Key points to remember
- The Ethereum community wonders if big validators might end up being forced to censor transactions after the merger.
- Ethereum creator Vitalik Buterin believes censoring transactions would amount to an attack on the network.
- Some Ethereum projects have already started blacklisting sanctioned addresses.
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As the upgrade to Proof-of-Stake rapidly approaches, the Ethereum community is wondering if the recent sanctions against Tornado Cash could end up endangering the blockchain itself.
Merge Hype Eclipsed by Tornado Cash
The Ethereum community is concerned about censorship.
There is only one month left before Ethereum transitions from its Proof-of-Work consensus mechanism to Proof-of-Stake. The transition, colloquially known in the crypto space as the “merger,” is expected to reduce network power consumption by 99% and reduce token issuance rates by 90%. Delayed multiple times in the past, the highly anticipated upgrade seems defined will take place next month on September 15.
However, the recent decision by the US Treasury’s Office of Foreign Assets Control (OFAC) to to add popular privacy protocol Tornado Cash to its sanctions list, claiming the app was primarily a money laundering vehicle for cybercriminals. This decision is unprecedented as it is the first time that a piece of open source code has been added to a sanctions list. Following the decision, Dutch authorities arrested a Tornado Cash developer as part of a separate privacy protocol investigation.
Upon news of the Tornado Cash ban, several companies such as stablecoin issuer Circle, software release management platform Github, and Ethereum infrastructure provider Infura quickly complied with the sanctions, blacklist of Ethereum addresses affiliated with Tornado Cash listed in the OFAC statement. The Tornado Cash case sets a disturbing precedent, and now the crypto community is deeply concerned that centralized entities running Ethereum Proof-of-Stake validators will be forced, in the future, to censor transactions on the Ethereum blockchain itself. .
Ethereum vulnerability to censorship
The crux of the matter is that once Ethereum upgrades, it will no longer rely on proof-of-work miners to build consensus, but on proof-of-stake validators. Instead of expending energy creating new blocks like miners do, these validators have to stake ETH tokens. While each validator needs 32 staked ETH to operate, a single entity can run multiple validators, increasing their influence on the network. And like Noted per DXdao contributor Eylon Aviv, five of the six largest validating entities would most likely be required to comply with OFAC regulations.
Aviv named crypto exchanges Coinbase and Kraken, staking services Staked and Lido, and crypto services provider Bitcoin Suisse as entities that would likely be forced to censor transactions on Ethereum. “I kind of believe Coinbase will find a way to make sure they don’t validate a block with Tornado [transactions]“, he said, before adding:
“While 66% of validators will not sign specific blocks, block builders / relayers who offer blocks with sanctioned [transactions] are less likely to be included, which means that these block builders will lose money, which makes the inclusion of such [transactions] economically viable “.
In response to these concerns, several community members pointed to the slashing system built into Ethereum’s upcoming Proof-of-Stake consensus mechanism. As the creator of Ethereum, Vitalik Buterin Explain in a 2018 tweet: “If a 51% coalition starts censoring blocks, other validators and clients can detect that it’s happening, and use the 99% fault-tolerant consensus to agree that it’s happening and coordinate a minority fork.
In other words, if the larger validators decide to censor transactions, the rest of the Ethereum validator community, even if in the minority, has the opportunity to destroy the funds of the censor validators.
OFAC compliance as censorship
The possibility of slashing the funds of major validators gives way to another question: Should compliance with OFAC regulations be considered an attack on Ethereum itself?
Swedish bitcoin lawyer Eric Wall seems to think so. “Ethereum cannot comply with all nations’ censorship requirements at the validator level,” he said. declared. “Zero censorship is the only neutral option for global consensus.”
Wall asked in a poll on whether the Ethereum community should burn the bet of major validators attempting to comply with OFAC sanctions. Of the 9,584 Twitter users who took part, 61.2% were in favor and 9.3% against (with 29.5% asking to see the results). Vitalik Buterin also weighed in, indicating in a comment that he was among those voting yes.
However, large validators who have already integrated ETH into the beacon chain may find themselves with few options. After the merger, staked ETH will remain locked until 2023, which means that validators will not be able to withdraw their staked funds from the Ethereum network even if they wanted to avoid censoring transactions according to OFAC regulations.
One option they have is to “go out voluntarilyby purely and simply ceasing to carry out their functions as validator. By doing so, they would not be able to join the network or access their ETH until withdrawals were enabled. Worse still, they could potentially be hit with an inactivity fee worth 50% of their stake.
When asked on Twitter if Coinbase would rather censor transactions or shut down its validators, CEO Brian Armstrong replied:
“It is a hypothesis that we hope not to be confronted with. But if we did, we’d go with it [shutting down] I think. I have to focus on the big picture. There may be a better option (C) or a legal challenge that could help achieve a better outcome.
Still, stuck between a rock and a hard place, Coinbase and other validators may end up choosing to hard-fork to save their funds, Spacemesh developer Lane Rettig believes. This would result in two different Ethereum Proof-of-Stake chains: one OFAC-compliant, the other permissionless. “It’s possible the OFAC-compliant fork will win,” Rettig said. “It would totally change the landscape of Ethereum, because it’s very likely that stablecoins, asset-backed things, and a lot of [decentralized finance protocols] wouldn’t be able to track the non-compliant fork.
Ethereum’s Hard Road Ahead
Beyond the issue of Ethereum’s consensus mechanism, some crypto projects in the ecosystem have decided to preemptively ensure that they are OFAC compliant. TRM Labs has already spear a wallet filtering service that allows decentralized finance (DeFi) protocol interfaces to block sanctioned addresses, or those that have been the counterparty of sanctioned addresses. The decision was criticized by the wider crypto community.
“Hackers don’t use your interface,” Banteg, Lead Developer at Yearn.Finance declared. “You can only block legitimate users. TRM played you absolute fools. Banteg then shared a post from a DeFi hack victim describing his inability to access his funds on the DeFi Aave lending protocol because a direct transfer had already taken place between his wallet and a sanctioned wallet – the transfer being a hack in which he lost $200,000.
Flashbots, an organization that helps Ethereum mitigate the drawbacks of on-chain price arbitrage, has also noted it would be a blacklist of OFAC-sanctioned addresses, prompting calls for validators to use a different relay. Flashbots responded to criticism by making their own relay code open source.
As the merger deadline draws closer with each block, the uncertainty surrounding the ecosystem’s fate seems heavy to some. “[Ethereum] had a job – A JOB: censorship resistance,” says rettig. “It’s ONE THING that makes all the pain worthwhile: all the loathsome, slow, and painful theater of decentralization. If you can’t do this one thing, then there’s no point and we should all pack up and go home.
Disclosure: At the time of writing this article, the author of this article owned ETH and several other cryptocurrencies.