Ethereum’s 2022 in Review: The Merge, MEV and Mayhem

Ethereum’s 2022 in Review: The Merge, MEV and Mayhem

Ethereum

In 2022, Ethereum ticked off several boxes on its checklist toward creating a global computer and decentralized financial system. Most notably, the second-largest blockchain finally completed its radical shift to a new, vastly more energy-friendly system for powering its network.

But the year was also marked with problems – from concerns around censorship to record-shattering hacks on Ethereum-linked infrastructure.

Let’s dive into the major themes and events that have defined Ethereum’s rollercoaster year.

The Merge

Any recap of Ethereum’s 2022 would be incomplete without mention of the Merge – the blockchain’s massive, years-in-the-making upgrade to a more energy-efficient system for processing transactions.

Ethereum’s switch to proof-of-stake from proof-of-work, which happened in September, marked a massive reduction to the network’s energy footprint, ditching a power-hungry crypto mining system in favor of a new method for issuing and validating transactions on the blockchain.

Read more: The Ethereum Merge Is Done, Opening a New Era for the Second-Biggest Blockchain

Although the Merge did not address Ethereum’s relatively high transaction costs and slow network speeds, it is estimated to have cut the network’s energy consumption by around 99%.

But the Merge wasn’t all good news. Ethereum’s new power structure, where validators “stake” ether (ETH) with the chain for the chance to write transactions to its ledger, has led to charges that it is becoming too centralized. Also, while the Merge put Ethereum on a path to becoming a deflationary asset, the event came in the midst of a bear market and never spurred a long-hoped-for bump to the price of ether (ETH), the chain’s native currency. The price of ETH has sunk more than 20% since the Merge.

Over the past year, there have also been increasing signs that the U.S. Securities and Exchange Commission will seek to classify Ethereum and other proof-of-stake currencies as securities (rather than commodities). Such a classification could lead to major changes in how the network is used and how ETH is taxed and traded.

MEV and flashbots

Ethereum’s Merge ushered in changes to the world of MEV, or Maximum Extractable Value.

As the Ethereum Foundation explains, “Maximal extractable value (MEV) refers to the maximum value that can be extracted from block production in excess of the standard block rewards and gas fees by including, excluding, and changing the order of transactions in a block.”

Read more: What Is MEV, aka Maximal Extractable Value?

In the early days of MEV before 2020, its spoils were generally restricted to a handful of sophisticated miners and a new cadre of so-called “searchers” – bots that scoured Ethereum’s transaction backlog, called the mempool, for profitable trading opportunities. For a while, the concentration of MEV know-how in the hands of just a few actors led to the proliferation of MEV-optimized trading strategies, like bandit attacks, which had the consequence of screwing over regular traders.

In 2020, the research firm Flashbots burst onto the scene with a system designed to mitigate some of the issues with centralized MEV. That system, an auction house for MEV-optimized blocks, became responsible for around 50% of all Ethereum blocks by September’s Merge. From January to September 2022, Flashbots netted over $200 million in profit for miners according to the company’s public dashboards – turning MEV from a nuisance into an entire cottage industry.

Once the Merge hit and changed the way blocks are produced on Ethereum, Flashbots only grew in importance. Its new system for spreading out the spoils of MEV, called MEV-Boost, is currently used as a go-between for 90% of the blocks on Ethereum’s new proof-of-stake network.

Though Flashbots’ 2022 was undoubtedly one of success, the company has faced rising concern that it is making Ethereum’s block production apparatus too centralized – an ironic charge given that Flasbots initially came along with the goal of mitigating centralization.

Censorship and centralization

In addition to the accusation that Flashbots (along with some of Ethereum’s larger validators) risk centralizing Ethereum, in recent months the MEV firm has been followed by an even more pernicious narrative. Ask folks like Gnosis Chain founder Martin Köppelman, and they’ll point out – as we’ve covered exhaustively in past editions of the Valid Points newsletter – that Flashbots has, by dint of its increasing influence on Ethereum block production, led to increased censorship on the network.

Read more: Will Censorship Fork Ethereum?

Over the Summer, the U.S. Treasury Department’s Office of Foreign Asset Control (OFAC) made headlines when it sanctioned Tornado Cash – an Ethereum-based program for obscuring the source of crypto transactions.

For Ethereum’s validators and users, it remains unclear exactly what sorts of activities would be considered illegal under OFAC’s rules, which bar “facilitating” or “servicing” sanctioned parties. For instance, even if it’s clearly illegal for users to shuffle funds through Tornado Cash, is it illegal for validators to “attest” to the validity of blocks containing those transactions?

Moreover, some blockchain developers thought that OFAC, by sanctioning a smart contract, violated free speech. For those who believe Ethereum should be a “credibly neutral” platform, blocking off sanctioned transactions in any form amounted to a kind of censorship – even if, for now, those transactions can still find ways onto Ethereum’s ledger, albeit at a slight delay relative to other transactions.

Along with certain validators, Flashbots – and some of the more popular third-party “relayers” that deliver blocks to validators using Flashbots’ MEV-Boost program – have taken actions that curtail the ability for Tornado-linked transactions to make it onto the Ethereum ledger. According to MEV Watch – a watchdog group that tracks Ethereum censorship – around 70% of the blocks that get added to Ethereum’s network each day are OFAC-compliant, meaning they are assembled to exclude (or “censor”) transactions from OFAC-sanctioned addresses.

Censorship was a major point of contention for the Ethereum community towards the tail end of 2022, and one expects to see it become even more relevant as users, validators and regulators formulate a clearer viewpoint on what financial compliance should mean for Ethereum and other blockchains.

Scalability and zero knowledge

At the peak of crypto’s 2020-2021 bull run, Ethereum – the second-largest blockchain by transaction volume – became virtually unusable for some people as a result of its high fees and slow speeds relative to some newer blockchains. But 2022 saw major improvements in this regard with the growing popularity of layer 2 networks and sidechains – separate networks that process transactions for cheap and then “settle” them on the main Ethereum blockchain.

Read more: What Are Layer 2s and Why Are They Important?

2022 was a huge year for Polygon, the biggest sidechain platform whose marketing might and Rolodex of strategic partners made it the envy of competing chains. The Polygon team managed to attract a horde of celebrities and corporate partners onto its sidechain, and despite concerns around centralization and security, its decentralized finance (DeFi) and NFT markets became a popular entry point for many-a-crypto-trader priced out of Ethereum’s expensive mainnet.

This past year also saw a rise in the popularity of layer 2 rollup networks like Arbitrum and Optimism. These optimistic rollup chains, which both launched in 2021, are slightly more expensive than sidechains like Polygon, but they provide stronger security guarantees to users – meaning they have special systems in place to ensure that the transactions they pass down to Ethereum’s base chain haven’t been spoofed or tampered with.

2022 was also the year of the zero-knowledge (ZK) rollup, layer 2 chains that use fancy ZK cryptography in order to guarantee transaction integrity. This past fall, several firms – among them, Polygon, Matter Labs and Scroll – made major progress in the development of so-called zkEVMS, which are ZK-rollups that can host any Ethereum smart contract (previously, ZK rollups were limited to specific applications and use-cases).

Read more: What Are Rollups? ZK Rollups and Optimistic Rollups Explained

As Ethereum’s layer 2 chains duke it out over the next several months and years, it’s expected that one (or several) of them will eventually become the primary means by which most users access Ethereum in the years ahead.

Mishaps and mayhem

One would be remiss to discuss Ethereum’s 2022 without mentioning the myriad of blowups, hacks and failures that have made this year one of the most disastrous in crypto history.

According to Rekt, a website that keeps a running list of DeFi exploits ordered by the amount of money lost, seven of the ten largest-ever DeFi hacks occurred in 2022.

Things teed off in February with the $326 million attack of Solana’s Wormhole bridge, which allowed users to trade assets between Solana and Ethereum (as well as some other, smaller chains). The largest-ever crypto exploit took place the following month when the Ronin network – an Ethereum sidechain used for the Axie Infinity web3 game – was hacked for an eye-watering $625 million.

Ethereum’s core code has never been the victim of an exploit (the systems that were attacked on Wormhole and Ronin weren’t even technically on Ethereum), but most of the big DeFi thefts of this past year nonetheless wrought havoc on users of Ethereum’s DeFi ecosystem. They showed, moreover, that apps on Ethereum and other blockchains – particularly, the bridges that let you send assets from chain to chain – have a long way to go in terms of security.

But the failures of the past year were also proof for many of the necessity of decentralized financial infrastructure. The much-publicized FTX exchange fiasco, wherein Sam Bankman-Fried and his associates allegedly stole around $8 billion in user funds, was only possible because people entrusted their money with an intermediary. Future Ethereum development, as with past development, will focus on ensuring that users can transact and store assets without the use of middlemen.

Such a future, while perhaps more necessary than ever, will continue to prove elusive until Ethereum, and the apps built atop it, continue to improve their security and ease of use.

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