Ethereum Staking: A Post-Shanghai Update by ConsenSys

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2:32Welcome to Real Vision Crypto Daily Briefing. I'm Ash Bennington. Today I'm joined by Lex Sokolin, Chief Crypto Economics Officer at ConsenSys. Welcome to the show, Lex. Hey, good to be here. Boy, that's a great title. Tell us a little bit about what that means and what you do? It's one of the more difficult questions actually we'll probably cover today. You know, at the core of blockchain protocols functioning well is the concept of crypto economics. And that's a combination of figuring out, let's say, mechanisms for designing incentives so that people behave in certain ways and you have game theoretical structures that make sure those behaviors happen.

3:16So for example, the security within the Bitcoin model or within Ethereum or the mechanisms for paying fees within Ethereum, all of that is designed through, let's say, applied microeconomics. And then on the other hand, you're using crypto economics when you're thinking about building not particular companies. So it's not like, oh, I want to make a really futuristic laundromat and make sure its P &L is profitable, but rather I want to build an economy on a protocol, right? And so you're creating these macroeconomic experiments using mechanism design for how different people behave. And it's tricky.

3:55It's a new discipline. You didn't used to have economists run experiments. That's not something they could do unless they worked at the Fed. But now anyone in this discipline actually does it. And so my role is to analyze different protocols as well as to come up with token engineering models for the different projects that ConsenSys works on, as well as, you know, to take substantive views on the state of the macro economy and figure out how the company should respond to that. So let's talk about a lot of those things, the state of the macro economy, the state of the macro crypto economy, what's happening in the Ethereum ecosystem, which ConsenSys, of course, has a special focus on and which has undergone a recent series of upgrades known as Shappella.

4:41Talk a little bit about where we are in terms of the upgrades to the Ethereum ecosystem and what the impact is on people who are users of that ecosystem. Yeah, I think it's, for me, it's actually been really encouraging because crypto is very often filled with stories that people tell about how the future will be. You know, in the future, we'll have lots of applications and they're going to be very performant and they're going to be fast and they'll work really well and so on. There'll be all these use cases. And I think skeptics in our space often push around, push on these things like, is the protocol scalable?

5:22How many transactions can it handle? What's the security like? Is the security worth it? You know, is overclocking your graphics card and running server farms of miners, is that worth the, you know, the energy cost of what we get for it. And so Ethereum has been on like a steady path to address all these different levels of pushback. You know, so going from proof of work to proof of stake has addressed a lot of pushback from people who are ESG conscious or, you know, don't want mining to have an impact in terms of energy consumption. And so going to a model like proof of stake essentially removes 99.9 % of all of the emissions that would be inherent in mining.

6:12And I think one of the tricky things also in the strategy between protocols is that you have Ethereum, which is currently the largest networks in terms of decentralized applications and usage. And then you have many other blockchains that are trying to compete with it as a layer one. They're trying to compete with it as a market venue, as a place where computation happens, where attention goes. And their infrastructure often is very innovative. So proof of stake wasn't invented by Ethereum and it wasn't implemented by Ethereum first. It was implemented by other layer ones. But then over time, Ethereum was able to incorporate that into its own model.

6:55Now, the recent upgrade allowed unstaking. So the withdrawal of a stake. you know so you're committing capital into a box in order to provide security to the network and then now you're able to withdraw the capital back out now there's kind of complexity of how you do that and the timing around it and the queue and so on but the short of it is you're able to stake and unstake your capital which for institutional investors I mean it's a but for requirement right to have liquidity from your investment and be able to take it out and that of course was not always the case as you said suggest pre-Chapella uh that was locked on beacon chain and there wasn't the ability for users of that network to then withdraw the stake exactly yeah so people were using derivatives um or wrap tokens whatever you like to call them uh and of course derivatives have counterparty risk and and so on and can you can you explain that lex because i think that confuses a lot of people there are a lot of different terms uh in this space to describe the way that model works lsd being one of them liquid staking derivatives obviously a little bit of a tongue-in-cheek name there.

8:01But give us just the big picture, 50 ,000-foot overview of what the options were pre-Chapella from the staking ecosystems around Ethereum and what they are today. Sure. You know, this can get very confusing quickly. So I think just getting a concept of like collateralization or a derivative or even like a deposit account at a bank, right, is important to get an intuition for that. So let's say you have one case in which you hold a sandwich. It's like in your hands. It's delicious. You can just go and bite that sandwich. You know, it's in your custody. In another example, you don't have a sandwich.

8:45You gave the sandwich away to somebody else, but you have a receipt for that sandwich. And the receipt says, hey, you can come into our shop and get that sandwich anytime you like. and everybody's trading these receipts on the sandwiches because they're much easier to trade. They're pieces of paper. Maybe they're digital pieces of paper, digital receipts and so on. So you have a liquid market of these receipts. And so, you know, the concept of these receipts, they're derivative of the underlying asset. And in my silly example, a sandwich, in the case of Staked ETH, it's Ethereum, right? You're putting Ethereum into this box and you're getting, in the case of a protocol like Lido, you're getting a token that represents your stake.

9:27It's the receipt. It's not the actual sandwich. And the receipt is tradable. So it's a liquid staking derivative. It's derived from the underlying Ethereum that you've put into the box. And then it's liquid because you can take that receipt and go trade it with other people who have markets. Now, the fun part, of course, is can you cash in? Can you redeem your receipt? and the answers to that are weird and complicated. In some cases, yes. In some cases, no. There's smart contract risk. There's collateralization risk. There's regulatory risk, depending on how this stuff is set up. But I guess that's the short of it.

10:07Well, let's talk more about that because I think it really is a great metaphor. Whatever benefits a receipt may have in terms of liquidity, in terms of your ability to trade it, obviously you can't eat the receipt. And the challenge comes when you have, you know 22 sandwiches uh and 35 receipts when you have uh regulators who seize the receipts in some sort of enforcement action i mean there are a whole lot of things that can go wrong give us the menu of what some of those potential challenges could be uh in a staked system that is based on a collateralized contract being traded yeah that's that's a difficult question um first off there's you know different services build different connectors in how they create the the actual derivative right so um you can you can build it such that there is no mechanism that connects one price with the price of the other right like it could just be you believe that the the derivative is worth the same thing as the underlying asset.

11:18And maybe you trust that the markets are going to arbitrage the derivative such that the prices are going to be equivalent. But we saw a de-pegging between ETH and staked ETH during the whole liquidation cascade that happened, including FTX and so on. So if you're following the sandwich metaphor, it means the sandwich is worth more than the receipt because you can't eat the receipt and there's some risk of you not getting the sandwich back. And there's, you know, and the chance of not getting the sandwich can go up dramatically for all sorts of weird reasons. You know, somebody might hack the receipt printer and print to themselves a lot of receipts because they flash loaned it, and they're really cool on Twitter.

12:09And then the SEC shows up in their house and that's a real thing that happened to Mango Markets hacker Abraham Eisenberg, right? Yeah, we covered it right here at Real Vision. Exactly, yeah. So you can break the smart contract and alternately you can, for example, let's say you're relying on a centralized exchange to be the printer of the receipts, right? So let's say it's not Coinbase, but Kraken that has a staking program. Well, if Kraken designs its staking program in a way that's not just kind of giving you access. Oh, there we go. I've got to help my kid for a second. I'll be right back. All right, we'll be right back.

12:56Okay, we're back. Lex, we were talking a little bit about sort of the theoretical construct for how to understand the way this works. We talked about it in terms of sandwiches, which I think is a brilliant metaphor that I may have to steal because it's just so good. But let's transition that to talk a little bit about where Ethereum is right now. In terms of the menu of options out there for users of the ecosystem, what are the options as you see it? What are the big buckets, the big categories that you divide the staking options into? Obviously, as we mentioned at the top of the show, staking is absolutely critical because Ethereum is now a proof-of-stake system.

13:28So what are those menu of options out there in terms of users of the Ethereum ecosystem? Yeah, absolutely. So you can go the derivative route, which is still probably, from a user perspective, one of the easiest things to do. In the MetaMask wallet, there's actually a way to do that in the portfolio app where you click through and you have a bunch of staking providers and you can just implement it. and for retail users that let's say don't have 32 ETH which is one of the key key requirements to be a more institutional participant and this is built into the protocol itself it's important to point out the 32 ETH limit yep yep going the going the staking derivative route is easy and gives you exposure although you do have the types of risks we talk about if you want to be more involved and hands-on, you can try to run your own validator, or you can try to get somebody to run validator infrastructure for you.

14:34So, for example, ConsenSys has a staking platform that's provided to large institutions, and we run the software on their behalf, but everything is passed through. So, it's not creating intermediary tokens. It's passed through on behalf of the institution. Or alternately, if you're technical enough to run your own validator and your own hardware and you have the 32 ETH minimum, then you can do it yourself. Okay, let me ask you this. Talk a little bit about what's happening with ZKEVM. Tell us what that is. I know this is something that's on your radar and that's important to you. Yeah. So I started by saying that the protocols have been making these promises about the future, promises about scalability and how much software they can run and the use cases they can have.

15:27And one of the things that got solved is going from proof of work to proof of stake. Well, another thing that's being solved is transaction capacity as well as privacy. And this is in the creation of layer two networks. So layer two networks attach to layer one networks and they're able to batch transactions and use the security of the underlying protocol to run software at the top. So if you're frustrated in using Ethereum or some blockchain protocol because the gas fees are spiking when crypto caps are expensive or crypto punks are trading a lot or there's some mint going on, in that case, you're really going to enjoy having a layer two where all these transactions take place.

16:18So ZK EVMs are a type of layer two that are zero knowledge proof. That's the ZK part. And that means they come with certain privacy guarantees. And then the second part is EVM, which means they use the Ethereum virtual machine. And so the software that's written for the ZK EVM is the same as the one that's written for Ethereum. So applications don't need to do a lot of work or rewriting the software in order to function on this layer two blockchain. So essentially it's native in the Ethereum protocol. And it's important to point out that the reason why these layer twos exist for people who may not be as technical as this is the so-called scaling challenge.

16:59The speed of the transaction as well as the cost of the transaction often being very high on the layer one, building a layer two on top of it in an attempt to solve that challenge. Exactly, yeah. And the question is, you know, which technology is going to win? Because we have a splintering right now of different attempts to create more transaction throughput for Ethereum. Because all of this stuff anchors back in. And this has been a big question. We've talked about it here a lot on the show. Two of the methodologies, or at least the broad categories that we talk about here very often, Lex, are optimistic roll-ups where the underlying supposition of the chain is considered to be valid unless challenged.

17:38and ZK, zero knowledge proofs, a structure that comes out of some of the work that Silvio McCallie did, I believe in the 1980s at MIT with essentially finding a method of proving that you know something without revealing what that thing is. One of the metaphors that we often hear about this would be like if you went to, you go to a bar and a bouncer asks you for your ID, you don't actually have to show them your ID that has your, you know, your birth date on it and all of your, your address and everything else. You can just prove by, by a challenge that you were in fact born before a certain date.

18:08to prove that you were 21 as an example. Exactly, and I think that the kind of issues of human dignity that are inherent to this, where the systems we have today in the world own all of our identity. So we go around the digital world putting our stuff in various lockers. We put our payment information, we put our search information, our search intent, we put our financial transactions into our banks and so on. And so I think bringing ZK technology into the Web3 world kind of reinforces some of the promises that Web3 stands for. Where today, like, you can map a person to a pseudonymous address and a lot of the stuff disintegrates in terms of privacy.

18:54And so ZK EVMs, they don't just give you the performance benefits. They don't just give you the compatibility with Ethereum, but they also, I think, provide people this kind of counter to the Web2 narrative where others are custodying your assets or others are custodying your information. Lex, that's so well said and so well explained. I also want to just open this conversation up to some of our viewers from questions. I know we have some that have already come in. Please put down your questions in the chat wherever you're watching. We'll ask the best ones on the air. Remember, Real Vision members take priority, but the good news is membership is, of course, free.

19:34That's realvision.com forward slash crypto to sign up for free. If you're watching on YouTube, please tweet this link out so we can get this out to as many people as we possibly can. We are, of course, committed to this conversation remaining free on YouTube and on the platform. Of course, you can always follow me at Ash Bennington on Twitter, and please give Real Vision a follow at Real Vision on Twitter. We have a question, our first one that comes into us from Chris Bullock, aka our friend Blast of Past here on real vision uh he says i have a question for lex i'm wondering uh if he has any insight on what's driving eth fees so high right now i know we have meme coin mania going on but i think there is more to it than that great question uh from blast to pass any sense of what's driving eth gas fees so high that is a great question um i i don't have an answer for you on that one um yeah so i'm not going to fib on it.

20:30I do think that we are seeing a little bit more activity from people in the last few months of the year, of this year. So, you know, there was a real lull in terms of consumer usage towards the end of last year and the beginning of this year, but then starting February, March, and thereafter activity picked up. And we see that not just in transactions on chain, but in active users of MetaMask. And my hope is that it's the diversity of transactions that people can take now rather than kind of one thing that's spiking. But I wouldn't be able to point exactly to what the reason is recently. Interesting.

21:22So let's talk a little bit about a topic that I know is near and dear to your heart and something I'm incredibly interested in as well, which is AI, artificial intelligence. I'm curious if you're thinking about AI broadly, and I know that you've written a fair amount about this, but specifically in terms of what is possible in the domain of crypto, this is a question that we get all the time. What are the potential use cases within the crypto ecosystem for AI? Yeah, so this is going to be a little bit of an attempt to future cast. And, you know, it can be embarrassing to, like, talk about AI and Web3 and the metaverse.

21:57And we've all deflated a lot of that hopium. But at the same time, there are some really specific things that LLM's large language models and generative AI have shown to make to manufacture. And I think we're starting to get a much better sense for the type of thing that AI is that is being made, right? It's this kind of cloud of human intelligence that's been automated, right? It's not a machine intelligence necessarily. It's all human intelligence that is now queryable and essentially infinite that you can search and use. And I think of the sort of generative AI moment as the extreme of what Web2 is able to accomplish.

22:46So it's like it's the logical conclusion of the Web2 thesis, which is that all content is infinite. All content is free. You know, you have massive centralization to companies that own data. And those are the companies that are able to produce the AIs, right? So it's not a surprise that it's going to be Microsoft and Google. An interesting sort of aside is that Facebook released its model as open source. They're in spot number three. And so now the open source community is running both with large language models as well as image generation. And so the question is then, how does this extreme Web 2 terminus interact with Web 3 and its architecture?

23:34And Web 3 is a limiter on Web 2. It creates economic architecture. It forces ownership on top of digital content because Web2 does not have digital ownership and then Web3 does. And so all the questions about, okay, well, AI labor, right? Can that, what is, is that worth something or is that worth nothing? Is it just going to be infinite production of digital goods or are those going to be anchored and traded, right? So if you want provenance, for example, in AI generated goods, That's a fantastic use case for blockchain. Or, for example, there's now... What does that mean, Lex, in terms of the provenance component?

24:17Yeah, so people were complaining about NFTs that you can right-click and save as the NFT, that you have the JPEG. And the answer to that is, well, that's nice, but there's an original and then there is a copy. even if they're digital, right? So if I have the Mona Lisa and I take a really high definition picture and then I 3D print that canvas and it looks exactly the same as the physical object, there's still an original and the original has provenance and it has a history and everything that's happened to it actually happened to it and so on. And so it's important for its story rather than it's important because of how the object is.

25:01And so with digital goods, this is also the case. But now you have this problem in a more multidimensional way where an artist might have their style reproduced by an artificial intelligence that's been trained on their style. So it generates objects that are identical to the style of that artist or maybe writing identical to the style of that artist or music, right? And so having digital scarcity, having an NFT that says, okay, well, this was issued by the artist and this was issued by the Hive Overmind that was trained on the artist, that's a useful distinction to have. And it's the only way we can really have digital goods with, let's say, authorship.

25:51Interesting. Yeah, to anchor them. So it's essentially the blockchain becomes a mechanism for securing the digital scarcity and understanding the authenticity or provenance of a particular piece of digital content. Because blockchains are very good at doing exactly this, securing in a public and open source way the provenance and validity of a particular piece of digital representation of value in some form or other. Yeah, it could be, you could say that AI is creating a problem that blockchain has been solving. So over the weekend, I saw a piece that was written by Tyler Cowen talking about the risks of artificial intelligence and essentially asking the question of how do we know that anything is true?

26:36If you have artificial intelligence that can generate with such a fair degree of veracity, the style, the structure, the potentially fake sources. And I think one potential solution to the challenge that Mr. Cowan raises is the idea of blockchains being the source of truth for open source digital veracity and validity. Yeah, I think it's a very clear and analogous point, right? Because you think about a lot of the pushback before is like, well, why do we want, why do we care about news on chain? What's the, why do we care about this? What's the cost savings? What's the revenue generation? And now it's like we care because we don't want to be stuck in a gigantic machine vortex of misinformation.

27:22And the only way to make our way through the internet without kind of being completely lost is by having something that authenticates things. And then the question is, okay, well, who do we trust to authenticate things? Do we trust Elon Musk's blue Twitter checks to authenticate things? Do we trust the New York Times to do it or the U.S. government? Or do we have some sort of open source solution that, you know, has market mechanisms? So I think it's an interesting direction. And by the way, we should say as we talk about this and try and begin to get our heads around what this world may in fact look like, that one of the, I think, most frightening aspects of this is the rise of deep fakes with now better artificial intelligence generating some of those generative images and the ability to know, yes, this in fact was a video that was taken, for example, of a speech that the President of the United States gave.

28:22We can actually see through a secure chain of custody based on the existing public key encryption infrastructure that this is, in fact, it was shot on, you know, May 8th, 2023. And we know where it was because it's geo-stamped from a particular location at a particular time. The ability to do that blockchain seems to be uniquely well-suited to solve all of those challenges. Yeah. You know, we were in the Web2 world. It didn't really matter who makes the thing, right? So if I copy, I don't know, The Matrix and upload it to YouTube, it doesn't matter that I didn't have rights to The Matrix. You don't care.

29:05You're just enjoying that piece of content. But if it's, you know, the president's speech, it sort of does matter who makes it. And if I have an AI hallucinated that's as convincing to a human being as a real life shot, then it becomes a problem. And so you need a way to counter that. I think that's one direction is sort of like population scale problems. I think another direction is this concept of agents, you know, so AI agents. And you'll see a lot of companies now trying to build things on top of the LLM that is tailored to an individual. You know, so what's your personal AI assistant that's trained on, you know, your content or your tastes and so on?

29:56And that becomes a really, what's your digital twin, basically? And then for me, that becomes both really interesting and super dangerous because it's very convenient to have a digital version of you live your digital life. I think it's seductive, you know, how much time you can save and so on. But it's also really dangerous because that thing is such a breach of sort of your privacy and can put people in really bad situations if they're ever taken from you or used for a different purpose, right? So it's worse than losing your passwords. It's losing not just your passwords, but losing like the thing that's trained to behave as you with access to all your stuff.