Ethereum hits the brakes on staking, DeFi giants collectively strike back

Author: Baihua Blockchain

On August 4th, a bomb quietly dropped on the Ethereum forum.

Justin Drake, along with five core developers, submitted a proposal named EIP-8363: when the staking rate reaches 50%, the protocol will stop issuing new rewards to validators. All consensus layer earnings will be burned.

48 hours later is the deadline for the core developer meeting to confirm the Hegotá upgrade candidate proposal.

There are only two days for the entire ecosystem to digest this monumental change in monetary policy. The forum erupted, with core members of Aave, Lido, and ether.fi collectively firing back.

What exactly is this proposal going to burn?

Currently, over 40 million ETH are staked in Ethereum, accounting for 33% of the total supply, with a net inflow of 1.75 million ETH per month. The rise of liquid staking tokens, the maturity of institutional staking infrastructure, and the compliance of spot ETFs have simultaneously tightened the spring of staking growth.

The problem is that the current issuance curve has no brakes. Even if all the ETH in the world is staked, the base yield for validators remains at 1.5%. As long as someone believes this yield can cover the risks, the total amount staked will expand infinitely.

Justin Drake believes that 30 million ETH is enough to secure the network, while Vitalik even thinks 15 million ETH would suffice. The current 40 million ETH is at least double what is needed.

The solution of EIP-8363 is an increasing burn curve: the higher the staking amount, the greater the proportion of rewards that are burned. At a 50% staking rate, everything is burned, and net earnings drop to zero. After that, validators can only survive on transaction priority fees and MEV.

The proposal does not expect to actually stop at 50%. Validators still have to bear hardware costs, penalty risks, and liquidity lock-up, and the market will demand a positive premium, naturally bringing the equilibrium point down to a lower position.

In simple terms, this is an automatically tightening faucet.

The original intention is to prevent centralization, but the first to die are independent stakers

Consensus layer issuance accounts for 93% of the total income of validators. Cutting this part treats all nodes equally in theory, but in reality, it precisely targets small capital.

The cost of running a node is rigid: hardware, bandwidth, electricity, and operational time. Large service providers spread these costs across tens of thousands of validators, making the marginal cost approach zero. Independent stakers must bear all expenses with 32 ETH per node.

Independent stakers currently only account for 5.4% of the total staking amount in the network and are shrinking year by year. Their combined income has dropped from 2.86% to 1.48%, nearly halving, and they will be the first to fall below the breakeven line. The last batch of practitioners of Ethereum's decentralization spirit will be physically erased from the economic layer.

Opponents have modeled a more ironic future: on-chain LST users are highly sensitive to yields and will flee as soon as yields drop. However, exchanges like Coinbase have very low operating costs and are tied to a large number of ETF clients who are insensitive to yields. Four years from now, Coinbase may independently control over 33% of the network's staking amount. The centralization that the proposal aims to prevent may actually accelerate.

A more insidious harm comes from MEV.

With consensus issuance reduced, the weight of MEV in total income is passively amplified. Model calculations show that when the staking amount reaches 48 million ETH, MEV's share will soar from 7% to 19%; at 54 million ETH, it will approach 30%.

MEV distribution is extremely uneven. Independent nodes may go months without any earnings, while large mining pools can easily smooth out variance due to their base of validators.

Currently, most MEV-Boost relays in the market follow the OFAC sanctions list and have a tendency toward censorship. When base yields are abundant, nodes still have the confidence to connect to neutral relays, sacrificing some profits for the ideal of decentralization.

But when MEV becomes a lifeline for survival, choosing a censored relay is no longer a moral choice but a business survival rule.

The proposal aims to maintain network neutrality, but it significantly raises the financial threshold for maintaining neutrality. It is counterproductive.

There is also a tax trap. The transition design is "double the paper rewards first and then burn half." In the U.S., U.K., and Germany, staking rewards are considered taxable income as soon as they are recorded. The taxable base for validators doubles, but their net earnings actually decrease. Aave founder Stani Kulechov directly pointed out: this is forcing compliant household nodes out at the protocol level.

The foundation of DeFi Lego is shaking

Ethereum's staking yield is seen as the "risk-free benchmark interest rate" for the entire DeFi ecosystem. All lending protocols, liquidity pool strategies, and interest-bearing asset pricing are strictly anchored to this benchmark. Pulling out the cornerstone will lead to a repricing of the entire Lego tower.

LST protocols hold over $42 billion in assets, relying on extracting 10% of staking rewards to maintain operations. Halving the yield will rigidly cut the protocol's income in half, significantly reducing the ability to reinvest in security audits and infrastructure maintenance. Once investors determine that a 1% yield cannot compensate for smart contract and decoupling risks, massive capital will sell off LSTs in exchange for native ETH, triggering a discount spiral.

A more direct impact is on leveraged cycles. Many institutions are using Aave for leveraged cycles: depositing stETH, borrowing WETH, and then converting it back to stETH for further deposits. Under E-Mode, leverage can exceed 10 times.

The premise of this strategy is that staking yields are higher than borrowing rates. The base yield has dropped from 2.6% to 1.2%, while borrowing rates have temporarily remained at 1.5%. The interest spread has flipped from a positive 1.1 percentage points to a negative 0.3 percentage points.

The money printer has turned into a daily loss machine.

A collective deleveraging means a massive sell-off of stETH. Liquidity pools will dry up, collateral values will shrink below liquidation thresholds, leading to a cascading liquidation waterfall. The severe decoupling of stETH during the 2022 Terra collapse may reoccur.

Solana is waiting nearby

If the on-chain yield of ETH is pushed toward zero while stablecoin yields remain at 4% to 5%, the rational move is to use ETH as collateral to borrow and buy high-yield stablecoins. ETH will become the yen of the zero-interest era, specifically used for borrowing.

Meanwhile, Solana's native staking yield exceeds 5%, and the Alpenglow upgrade plan reduces block finality from 12.8 seconds to about 150 milliseconds. Wall Street is already applying for Solana ETFs with staking dividends.

Ethereum has attracted over $10 billion in institutional funds through ETFs. This money values predictable and continuous cash flow, which Wall Street has dubbed "internet bonds." EIP-8363 uses a mechanism not controlled by holders to bring this "coupon" to zero. No institution is willing to underwrite a financial instrument where "the coupon can be eliminated by the actions of others at any time."

To reduce annual issuance by about $1 billion, the cost may be the evaporation of hundreds of billions in institutional net inflows.

Aave DAO representative Marc Zeller publicly called for an alliance between Lido, Aave, and ether.fi, threatening to "directly reject EIP-8363" if necessary. EIP-8148 author Greg Koumoutsos questioned whether they plan to push the proposal through the upgrade within a feedback window of less than 48 hours. Idealistic researchers and builders burdened with tens of billions in real capital are colliding head-on at Ethereum's governance table.

Ethereum does need a staking brake mechanism. However, without a comprehensive plan to address LST decoupling, institutional capital flight, and validator centralization, the damage caused by slamming on the brakes may far exceed the problems it aims to solve.

Two days to digest a monetary revolution. This question has no standard answer.