HKUST Business School Magazine

Centralization compromises The aforementioned solutions, such as Layer 2 and Proposer-builder separation, were originally designed to maintain decentralization in block proposal and validation. Ironically, they have led to new forms of centralization within various parts of the ecosystem, albeit in sub- or off-chain organizations. The extent to which this centralization poses challenges for the ecosystem remains an open question. Less decentralized Layer 2 chains might defraud users or impose monopolistic fees. Concentrated builders could coordinate to censor transactions from certain users for non-economic reasons or to increase fees paid to them. Therefore, Layer 2 chains and builders try to signal that they are not malicious and care about their reputation, indicating a resurgence of a trust-based economy. The PoS consensus mechanism itself faces additional challenges from recent “innovations”. Currently, becoming a validator requires a deposit of 32 ETH (approximately 800,000 HKD). Some entities have introduced staking pool services to enable smaller ETH holders to participate in validation. These services pool ETH frommultiple users, stake it, and distribute the staking revenue to the original owners. Additionally, some providers, such as Lido, 6 have launched liquid staking services, which issue tokens equivalent in value to the staked ETH. This allows ETH holders to earn staking revenue while maintaining liquidity through these equivalent- value tokens—provided the service remains viable. While these services help redistribute the staking revenue to small validators, they can also effectively centralize the validation process among a few operators, jeopardizing the security of the consensus mechanism. Monetary policy in crypto chains The last, and perhaps most critical challenge for any crypto chain on the path to mass adoption is the high volatility of its value. For a crypto chain to be widely accepted as a standard means of transaction, stabilizing its value is even more important than addressing previous issues. This necessitates a re-evaluation of the central bank’s role beyond validation, particularly concerning monetary policy. Currently, ETH is issued as a staking fee when a block is proposed and validated and is burned as a transaction fee. The staking fee rate has remained relatively fixed—5 ETH since its launch in 2015, 3 ETH since a fork in 2017, and 2 ETH since 2019. The question arises: can and should monetary policy be adjusted to stabilize value? For fiat currencies, monetary policy can address either inflation and economic fluctuations or exchange rate volatility—but not both simultaneously with free capital flow across currencies, known as the famous monetary policy trilemma. In crypto chains, however, the effects of monetary policy on the security of the consensus mechanism must also be considered. Changes in staking rewards can influence the number and types of active validators, complicating the already “impossible” trilemma for crypto chains. Finding a solution to this complex problem remains elusive. Concluding remarks In this article, I have reviewed the challenges faced by crypto chains— particularly Ethereum—along with the proposed and implemented solutions, as well as emerging issues. The reduction of fixed costs for entry into the transaction-systemmarket has transformed crypto chains into innovative platforms. The community’s rapid iterations through trial and error lead me to believe that this industry will eventually reap substantial rewards. Moreover, I am convinced that economic analysis of these issues will significantly benefit the industry’s development. As we stand at the intersection of technological innovation and economic principles, one thing is clear: the future of crypto chains is not just about code; it’s about decoding human behavior in a decentralized world. The race is on, and the finish line may well herald a new economic paradigm. References 1. https://ethereum.org/en/roadmap/merge/ 2. https://vitalik.eth.limo/general/2017/12/31/sharding_faq.html#this -sounds-like-theres-some-kind-of-scalability-trilemma-at-play-what-is-this-trilemma-and-can-we-break-through-it 3. https://lightning.network/lightning-network-paper.pdf 4. https://coinpaprika.com/news/two-mining-pools-now-control-57-of-bitcoin-s-hashrate/ 5. https://eips.ethereum.org/EIPS/eip-7732 6. https://lido.fi/ Insight Biz@HKUST 44