Cryptocurrency18.09.2023

Ethereum’s successful Merge could bog down network

One year after one of the most talked about software upgrades since the Y2K changeover more than two decades ago, crypto’s most important commercial highway risks becoming a victim of its own success.

The revamp of the Ethereum network, which was known as the Merge, turned out to be a seamless transition to a more energy-efficient system of ordering transactions on the blockchain.

One of the incentives offered to participants is the ability to earn a yield on tokens used to help the network run.

Surging demand for the so-called staking feature has now raised the prospect of the network bogging itself down.

As part of the staking process, the Ether tokens that underpin the network are “locked up” in digital wallets to help order transactions and to earn the yield.

Already about 20% of all Ether in circulation, valued at about $41.5 billion, has been staked, according to data tracker Staking Rewards.

If the current pace continues, that amount would balloon to 50% by May and 100% by December 2024, according to a paper whose two authors include Tim Beiko, who coordinates Ethereum developers.

What’s driving the demand is that staking has emerged as one of a few reliable ways to earn returns in crypto.

Most token prices are still less than half the record highs reached in late 2021. Ether owners can currently earn a yield of around 4% by staking.

“We all like up-only, but not when the safety of Ethereum is at stake,” the paper’s other author, who goes by Dapplion, said on X, the social platform formally known as Twitter.

The worst-case scenario is that there won’t be any Ether available to actually make transactions on the network.

At a minimum, it increases the strain on the part of the network used to order transactions.

That’s why Ethereum developers are working to slow the staking influx down.

On 14 September, the developers agreed to cap the number of new validators, which operate the staking wallets, allowed to join the network every six minutes.

The change will be tagged onto the next major Ethereum software upgrade later this year.

With the so-called churn change, Ethereum won’t reach the theoretical point of 100% of all circulating Ether being staked for several years, according to the paper.

“We want to slow it down a bit to buy us some time,” Matt Nelson, a product manager at Ethereum infrastructure builder Consensys, said in an interview.

The respite will allow developers to figure out longer-term solutions.

With staking achieving “unprecedented success, beyond the original intended targets of stake rate,” the paper said, developers may look at adjusting validator rewards “to discourage staking past a certain point.”

Most people don’t stake their Ether — and act as validators — directly.

Instead, they give their tokens to various services, operated by the likes of Kraken, Lido and Coinbase Global Inc., which pool the tokens and share in the rewards.

Lido, which issues Ether holders another token they can trade on exchanges while their coins are staked, has about a 33% market share, according to data service Dune.

“A knock-on effect is that it enshrines current staking providers,” said Jim McDonald, chief technology officer at Attestant, one of the largest Ethereum staking providers.

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