One Year After Ethereum Merge: Energy Consumption Reduced by 99.9%, Liquid Staking Rises, ETH Enters Deflationary Era

Author: CoinDesk

Compiled by: Nick, Tuo Luo Finance

It has been over a year since Ethereum transitioned from PoW to PoS, a change known as "the Merge" that introduced the concept of "staking," a new way to add and approve transaction blocks on the blockchain.

In the PoW model, miners compete to add blocks by solving cryptographic puzzles. Now, in the PoS model, Ethereum validators stake 32 ETH on the network and are randomly selected to add blocks. In both models, if miners and validators' blocks are added to the blockchain, they receive some ETH token rewards.

By staking, Ethereum has significantly reduced the blockchain's environmental impact, but it still faces a series of challenges around centralization, censorship, and the potential exploitation of certain infrastructure intermediaries. Here are five major changes in the Ethereum ecosystem since the Merge a year ago.

Ethereum's Energy Consumption Decreased by 99.9%

The Merge fundamentally reformed the network's consensus mechanism, which the "decentralized" community of network operators uses to secure the network and process transactions. The old PoW (Proof of Work) model relied on an energy-intensive "mining" system, where network operators essentially competed to process blocks by consuming computational power.

The shift from crypto mining to staking is expected to greatly reduce Ethereum's energy consumption, completely eliminating the energy-intensive systems previously used to generate blocks and protect users.

Before the Merge, Ethereum's energy consumption was roughly equivalent to that of a small country, and its energy usage statistics were a major focus of criticism from early NFT and DeFi critics. According to the Cambridge Bitcoin Electricity Consumption Index, Bitcoin still uses PoW to power its network, consuming an amount of energy comparable to that of Singapore.

A year after the Merge, Ethereum's new emissions have sharply declined. The new proof-of-stake system consumes 99.9% less energy than the old mining system. Regardless of whether other aspects of this upgrade are successful or not, it is now difficult to associate Ethereum with environmental impact.

Staking Distribution Raises Centralization Concerns

In addition to criticism for its high energy costs, Ethereum's old consensus model was also criticized for concentrating power in the hands of a small number of cryptocurrency mining companies that had the funds, specialized hardware, and expertise to build large-scale mining facilities. Before the Merge, just three mining pools dominated most of Ethereum's hash power.

When Ethereum transitioned to PoS, the network abandoned mining in favor of staking. The hardware requirements and computational costs of PoW were eliminated, partly to allow more people to participate in the operation of the Ethereum network.

However, a year after the Merge, centralization remains one of the biggest challenges facing Ethereum. To stake on Ethereum, validators need to lock up 32 ETH in the network, which is about $50,000. These funds can earn stable interest, but if validators make mistakes or act dishonestly, these funds may be slashed. Setting up a validator node to stake on the network is a complex task, and improper setup can lead to economic penalties.

Due to the costs and technical barriers of establishing nodes, intermediary services have emerged. Companies like Coinbase and decentralized projects like Lido allow users to pool their ETH together to create the 32 ETH needed for a node. These intermediary entities take on much of the heavy lifting, taking ETH from users, staking on their behalf, and taking a portion of the rewards earned from operating validators.

Even before the Merge, some anti-PoS advocates were concerned that staking could increase Ethereum's level of centralization, meaning that a small number of these intermediaries could gain disproportionate control over which blocks are added to the network.

This situation seems to be unfolding, as the largest staking provider is the decentralized staking pool Lido. Lido accounts for 32.3% of the total staked ETH, raising concerns about centralization as it approaches the 33% threshold, which developers say could lead to security issues if surpassed.

MEV and Censorship

After the Merge, validators have successfully earned significant additional profits through a mechanism known as Maximum Extractable Value (MEV). Validators and builders can charge users fees by strategically inserting or reordering transactions before adding them to the network.

When MEV unexpectedly became a vehicle for centralization and censorship on the network, third parties intervened in an attempt to address the issue.

Ethereum development company Flashbots invented MEV-Boost, software that validators can run to mitigate the negative effects of MEV. However, Flashbots' solution to the MEV problem is controversial. While some believe MEV should be completely eradicated, Flashbots has intensified concerns about centralization by introducing MEV-Boost.

Currently, about 90% of blocks on Ethereum are produced through MEV-Boost, which optimizes how transactions are organized into blocks to maximize profits for validators.

The popularity of MEV-Boost has become a focal point of debate within the network. As mentioned earlier, MEV is seen by some as an unfair charge to users. Flashbots' central role in the Ethereum MEV market has been criticized, as most blocks built through Flashbots software are relayed or passed to validators by Flashbots itself.

This centralization is viewed by some as a potential medium for censorship. When the U.S. Treasury sanctioned certain Ethereum addresses associated with Tornado Cash, Flashbots stopped including these transactions in the blocks sent to validators. This move was met with opposition from Ethereum builders, who believe that the infrastructure layer occupied by Flashbots should be completely neutral to prevent the entire network from becoming akin to centralized payment processors like Visa.

Since the Merge, the Ethereum community has been working to reduce censorship by configuring MEV-Boost to use non-Flashbots relays. Currently, 17.3% of blocks rely on Flashbots relays to extract MEV, with the censorship rate dropping to 35%, a significant reversal from the 78% peak in November 2022.

Liquid Staking Tokens Have Dominated the ETH Market

Since the Merge, liquid staking has risen within the Ethereum ecosystem.

Anyone can earn rewards and participate in Ethereum's security system through staking, which involves locking ETH tokens in an address on the Ethereum blockchain to earn stable interest. However, there is a problem: once tokens are staked, they cannot be bought, sold, or used in DeFi (for example, as collateral for loans), limiting their appeal to investors looking to maximize returns on their investments.

Liquid staking services from third parties provide an alternative to traditional staking. Users staking through services like Lido can receive a derivative ETH token representing their staked assets instead of staking directly through Ethereum.

These liquid staking tokens, or "LSTs," earn interest just like normally staked ETH, but the difference is that LSTs can be traded. This is an extremely attractive investment for DeFi traders looking to participate in ETH staking. There is an additional benefit: LSTs mitigate staking risks for users without requiring them to lock up 32 ETH.

Before the Shapella upgrade in April 2023, stakers could not withdraw their staked ETH, so users initially turned to liquid staking to earn staking rewards without taking on the unknown risks of locked tokens. Once staked ETH could be withdrawn, a major risk for Ethereum was eliminated, but the additional value of Ethereum was lost. Some believe the liquid staking market may shrink in favor of traditional staking, but this has not been the case.

Currently, the liquid staking market is valued at nearly $20 billion and is rapidly growing. This is primarily due to the omnipresence of LSTs in DeFi and their easier accessibility compared to traditional staking. Lido's token, stETH, holds the largest share in the LST market, accounting for approximately 72.24%.

Net Supply of ETH Decreased

The Merge has brought some changes to the tokenomics of ETH.

Most notably, this upgrade has resulted in ETH experiencing "deflation" for the first time, meaning that the total supply of ETH is decreasing rather than increasing. The circulating supply of ETH has decreased by 0.24% compared to a year ago. The reduction in supply is partly due to EIP-1559, a network upgrade that occurred about a year before the Merge. After the EIP-1559 upgrade began, some ETH from each transaction on the network started to be "burned." However, it was not until the Merge further reduced the issuance rate of new ETH that net deflation of ETH occurred.

As the supply of ETH grew year over year, some investors worried that their holdings of ETH would depreciate over time. Some investors hope that deflation will help make ETH more valuable. So far, it is difficult to say whether this has occurred. In the months since the Ethereum Merge, the price of Ethereum has not changed much, and the impact of macroeconomic factors in the short term may be greater than the impact of changes in supply.