Ethereum (ETH) Spot ETFs in the United States Could Lead to “Serious” Security Risks, Crypto Experts Warn

The issuers of Ethereum ETFs had to remove the clause concerning the staking of clients' ETH to facilitate the approval process.

The approval of Ethereum spot ETFs in the United States has sparked concerns among crypto experts, who warn that centralization issues could lead to “serious” security risks, particularly if staking is integrated into the ETFs.

In order to facilitate the approval process, the issuers of the Ethereum ETFs had to remove the clause concerning the staking of clients’ ETH. However, this decision could have long-term consequences on the security of the Ethereum network.

Following the transition to proof-of-stake in September 2022, validators are now required to lock up their ETH in a process known as staking. In exchange for securing the network, validators receive rewards, while poor performance incurs penalties.

Previously, there have been centralization concerns as some validators acquired a substantial portion of the staked ETH, leading some to liken liquidity provider Lido to a “cartel.”

“The removal of the staking clause in ETH ETF authorization applications was intended to appease the SEC,” Ganesh Swami, CEO of Covalent, told Decrypt. “But this short-term solution might cause a long-term problem. If multiple ETFs use the same custodians, it would increase concentration, exposing the network to operational risks such as malicious collusion.”

Centralization risks and lack of regulation

The risk of centralization is already evident with spot Bitcoin ETFs in the United States, where Coinbase holds 90% of the total assets—a situation that could be exacerbated by adding staking to the equation.

“If ETFs concentrate their participation with a small number of custodians, this could concentrate crypto validator participation,” said Andrew O’Neill of S&P Global. “This concentration, in turn, creates risks of concentration of crypto validators.”

Coinbase, the second-largest Ether validator, is set to be the custodian for six of the nine firms planning to launch an Ethereum ETF. If these ETFs garner enthusiasm comparable to that of the Bitcoin ETFs, this concentration of power could threaten the security of the network.

“One can measure the concentration risk by the number of nodes a single entity would need to control the chain,” explained Mona El Isa of Avantgarde Finance. “The lower this number, the higher the single point of failure.”

While the SEC classes staking as a securities service, hence its removal from the Ethereum ETF applications, authorities have failed to establish any guidelines to mitigate the risks of centralization and concentration without staking. In fact, the SEC has already taken action against Kraken and Coinbase to prevent them from offering staking services to U.S. clients.

Hence, crypto experts are urging close monitoring of Ethereum ETFs to avert major security risks. It is imperative for regulators and industry players to collaborate in developing clear guidelines aimed at reducing these potential risks and ensuring the long-term security of the Ethereum network.