Hello, I am writing here to argue AGAINST auto-compounding balances (as was raised at PM call 111, note there). And also possibly, as a side effect, against this proposal entirely.
Changing the fee to auto-compounding makes Ethereum appear as an interest-bearing security. We must end all consideration of this change.
A brief history of time
Some time in 2021 regulators in the United States, Europe and other regimes have basically come to accept Bitcoin and Ethereum as commodities/currency. This is a preferable to being considered a security. Hopefully this point does not require elaboration. Many other projects are considered as securities, from a now-famous comment by the U.S. Securities and Exchange Commission chair. Even other projects that are basically the same as Ethereum are considered securities, but Ethereum has been effectively exempted because “it’s been around for a while”, and “it’s running on its own.”
Then Ethereum released version 2.0 which makes Ether payments are given for participating in staking/validating.
Regulators have not said very much about this change. And they have not explicitly made a technical analysis of this mechanism. But generally the atmosphere is that “Ethereum is the same thing” and so there has not been a reevaluation.
Now Ethereum is preparing version 3.0 which changes Ether payouts to be auto-compounding. Yes, changing the way you pay out Ether is a MAJOR release version, every time. According to SemVer.
These are major changes
Every time we change payouts, fees, minting/burning, there is a possibility that regulators will reevaluate Ethereum and decide that it no longer qualifies as a commodity and that it instead is a security, or a money laundering platform or whatever else they want to classify it as.
Additionally, because Ethereum is a centralized application where you, the core devs, decide what is in the next version, and everybody else has to upgrade, the things you discuss (i.e. this meeting) are all part of the discoverable testimony that can be considered as part of regulators’ decisions. Eventually regulators will realize they can just compel you to ban Tornado Cash (U.S. Treasury) or require back doors in everything (EU Data Act), but that’s a blog post for a different day.
But back to compounding interest…
This major change
If a validator receives payment for validating, this is and appears to be payment-for-services. Normal people understand that. Regulators understand that.
If a validator receives a second payment for validating a second thing… same thing… that appears to be payment-for-services.
Let’s rewrite that with compounding.
The first time a validator receives payment for validating. Payment-for-services.
Then the second time the validator receives payment for validating… and ALSO extra payment for the money that they put into the system (i.e. the payout from the first services). What’s that? It’s interest. Normal people would call that interest. And regulators would call it that too.
In summary, a change to Ethereum staking payouts which introduces compounding payments is being considered. Normal people and regulators will see this as interest. Payout of interest might result in Ethereum being classified as a security by any of the myriad regulators on Earth. We must end any discussion of this.
Instead we must only consider validators as active, witting participants in the network security, whereas those people are performing effort to run validator nodes and Ethereum is paying them for their efforts in running a secure node. Running a secure node is difficult, trying new clients is difficult, and THIS is why payment is made to those participants. Payment is never based on, predicated on, or motivated by any investment in a common enterprise nor an incentive for moving money in (or not moving money out of) an account.