stake
The massive amount of stake controlled by Lido is a growing risk factor to the network, especially given that parts of Lido’s operations remain centralized and therefore can be targeted as an attack vector or potentially censored by government authorities. Mitigating Lido’s dominance over time is an important initiative for distributing Ethereum’s staking infrastructure so that the network’s security as PoS protocol is not reliant on a single provider. To this end, increased competition from liquid staking alternatives such as Alluvial and Rocketpool is viewed as a positive trend that could materially improve the distribution of staked ETH supply over the long-term.
However, as pointed out by Ethereum Foundation researcher and developer Danny Ryan, the liquid staking market on Ethereum is predisposed to become monopolized by a single protocol if that protocol controls more than 1/3 of total ETH staked. This is because past the threshold of 1/3, and in excess of ½ or even 2/3 of total ETH staked, a liquid staking protocol like Lido can achieve outsized profits for its users compared to other competing protocols through coordinated strategies for MEV extraction, block-timing manipulation, and transaction censorship. Given that Lido already controls almost 1/3 of total ETH staked on Ethereum, the concern that new users staking on the Beacon Chain could be financially disincentivized from using other staking protocols is an immediate rather than hypothetical concern in the minds of Ethereum core developers.
As such, there are several research and development initiatives being proposed by core developers and community members alike to address the issue of stake centralization on Ethereum. One proposal by Ethereum Foundation researcher Justin Drake suggests the creation of a liquid staking derivative token called LSD that is natively supported by the Ethereum protocol. Independent node operators running their own validators as opposed to that of other users’ could then be able to enjoy the same benefits as that of users on Lido and receive a staked ETH derivative token that can be re-hypothecated for additional yield. This set-up for creating LSD would circumvent the need for validator node operators to rely on third-party protocols such as Lido for liquid staking and thereby improve Ethereum’s decentralization ethos.
Drake’s proposal if implemented would be a major code change to the Ethereum PoS protocol and design. Given that the Merge upgrade has not yet been activated and there are a series of other pressing, high-priority Ethereum Improvement Proposals (EIPs) already slated for activation in the hard fork immediately following the Merge, it is unlikely that a protocol-supported liquid staking token becomes supported in Ethereum’s near future. Drake’s proposal will likely be discussed and debated within the Ethereum community over the next 12 months and modified as the research behind how to support the decentralization of stake on Ethereum continues to develop.
In the meanwhile, Lido is actively working towards migrating all operations fully to smart contracts. In particular, the Lido developer team is focusing on ways to make their node operator onboarding process, which currently requires vetting by LDO governance token holders, a permissionless process. Rocketpool, which is already operating exclusively through unstoppable code on Ethereum, is also looking at ways to potentially remove its 16 ETH requirement from node operators in order to scale their operations more efficiently to compete with that of its more centralized counterparts. As positive as these efforts are from liquid staking protocols at present, the incentives and business models of third-party staking providers may not always align with the values of the broader Ethereum ecosystem. Some degree of trust in the Lido protocol to not backslide on their commitment to users and the decentralization ethos of Ethereum is being actively exercised by core developers in the short-term until more robust solutions can be implemented for preventing the centralization of staked ETH.
Some members of the Ethereum community have been advocating for even greater altruistic behavior by the top staking protocols in the form of self-imposed staked ETH deposit caps and increases of user fees. For example, if a staking provider such as Lido controls more than 15% of total ETH staked, the thinking is that the provider should keep increasing their fees on users until their share of the staking market falls back below 15%. While such goodwill behavior may seem laughable at first for a permissionless protocol, mining pools have already adopted a similar approach to tackling maximal extractable value on Ethereum. The largest Ethereum mining pool by hashpower, Ethermine, has publicly tweeted about refraining from MEV opportunities that do not align with the “ethos” of the Ethereum community out of support for the longevity and security of the network. (Read this Galaxy Digital Research report for more information about MEV.)
Finally, there is also active research into distributed validator technology (DVT), which enables the operations of a validator to be split up between multiple node operators. This would primarily help increase the distribution of stake infrastructure on Ethereum and in doing so the resiliency of the network from geographically targeted attacks or downtime. . Normally, a staking provider will delegate increments of 32 ETH each representing an Ethereum validator to a single node operator. In the event of a technical failure of that node, the delegated staked would be penalized. Through DVT, which splits up the keys required to operate a validator among multiple nodes, the risks of a technical failure are shared among more than one node improving the resiliency of Ethereum’s staking infrastructure and in turn the distribution of staked ETH supply.
Although Ethereum had a significant portion of its supply issued to contributors and insiders upon its launch, over the past 7 years Ethereum’s supply has become an increasingly more distributed network due to selling by original holders and the distribution mechanism of Proof of Work, which has helped to dilute the power of holdings controlled by large whales and early investors. However, with Ethereum expected to transition into a PoS protocol before the end of the year, the current distribution of supply becomes even more important to examine because it will become the main criteria determining which stakeholders are eligible to earn new network issuance post-Merge, as well as which entities can use pure capital to exert control over the network’s block production and consensus.
Instead of miners, validators, which are entities staking increments of 32 ETH, will take over the block production and verification of the network after the Merge upgrade. As such, the decentralization of supply, and more specifically staking supply, will become imperative to the censorship-resistant and security of Ethereum over the long-term. To that end, an early analysis of stake distribution on Ethereum evidences a high degree of concentration to liquid staking protocol Lido.
Lido, in addition to core developers and several other staking protocols, is actively researching and developing new technology to support the decentralization of staked ETH in permissionless ways. Part of this research centers around DVT, which is intended to significantly enhance the resiliency of any Ethereum staking node infrastructure. Given that decentralization is the defining characteristic of Ethereum over other Layer-1 protocols, it is imperative to the intrinsic value of ETH and the future of the network to preserve and continue to improve supply distribution dynamics.