If Ethereum Starts Slashing, It Burns

The Ethereum community has of late been thrown into a state of mild disarray by the prospect of transaction filtering both at the protocol and the application layer, brought on by the U.S. Treasury Department’s sanctions against Tornado Cash. At the application layer, major decentralized finance (DeFi) platforms are imposing address screening at their interfaces.

The blockchain itself isn’t affected: Users can run nodes and use alternative interfaces (to the extent they exist) to access these applications. But running nodes is hard, and switching from front end to front end is risky and difficult.

CoinDesk columnist Nic Carter is partner at Castle Island Ventures, a public blockchain-focused venture fund based in Cambridge, Mass. He is also the co-founder of Coin Metrics, a blockchain analytics startup.

These Web3 censorship tactics are not unlike the deep deplatforming that happens on the internet to designated opponents of the regime. Deplatformed with suspicious synchrony from Facebook, AWS, Cloudflare, Salesforce, and PayPal? Just build your own social media, hosting, distributed denial of service (DDoS) protection, customer relationship management (CRM) and … bank.

The government didn’t call it Operation Choke Point for nothing. In practice, you just have to make it very inconvenient for users to access the service in question, and you have kicked them off. If they have to run their own beefy Ethereum node and use the command line to interact with an uncensored Aave or Oasis, the vast majority of users will be de facto walled out of the service.

And the Treasury Department isn’t content with de facto filtering at the interface level. It recently took the unprecedented step of sanctioning Tornado Cash, a cluster of autonomous contracts, uncontrolled by any human. Notwithstanding the awkward questions Treasury must now answer regarding the constitutional feasibility of sanctioning blockchain addresses and contracts rather than individuals and entities, this was an aggressive shot across the bow.

The effects were immediate – Tornado became inaccessible to anyone except the highly motivated and foolhardy. Notably, Ethereum’s largest mining pool, Ethermine, has already incorporated filtering into its block construction.

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Now a curious discourse has emerged whereby Ethereans are threatening to sanction slash validators like Coinbase (COIN) if it complies with the law and filters sanctioned transactions, as the firm surely will. (Brian Armstrong can posture all he likes, but the Board won’t allow him to shut down Coinbase’s massively lucrative staking business because some .eths were mean to him online – they would sooner fire him.) Eric Wall has described the credible threat of slashing “a prerequisite for security and censorship resistance in a blockchain.”

Notable among Ethereum elites supporting the slashing of Evil Coinbase is Vitalik Buterin himself. No surprise that Buterin has signed on to the crusade, as it is he who is largely responsible for promoting the concept in his early defenses of proof-of-stake (PoS). “We will slash the bad people” is so elegant in theory. The drone pilots only intended to drop the precision munitions on the insurgents, and never the wedding guests.

The first problem is, of course, that there’s no actual slashing rule on Ethereum. Any imposition of one – taking away staked tokens from validators – would be contrived and arbitrary, effectively unconstitutional. Now, you might say, as a young protocol, Ethereum’s governance should be malleable, but the stakes are far too high for that now. Ethereum is a protocol that manages hundreds of billions of dollars’ worth of value daily. The very defensible DAO rollback (in 2016, following a $50 million hack) caused a mighty hangover that persuaded many that Ethereum was a hopelessly subjective mess, de facto controlled by a small group making things up on the fly.

The desire to simply confiscate the funds of designated wrongdoers is seductive, but completely short sighted.

A newly imposed slashing rule spirited from thin air, imposed against the crypto world’s largest financial institution no less, would be far more damaging. Skeptics could justifiably point out that Ethereum will have completely surrendered the moral high ground, with leadership acting expediently.

So Ethereum’s reaction to nation-state sanctions would be to impose sanctions of its own. It’s an identical desire to the one that drives the U.S. government to sanction so aggressively: to use purportedly surgical financial weapons to fight enemies, foreign and domestic, without firing a shot.

But Ethereum leadership must rise above this urge, which would make the network no better than the system it seeks to replace. One of the distinct advantages public blockchains have over their legacy counterparts is their genuine neutrality. To impose a slashing rule – in such an arbitrary and slapdash manner, with no prior codification – would undo that advantage completely.

An expropriation of Coinbase’s funds as directed by, say, Vitalik Buterin or others in the small community of Ethereum leaders would completely discredit any commitment to neutrality Ethereum has built up so far. Who is to say that Ethermine (or any censoring PoS validator) is “breaking” Ethereum’s rules by selecting transactions of their own volition? What rule? What line in the white paper specifies this rule? If the rubric is instead “social consensus,” how is this measured? Who measures consensus? Does Coinbase get an appeal? In which court?

These questions are unanswerable, given the vast array of Ethereum’s many stakeholders and their many different views. There is no socially scalable way to “slash only the bad people.” In the real world, there are no such things as villains. There are only competing interests. Coinbase’s interest is to comply with the laws where it operates while running a profitable business.

(And as far as constitutionality is concerned, Eric Wall admits that there is no formal rule committing Ethereum to slashing censoring validators, or even language in the white paper to this effect. All we really have are Vitalik Buterin’s writings about the theoretical merits of slashing. The Casper upgrade white paper discusses the mechanics of slashing at length, but does not describe how the intent of an “attacker” might be assessed, and how the community would organize a slashing in response to an ambiguous “attack.” Ethereum’s scattered constitutional documents contain only letter and no spirit.)

The desire to simply confiscate the funds of designated wrongdoers is seductive, but completely short sighted. It’s the same impulse that drives all campaigns of nationalization, expropriation and collectivization. This isn’t working. Why don’t we, the technocrats, suspend the rules, and simply commandeer these resources for ourselves?

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Countries that take a socialist turn and expropriate foreign firms for crimes real or imagined always suffer in the long term. Their nationalized industries end up becoming inefficient; no one wants to lend to them (as they have proven themselves unreliable) and no one is willing to invest there either. Securing meaningful credit and investment requires, above all else, stable governance and a commitment to property rights.

If Ethereum protocol elites arbitrarily sanction validators like Coinbase, they could suffer the same fate as an expropriating national government. The very best, most technically resourced, and protocol-aligned firms would cease to work on behalf of the protocol. The risk of theft would dissuade others from investing in the infrastructure which keeps the system running.

Now this is not to say that if major validators impose sanctions-related filtering at the protocol layer Ethereum is doomed. I am not advocating that Ethereum fight with one hand tied behind its back by moving to PoS while spurning the slashing component. Simply remaining on proof-of-work (PoW) – this oughtn’t be taken as an endorsement of any fork – would likely abate the problem. Stake exposes consensus to government will through regulated financial institutions, which are slated to dominate validation, whereas PoW is far more distributed and covert. Switching mining pools is instant and trivial; with PoS, it’s cumbersome. The validator set churns constantly in PoW and there is no hardware bottleneck as Ethereum still uses mostly GPUs.

In light of this state-level attack, I do question the prudence of the rushed move to PoS – empirically dominated, as I previously predicted, by large, regulated custodial institutions. But this doesn’t mean Ethereum could never recover from a portion of its validators engaging in filtering. Ultimately, the question of unfiltered consensus comes down to decentralized block templating as well as production: Both are necessary, but neither is sufficient on its own. Ethereum’s odds are likely better in my estimate if it remains on PoW, but it is not necessarily doomed even post-Merge.

For instance, I don’t buy the argument that the Treasury Dept. will forbid stakers from building on top of prior “bad” blocks, effectively creating a “Treasury Activated Soft Fork.” For this reason I am optimistic: Even if large validators do engage in transaction filtering, others will pick up the slack and include the neglected transactions.

All of that said, winning key victories against the creeping surveillance state does require that protocols like Ethereum successfully resist this overreach while we win the necessary political battles. It’s not enough to complain that you are being badly abused by your government and hope replacements arrive soon. You have to hold them off first, so the political case is all the stronger. A law that is blatantly incompatible with technology and popular will is a brittle law, and one that is liable to be replaced. The greater the tension created by the incompatibility between the state’s interpretation of the world and base reality itself, the better your odds are.

Ultimately, obtaining the financial privacy that we all seek isn’t really a matter of passing or retiring specific regulation. It’s not really about the 1970 Bank Secrecy Act, or the third-party doctrine, or the U.S. Constitution's Fourth Amendment, or the precise nature of a central bank digital currency (CBDC). There’s no magical incantation that will restore our lost transactional privacy in a world of digitized payments; no clever constitutional or legal argument, and certainly no line of code.

Rather, it’s very simply a question of how much we want to reclaim our lost freedoms. Holding off the censor and maintaining the orderly functioning of these open monetary protocols is a necessary prerequisite.

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To achieve genuine change, we must understand that in a common-law republic, laws are malleable, and can and do adapt to new realities on the ground. We do have a new reality: just take Tornado Cash, now twisting the government into indefensible contortions as it attempts to impose an ancient sanctions doctrine on a new terrain.

I’m optimistic that, whether legislatively or in the courts, we will eventually win. But to even pose these hard questions, blockchains have to endure first. Preemptively compromising blockchain neutrality and worse, showing that a small cabal of leaders can change core constitutional rules at a moment’s notice, would do the government’s job for them.

If I were Treasury Secretary Janet Yellen or Sen. Elizabeth Warren (D-Mass.), I’d be thrilled that Ethereum leadership was considering debauching the protocol’s neutrality with a panicked reaction of this nature. I’d be much more fearful if Ethereum leadership recommitted to a truly neutral system that makes the highly politicized dollar infrastructure look like an embarrassment.