Since the merge, Ethereum has transited from a Proof-of-Work consensus mechanism to Proof-of-Stake, which has given the power to validators after they have assumed the role of block production on the network, at the expense of miners, who previously secured the network with electric power (which determines the hash rate).
Validators do not need power-intensive GPUs to produce new blocks; instead, they rely on capital by staking Ethereum tokens (a minimum of 32 ETH) to validate transactions.
This new approach has gotten several investors worried about the ingenuity of Ethereum blockchain's security; concerns are growing about the network's ability to resist censorship due to the new model that attracts many regulatory-compliant organizations.
First, let us examine how the Ethereum Network Can Be Censored.
Temporary and Permanent Censorship
Ethereum's co-founder, Vitalik Buterin, says that two types of censorship could happen on ETH 2.0.: Temporary and Permanent.
Temporary censorship would occur when certain validating nodes, in the bid to remain compliant, choose to ignore sanctioned addresses. Eventually, subsequent nodes that validate successive blocks (and aren't bridled by regulations) will pick up the transactions and process them. Hence, these transactions will be delayed but will eventually be completed.
Permanent Censorship, on the other hand, will occur if validators with more than half of the total stake on the network refuse to broadcast sanctioned transactions on the Ethereum network; hence, the Ethereum network will have no choice but to fork into one that is regulatory compliant, and one that isn't. However, since PoS is more resistant to a 51% attack than PoW, the chances of permanent censorship are incredibly slim.
Concerns with Centralized Exchanges
According to data from Dune Analytics, Popular CEXs, such as Coinbase, Kraken, and Binance, have nearly 30% market share among all the ETH tokens staked in ETH 2.0. The downside is that these CEXs are regulatory-compliant and may refuse to validate transactions to the Ethereum blockchain if it contradicts government regulations. However, about 30% of the market share may be enough to influence the network to comply with regulations. Furthermore, due to the design of Ethereum staking, all ETH deposited on the beacon chain cannot be unstaked until after the Shanghai upgrade in Q2 or Q3 2023.
Vitalik Buterin says that the Ethereum community's actions are important in keeping the network from being censored; in an interview with Coinbase's CEO, Brian Armstrong, Buterin says that all staking providers have an obligation to comply with local laws, and at the same time, have a responsibility towards the Ethereum network to keep it safe. He says the honorable thing to do is to quit staking and shut down their nodes rather than comply with the network.
Armstrong of Coinbase, which controls 14% of staked ETH market share, affirms this stance, confirming that he would rather stop Coinbase's staking service than partake in censoring the Ethereum network.
Ethereum MEV Concerns
Mining is a consensus mechanism that deals with several nodes across the blockchain network; miners are presented with complex mathematical problems, which the majority of miners must solve to get a reward (Rewards in the Ethereum network will be in the form of Ether).
To get extra income outside mining, Ethereum miners seek profits from separate transactions beyond block mining; this income is known as the Miner Extractable Value (MEV). Typically, Ethereum miners can earn more by participating in Arbitrage Trading, Liquidations, and Frontrunning (or Backrunning) transactions. Hence, this enables Ethereum miners to make extra income.
Upon the Switch to Proof-of-Stake consensus mechanism; Ethereum Validators also found a way to gain extra profits via the Proof-of-Stake version of the MEV known as the Maximum Extractable Value, which allows validators to increase their staking percentage by 1.5%; however, in return, these validators must outsource their transactions to MEV-boost relays. These relays are off-chain services provided by regular, traditional business entities which are subject to local regulations; hence, in compliance with state regulations, they may prevent some transactions from happening.
Examples of these have been seen in the most recent ban of "Tornado Cash" users by several crypto bodies in compliance with state regulations. Due to the alleged links between the crypto mixer and money laundering activities, the Office of Foreign Assets Control (OFAC) sanctioned the platform, and in compliance with the regulatory council, Circle, the issuing company of the USD Coin (USDC) froze over $75,000 linked with 44 Tornado cash addresses. As a result, there are worries that linking network validation to centralized organizations will make the Ethereum network prone to regulation.
How Can Censorship Be Prevented?
The best way to uproot censorship from the Ethereum network before it even begins, is to include the censoring of the network as part of the criteria for a slashing penalty on the network. The Ethereum network slashes validator stakes when they engage in dishonest proposals or block attestations (in the bid to sign two blocks in a slot, double-vote, or change the blockchain's history).
If the Ethereum network equally includes dire penalties for censorship, then the roots will die off quickly before it ever gets to a stage where the 51% of the Ether stakes force the network into a fork to remain censorship-compliant.
Punishing the perpetrators seems like a generally accepted idea, as a Twitter poll (in which Buterin voted) ended with 61% supporting burning the stake of the validators who attempt to censor the network.
Due to its new model of staking, Ethereum 2.0 faces the risk of censorship; while temporary censorship can easily occur and lead to a delay in transactions, the real enemy is permanent censorship that could fork the blockchain and compromise it. Hence, network participants and key players in the Ethereum development council are expected to take proactive measures to counter Permanent censorship before it happens.