The potential approval of spot ethereum (eth) exchange-traded funds (ETFs) in the US, including staking plans, could amplify concentration risks within the ethereum network, S&P Global Ratings highlighted in a recent analysis.
According to the report, the SEC could approve eth ETFs as early as May. However, as financial heavyweights compete for a share in this emerging sector, the entry of ETFs could significantly influence the balance of validator power on ethereum, posing new challenges and opportunities.
The SEC has to decide on VanEck's application by May 23 and could rule on other eth ETF applications before that deadline.
Concentration risks
The Spot ethereum ETF proposals from Ark Invest and Franklin Templeton aim to generate additional yield by staking eth. However, if those staking-enabled ETFs see high enough inflows, they could impact participation rates on the ethereum validation network, S&P Global analysts wrote.
According to the report, Lido currently accounts for just under a third of staked eth and is the largest ethereum validator. However, the report casts doubt on the likelihood of these ETFs opting for decentralized staking protocols like Lido.
Instead, a preference for institutional crypto custodians seems more likely, suggesting a different impact on validator concentration depending on issuers' diversification strategies.
The report also highlighted that Coinbase, which serves as a custodian for some funds, could also pose a concentration risk if it accepts new eth on behalf of US ETFs.
Currently, the exchange is responsible for approximately 15% of staked eth, making it the second largest validator overall. It also acts as custodian for three of the four largest ethereum ETFs outside the US.
The report says these issues are critical because reliance on a single software entity or client can present risks of outages and validator attacks. He called for greater monitoring of the risk of concentration and highlighted its importance.
The emergence of new digital asset custodians could offer an avenue for ETF issuers to distribute their holdings more broadly, which could also mitigate concentration risk.
JP Morgan echoes concerns
The S&P Global report echoes concerns recently raised by JP Morgan in a similar analysis about ethereum spot ETFs. The lender's report also concluded that the dominance of Lido and Coinbase poses significant concentration risks to the ecosystem.
JP Morgan argued that a concentrated number of validators could become a single point of failure, jeopardizing the stability and security of the network. This centralization also presents lucrative targets for malicious attacks, ranging from hacking attempts to coordinated disruptions of network operations.
Additionally, JPMorgan analysts warned against the possibility of collusion among major validators. An oligopoly of validators could manipulate the governance and operational parameters of the network to their advantage at the expense of ethereum's broader user base.
This could manifest itself in censorship of transactions, engaging in preferential treatment for certain operations, or early execution, practices that would erode trust in the fairness and transparency of ethereum.
Ensuring that ethereum remains a robust, secure, and decentralized platform requires a collective effort to mitigate concentration risks and foster an environment where no validator or group of validators can exercise disproportionate power.
