After the merge, will Ethereum be censorable?

The Ethereum community is currently arguing whether or not the recent sanctions on Tornado Cash may end up putting the blockchain itself in peril as the Proof-of-Stake upgrade draws ever closer.

The Hype of Merge Is Obscured by the Cash of Tornado

The community surrounding Ethereum is concerned about the possibility of censorship.

There is only one more month left until Ethereum makes the transition from its Proof-of-Work consensus process to its Proof-of-Stake mechanism. It is anticipated that the shift, which is often referred to in the cryptocurrency industry as the “Merge,” will cut the network’s consumption of energy by 99% and cut token emission rates by 90%. The much awaited upgrade has been pushed back numerous times in the past, but it now appears that it will take place on September 15 of the following month.

The recent decision made by the Office of Foreign Assets Control (OFAC) of the United States Treasury to add the well-known privacy protocol Tornado Cash to its sanctions list deflated the community’s enthusiasm. The OFAC stated that the app was primarily used as a means of money laundering by online criminals. This action has never been done before, as it marks the first time that a piece of open-source code has been included on a list of prohibited items. The move was followed by the arrest of a Tornado Cash developer by Dutch authorities in connection with a separate probe into the privacy protocol.

Immediately after hearing about the prohibition on the use of Tornado Cash, a number of businesses, including the stablecoin issuer Circle, the software version management platform Github, and the Ethereum infrastructure provider Infura, swiftly complied with the sanctions by blacklisting Tornado Cash-affiliated Ethereum addresses that were included in the OFAC statement. The Tornado Cash case establishes a troubling precedent, and now the cryptocurrency community is deeply concerned that centralized entities running Ethereum Proof-of-Stake validators may be forced in the future to censor transactions on the Ethereum blockchain itself. These fears are fueled by the fact that the Tornado Cash case has set a precedent that is worrisome.

The Exposure of Ethereum to the Risk of Censorship

The crucial point is that once Ethereum is upgraded, it will no longer rely on miners using Proof-of-Work to reach consensus; rather, it will rely on validators using Proof-of-Stake. This is the essence of the matter. These validators are required to stake ETH tokens rather than using their computing power to create new blocks, as is the case with miners. Even though the operation of each validator requires 32 ETH to be staked, a single entity can run numerous validators, which will increase that entity’s control over the network. In addition, according to the observations made by a contributor to DXdao named Eylon Aviv, five of the six major validating firms would most likely be required to comply with OFAC standards.

Depositors for the Beacon Chain Source: Hildobby on Twitter

Aviv mentioned the cryptocurrency exchanges Coinbase and Kraken, the staking services Staked and Lido, and the cryptocurrency service provider Bitcoin Suisse as examples of businesses that might be compelled to censor transactions on the Ethereum network. Before adding the following, he stated, “I somehow believe Coinbase will find a means to make sure that it doesn’t verify a block with Tornado [transactions],” which is an excerpt from his original statement.

“Block builders / relayers who propose blocks with sanctioned [transactions] are less likely to be included if 66% of the validators will not sign specific blocks. This means that these block builders will lose money, which makes the inclusion of such [transactions] economically unviable.”

In response to these worries, a number of community members pointed to the slashing system that will be integrated in the Proof-of-Stake consensus mechanism that Ethereum will implement in the near future. In a tweet published in 2018, Ethereum’s creator Vitalik Buterin provided the following explanation: “if a 51% coalition starts censoring blocks, other validators and clients can detect that this is happening, and use the 99% fault tolerant consensus to agree that this is happening, and coordinate a minority fork.”

To put it another way, in the event that the validators with the most votes choose to censor transactions, the remainder of the Ethereum validator community, even if they are in the minority, have the option of stealing the funds of the censoring validators.

As a Form of Censorship, OFAC Compliance

Another dilemma arises as a result of the prospect of cutting major validators’ funds: should compliance with OFAC requirements be considered an attack on Ethereum itself?

Eric Wall, a Bitcoin enthusiast from Sweden, appears to hold this view. According to his statement, “Ethereum cannot comply with all nations’ censorship demands at the validator level.” “The only non-biased choice for reaching a global consensus is complete absence of censorship.”

Wall posed the question to the Ethereum community in the form of a poll, “Should the Ethereum community burn the stake of significant validators trying to comply with OFAC sanctions?” Among the 9,584 people who took part in the poll on Twitter, 61.2% of respondents supported the motion, while 9.3% opposed it (and 29.5% demanded to see the results). Vitalik Buterin has added his two cents to the discussion as well, stating in a comment that he is among those voting yes.

On the other hand, major validators who have already deposited ETH into the beacon chain might not have many options available to them. If validators wanted to avoid censoring transactions in accordance with OFAC regulations after the Merge, they would not be able to withdraw their staked funds from the Ethereum network because staked ETH will remain locked until 2023. This means that validators will not be able to withdraw their staked funds from the Ethereum network.

They can “voluntarily exit” the position by merely ceasing to complete the tasks associated with being a validator. This is an option available to them. If they did this, it would prevent them from rejoining the network and would also prevent them from accessing their ETH until withdrawals were enabled. Even worse, there is a possibility that they will be required to pay inactivity costs equal to fifty percent of their ownership.

Brian Armstrong, CEO of Coinbase, responded on Twitter to a question about whether the company would prefer to censor transactions or shut down its validators with the following:

“It’s a hypothetical situation that, God willing, we won’t actually have to deal with. If we did, though, I believe that we would choose to [close down]. You have to keep your eye on the big picture. It’s possible that there’s a better option out there (C), or even a legal challenge, that could contribute to a more favorable outcome.

However, since they are caught between a rock and a hard place, Coinbase and other validators may ultimately decide to hard-fork in order to safeguard their assets, according to the beliefs of the developer of Spacemesh, Lane Rettig. This would result in two distinct Proof-of-Stake chains for Ethereum: one that complies with OFAC regulations, and the other that operates without permission. According to Rettig’s statement, “it’s feasible that the OFAC-compliant fork would win.” “It’s quite possible that stablecoins, asset-backed items, and a lot of [decentralized financial protocols] would not be able to follow the non-compliant fork, which would completely transform the landscape of Ethereum,” said one expert. “It would completely alter the current state of affairs.”

The Challenging Road Ahead for Ethereum

Aside from the debate around Ethereum’s consensus process, certain cryptocurrency initiatives within the ecosystem have made the decision to proactively ensure that they are in compliance with OFAC regulations. A wallet screening service that enables frontends for decentralized finance (DeFi) protocols to prohibit sanctioned addresses or addresses that have been the counterparty of sanctioned addresses has already been deployed by TRM Labs. The decision has been met with disapproval from members of the wider cryptocurrency community.

The lead developer for Yearn.Finance, banteg, made this statement: “Hackers do not use your frontend.” “You are only able to block users who are legitimate. TRM has manipulated you into believing something that is not true. Banteg later shared an article that was written by a DeFi hacking victim. The article described how the victim was unable to access his funds on the DeFi lending protocol Aave because there had been a direct transfer between his wallet and a sanctioned wallet in the past. The transfer was a hack, and the victim lost $200,000 as a result of the hack.

In addition, Flashbots, an organization that assists Ethereum in mitigating the negative effects of on-chain price arbitrage, has suggested that it will be blacklisting addresses that have been sanctioned by OFAC. This has led to requests for validators to switch to a new relay. In response to the criticism, Flashbots made the source code for their own relay available to the public.

Some people are finding it difficult to cope with the weight of uncertainty around the future of the ecosystem as the Merge deadline draws closer with each passing block. According to Rettig, “[Ethereum] had one job—I repeat, ONE JOB: censorship resistance.” “It is the ONE THING that makes all of the suffering worthwhile: all of the annoying, slow, agonizing decentralization theater. If you are unable to complete that one task, then there is no point in continuing with any of this, and we should all just pack up our belongings and leave.”

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