IOSG: Is Economic Security a Meme?

Author: Danny Huang, IOSG Ventures

On June 3, Solana founder Anatoly and Ethereum Foundation researcher Justin mentioned economic security issues in a debate organized by Bankless, where Toly argued that economic security is a meme, sparking discussions among many bilateral KOLs.

The overall discussion was somewhat fragmented, so we will start from Toly's perspective and provide a simple整理 and analysis.

1. Toly's Logic

• Due to the existence of centralized staking services, the cost of acquiring 33% of nodes to launch an attack is far less than the actual staking value.

• POS chains with minimal staking economics have never been attacked, indicating that the security of POS networks is guaranteed by the operational mechanisms of distributed networks.

• Even if an attack occurs, rapid recovery can be achieved through the social layer, preventing attackers from seizing value greater than their costs.

• Recovery through the social layer may temporarily cause the network to lose activity, but this impact is negligible.

Therefore, his conclusion is that economic security is a meme for POS networks, and the security of Ethereum comes from excellent engineering design, node distribution, and client diversity.

Subsequently, both communities' KOLs expressed their views on economic security, but it was difficult to reach a conclusion. Let’s try to clarify the proposition, analyze the arguments, and provide evidence.

2. Is Economic Security a Meme?

Before discussing this, we need to clarify the definitions and relationships among staking, economic security, Ethereum security, and shared security. These four terms are often used interchangeably in many discussions.

The following diagram attempts to describe their relationships: the staked ETH partially becomes economic security. Economic security, along with other security factors, constitutes Ethereum security, which in turn is partially used as shared security services by AVS.

Source: IOSG

Toly's first argument is that the security provided by staking in preventing attacks on POS chains is far less than the staking value. To verify this, we need to know how much of the staked ETH is actually converted into Ethereum security.

The relationship of staking -> economic security -> Ethereum security

Currently, the staked ETH has reached 33 million, with a market value close to $120 billion. Does such a large amount of staked capital equivalently become economic security?

Before that, let’s review the concept of "attack," with two types of attacks being our main consideration:

• Nodes >= 33% can theoretically launch double-signing attacks or cause the network to stall.

• Nodes > 50% can review transactions and initiate short-range reorganizations.

Theoretically, the ways to obtain 33%/51% of nodes include:

• Running new nodes

• Controlling existing nodes

In the first case, since new nodes need to queue to enter the network, adding more than 33% of validators would take hundreds of days, making it nearly impossible.

In the second case, Toly believes that due to the existence of LST protocols and centralized staking services, the cost of acquiring 33% of nodes for an attack is far less than the staking amount. Essentially, the cost here refers to the attack/bribery cost against liquid staking protocols or centralized staking service providers rather than the capital cost.

Now let’s look at the staking status of liquid staking protocols and centralized staking service providers. Currently, Liquid Staking accounts for nearly 33% of the staking ratio, while centralized services like CEX account for 24.4%, which is quite close to the 33% threshold.

Source: hildobby - Dune Analytic

For CEX, with the approval of Ethereum ETFs, the ratio may further increase—Coinbase is often used as a fund custodian in Bitcoin ETFs.

Source: Maximum Viable Security: A New Framing for Ethereum Issuance

The degree of centralization in CEX staking is very high; Coinbase has even created a situation where eight consecutive blocks came from its own validators. This level of centralization means that this portion does not contribute to economic security and may even have adverse effects.

Source: IOSG Ventures

Liquid Staking

Overall, Lido, as the leading protocol, controls nearly 1/3 of the staked ETH, which means that from a protocol perspective, the Satoshi coefficient has dropped to 1 (only one protocol is needed to attack the entire network).

Compared to CEX, liquid staking mitigates centralization through various means, including DAO governance for service provider selection, dual-token governance, Lido's DVT, and Rocket Pool's Mini Pool. The HHI index drawn by Steakhouse measures the degree of centralization in Ethereum staking (which, in a sense, represents the efficiency of converting staking amounts into economic security). HHI Lido Real indicates that Lido has undergone decentralized governance, HHI Lido Single means Lido has not undergone decentralized governance, and HHI No Lido means Lido does not exist. We can see that Lido, under active governance (blue line), promotes the degree of centralization in staking.

Source: steakhouse - Dune Analytic

We further analyze the changes in the HHI index. Around the time when ETH accounted for 11% of the total supply, which was around August 2022, with a supply of 120 million, the marginal utility of decentralized growth calculated by HHI began to diminish significantly. We believe this indicates a situation of "staking saturation"—that is, the decentralization improvements brought by new staking amounts have significantly weakened.

Source: IOSG

We find that in any case, an increase in staking amounts positively affects the degree of decentralization in staking, but the marginal utility brought by actively governed liquid staking protocols (0.9%) is more pronounced, and even after staking becomes relatively saturated (0.8%), it still demonstrates excellent marginal utility.

Source: IOSG Ventures

As the total staking amount of Ethereum continues to increase, it indicates that economic security may still be in a slow but steady growth phase.

Source: hildobby - Dune Analytic

Next, let’s look at Solo Stakers. This group contributes the most to decentralization because each individual adds a validator that is relatively independent in geographical and social terms. However, currently, individual staking faces disadvantages compared to centralized staking, primarily due to the cost structure of individual stakers.

Source: IOSG Ventures

Due to the high proportion of fixed costs, independent stakers (and small node operators) are more sensitive to changes in staking rewards compared to large node operators. Currently, the Ethereum Foundation hopes to reduce the future issuance rate, which means independent validators will face more severe competition.

Source: IOSG Ventures

Thus, we see that for the same amount of staking, the contributions to economic security from centralized service providers, liquid staking protocols, and individual stakers differ. While the specific differences are difficult to quantify, we can draw the following conclusions:

1. As staking amounts increase:

• Centralized staking service providers have a negative effect on economic security;

• Actively governed liquid staking protocols have a positive effect but with diminishing marginal returns;

• Individual validators have a higher positive effect;

1. With the approval of ETFs, the degree of centralization in staking will increase;

2. With adjustments in issuance rates, the disadvantages of independent validators will increase.

Source: IOSG

Aside from economic security, the social layer's defenses and user-driven forks are two major defensive measures for POS chains.

Ethereum is constantly monitored by thousands of developers and the community. If any attack occurs, the observed nodes will issue warnings, and the social layer will respond quickly to ensure network recovery. In the face of non-systemic attacks (such as government-level censorship attacks or vulnerabilities in the Ethereum system), user-led forks serve as the ultimate defense, with the downside being a temporary loss of network activity.

So, how do we understand the actual contribution ratio of economic security to overall security? This can be viewed through the lens of the security expectation demand model provided by Kunal to evaluate ETH. If we consider the price of Ethereum as a demand for economic security, then by comparing the total market value of staked ETH and the economic activity capacity of Ethereum, we can roughly see the market's assessment of the proportion of economic security in total security capacity. According to calculations, this proportion is currently around 50%.

3. Is Economic Security a Meme to a Certain Extent, and Is It a Bad Thing?

In Toly's context, meme refers more to "exaggerated promotional slogans." He believes that the effect of economic security actually exceeds current demand.

After the utility analysis in the first part, it can be found that this statement is basically correct:

• The actual role of economic security is less than the staking value.

• Centralized staking service providers do not necessarily promote security; the marginal promotion of security from liquid staking protocols is currently very small.

• Social defenses and other deterrent measures appear to be effective at present.

So what is Ethereum's motivation to promote economic security?

• Network Activity

First, the biggest difference brought by the presence or absence of economic security is its impact on network activity. Ethereum aims to become a world-class asset settlement layer, which means institutional-level trust. Any brief downtime will affect Ethereum's reputation in this regard. However, for Solana, the reconstruction after social layer disruption is very effective—people only consider Solana's restart and reorganization as normal because Solana has never claimed to be a blockchain that does not experience downtime or reorganization.

• User Perception

Secondly, there are certainly marketing motivations. Toly's denial of economic security as a marketing tool uses Luna as an example, illustrating that staking economic security may lead to misleading safety marketing. The problem with this is that users who need security will not seek safety attributes from Luna. However, Toly is correct in that economic security is indeed a better promotional metric than other attributes.

For users, especially institutions, specific economic security figures are more easily accepted. When users cannot directly perceive the network's security, a numerical guarantee is the best anchor. This number is 33 million ETH for ETH and 337 million SOL for Solana.

Source: IOSG

4. What Does the Future of Economic Security Look Like?

So far, we can basically see that economic security has developed to this point as part of Ethereum's long-term strategy, indeed experiencing a phase of staking saturation, resulting in overflow security.

At the same time, centralized staking service providers, liquid staking protocols, and independent validators play distinctly different roles. Let’s recap: centralized staking service providers have no positive effect on network security, and with the approval of ETFs, the increase in the proportion of centralized staking service providers is unavoidable. Liquid staking protocols can promote network security through more reasonable governance, but the effectiveness is gradually diminishing. The increase in individual validators contributes the most to the network, but they currently face disadvantages in cost structure, which will become more pronounced with adjustments in Ethereum's issuance and staking curves.

Based on this, some clear development directions will be:

4.1 More Refined Staking Amount Design

Leading this is Stakesure proposed by Sreeram and others, aiming to shift the measurement of economic security from a rough package of an entire protocol to calculating each user's expected loss in the event of an attack and providing insurance. This means that once an attack occurs, the funds penalized from validators will be able to cover all users' losses.

This method of quantifying staking amounts from the user's perspective rather than the attacker's perspective can more effectively measure the demand for economic security and utilize it more efficiently. Naturally, this requires stronger infrastructure, which is also a direction we are continuously exploring.

4.2 Encouragement for Independent Validators

The importance of independent validators is self-evident; essentially, the number and distribution of independent validators represent the network's resistance to censorship. Currently, the absence of independent validators does not affect network operation (for example, Solana). However, in the long run, achieving the vision of "autonomy" makes promoting the growth of independent validator networks an important but non-urgent task for Ethereum.

The marginal cost disadvantages of individual stakers are difficult to change. We see attempts like those of 0xMaki, which label independent validators and provide additional incentives similar to merge mining. We believe and are paying attention to the innovations emerging in this area.

Source: IOSG

4.3 Evolution of POS

Initially, the skepticism about Ethereum's transition to POS included defining it as a network where only large holders have a say, characterized by class nature. If we view independent validators as individual users and centralized staking service providers as large holders, we find that the ETH flowing into liquid staking protocols has gradually escaped the binary framework of POS.

Liquid staking protocols themselves are a product of the contradiction between security demand and liquidity demand. This has led to discussions within liquid staking protocols about how to enhance governance decentralization with a very cautious attitude. As a result, many discussions and experiments on alternative consensus mechanisms based on POS have emerged, including dual governance, proof of authority, and proof of governance. These models aim to govern the validator network and select validators through more efficient mechanisms without sacrificing the decentralized security effect.

Source: IOSG

Thinking in this direction encourages us to work backward from the endgame. What will Ethereum's POS ultimately look like? For example, due to absolute cost structure advantages, if 100% of Ethereum is staked in Lido—dual governance of tokens will be essential; or through some governance oversight mechanism, ensuring that selected nodes can operate reliably… In the visions of many industry thinkers, models like Proof of Authority & Proof of Governance, which rely on community governance and entity reputation, will be the endgame of POS.

We believe that liquid staking protocols actively exploring this area will go further and may even become an indispensable part of Ethereum's consensus mechanism in the future. At the same time, we also see new attempts at POS emerging continuously in the Cosmos ecosystem, which will be a direction we focus on.

4.4 Exploration Beyond POS

The essence of economic security is to ensure that nodes do not act maliciously, rather than the staking behavior itself. All the security solutions we are currently discussing still revolve around POS staking—penalties as a simple game mechanism. However, we have already seen that some protocols have begun exploring new consensus mechanisms, attempting to maintain network security at a lower cost or even without the need for economic security.

The transition from POW to POS has brought about a large number of paradigm innovations, and the next industry opportunity may be hidden within another change in consensus mechanisms.

5. In Conclusion

In a sense, Toly is right to say that economic security is a meme because the current conversion rate of economic security in Ethereum is indeed decreasing, and other aspects of security are strong enough. However, this does not affect Ethereum's demand for economic security. Economic security, as a part of the security composition, can protect the network's activity and is the form of security that users can most directly perceive, thus safeguarding Ethereum's core value.

Regardless, this phase of reflection has indeed prompted everyone to think about how to better move toward the endgame. This includes adjustments to the staking issuance curve, incentives for individual stakers, new governance models, new consensus models, and the development of shared security.

It is clear that we are still in the foundational construction phase. Nick Szabo proposed that the value of blockchain lies in social scalability, and Kyle Samani explained it as entering a building without first worrying about the safety of the structure, often starting to use various facilities inside the building with peace of mind. Therefore, it seems that the current social trust cost of Ethereum is still very high. The day we no longer need to delve into issues of security and can assume that Ethereum or other infrastructures can be trusted will indicate that we are getting close to that point.