The decision by the US Treasury Department's Office of Foreign Assets Control (OFAC) to name Tornado Cash to its sanction blacklist earlier this August has brought the issue of censorship resistance squarely into the forefront. To avoid criminal prosecution, RPC service providers Alchemy and Infura blocked access to data on Tornado Cash smart contracts, while Circle (USDC) banned wallet addresses on sanctioned lists. Other DeFi protocols, such as Aave, similarly blocked access to the blacklisted addresses. However, the smart contracts are still operational, and users may interact with them, although with many extra steps and considerable technical skills.

This raises the broader question of whether blockchains can be censored at the protocol level. The Ethereum community has expressed worries over protocol censorship, with 66% of the beacon chain validators vulnerable to OFAC laws following The Merge. If more than 13 validators (by stake weight) engage in censorship, the blockchain will be unable to progress. In this article, we will evaluate POW BTC and POS ETH in terms of censorship resistance, using three important problems that we have uncovered, before delivering our final thoughts.

The two types of censorship

There are two types of censorship: weak censorship and strong censorship.

Weak censorship occurs when an individual's transaction is not included in blocks by specific censoring block producers, leading to a worse user experience. A regulatory-compliant block producer, for example, may prohibit transactions from banned addresses. However, non-censoring block producers should ultimately pick up the transaction.
Strong censoring occurs when an individual's transaction is never included on the chain. Given the individual's inability to transact, this might be considered an effective loss of assets. This scenario can occur when an economic majority takes control, also known as a 51% attack, which also concerns the blockchain's viability.

In the following explanation, we will use Bitcoin and Ethereum as examples of POW and POS networks, respectively. We would first determine the censorship vector before delving into how Bitcoin and Ethereum might combat it.

The centralized block building process

Both Bitcoin and Ethereum suffer centralization issues with mining pools and validator sets. This opens the door to an attack vector in which mining pools or validator sets are required to comply with rules, suppressing any transactions considered unlawful within their area.

Ethereum

Since The Merge, the top two validators have a combined share of 42.11%, while the top three have a stake of 50.03%. This raises the possibility that Lido and Coinbase might together halt the network and, with the addition of Kraken, take control of the network.

Source: rated.network

Before delving into the tools Ethereum has at its disposal to combat the issue of centralization, let us first examine why validators wind up in centralized pools. Block proposers in POS ETH can determine which transactions to include in the next block and their subsequent ordering. This enables validators to engage in a process known as MEV extraction.

Ideal annual validator rewards

Source: Flashbots

As observed above, there is a significant difference in validator incentives when MEV is taken into account. Given the economic incentives involved, very sophisticated players have run several validators, outperforming the typical home validator. As a result, the single home validator is more likely to join validator pools in order to increase revenue stability and predictability, which adds to the stake centralization problem.

Another factor to consider when it comes to stake centralization is that crypto exchanges continue to be the best venue for people to purchase Ethereum. As a result, given the overwhelming number of users, stake will inevitably concentrate on these exchanges that offer convenient yields via their staking platform.

Users should, however, be educated on the hazards of staking with centralized platforms, such as getting slashed if centralized platforms chose to act maliciously as a consequence of jurisdictional pressure. So, how can Ethereum combat censorship caused by this centralization issue?

Solution 1: PBS (Proposer Builder Separation)

The Proposer Builder Separation is one existing approach that is now being intensively investigated (PBS). PBS divides the tasks of block building and block proposing in order to allow validators to partake in the rewards of MEV without having to be experienced operators, which should lessen stake centralization.

In the block building process, three crucial actors provide checks and balances to limit and finally eradicate any censorship.

Builders specialize in block building, and scheduling transactions to maximize MEV and transaction costs. They will then charge Proposers a fee to propose and add their block on-chain. As a result, a censoring builder would be unable to put transactions on-chain without the assistance of a Proposer.

Proposers, also known as validators, must either choose the top playing block or not include any blocks at all. If they believe that builders are suppressing transactions, they can suggest a censorship-resistant list (crList) in which builders must include these transactions as long as the block is not full, otherwise, their block will not be presented. Since the implementation of EIP-1559, more than 80% of blocks have spare gas, which indicates that as long as a user pays a priority charge over the basic rate, their transaction should be included in the block.

In short, Proposers can maximize their profit by picking the highest-paying block while still being able to push censored transactions through the crList.

Attestors will watch the block building process and will only testify to a Proposer's block if it contains the highest paying block. This prevents fraudulent proposers from filtering transactions.

While the above solution considerably improves validator decentralization, it does not address the difficulties associated with centralized builders.

Solution 2: Encrypted mempool

Another alternative under consideration is the creation of an encrypted mempool. This implies that users will encode their transactions before broadcasting them to the mempool, and the transaction will only be decrypted when it is included in a block that is placed on-chain. This prevents any possible censoring party from learning the contents of the transaction while the block is being built.

Furthermore, it can aid in avoiding harmful MEV behaviors like front-running. Another advantage of encrypted mempools is that they may eventually eliminate builder centralization, allowing proposers to create their own blocks by simply selecting those with the highest fees from the encrypted mempool rather than choosing blocks from more sophisticated builders.

Bitcoin

Bitcoin has long been regarded as the gold standard, not just as a technological store of wealth, but also for its resilience to censorship. While Bitcoin is less programmable than Ethereum, which reduces the possibility of MEV, it still faces the issue of miners being more geographically concentrated. Furthermore, due to the technical expertise required to operate a mining machine, as well as the capital-intensive character of the hardware and energy costs, bitcoin mining has shifted toward resource pooling in exchange for lower volatility in payouts, with miners spending a service fee to the pool in order to receive rewards relative to the hash they provide.

Evolution of country share

Source: Cambridge Bitcoin Electricity Consumption Index

As seen above, prior to the country's prohibition on crypto mining in June 2021, China accounted for more than 45% of the worldwide hash rate. As of January this year, the United States accounted for 38% of the worldwide hash rate. This creates a censorship risk since mining firms may follow local restrictions to reject particular transactions. So, how can Bitcoin combat censorship caused by this centralization issue?

Solution 1: Changing mining pools

Miners can simply switch mining pools if the incentives of mining pool owners do not fit with their values. Because rewards are made on a daily basis, miners can move to different mining pools by simply changing the pool address within the mining program. Miners were able to easily travel abroad and alter their hash rate to foreign mining pools during China's mining prohibition in 2021. The hash rate had rebounded and is presently greater than it was before the ban was issued.

While Ethereum can accomplish the same by people unstaking and re-staking to validators that share their opinions, there is still a time lag when a cooling period and queuing system are considered.

Solution 2: More control for miners

Most bitcoin miners channel their hash power towards mining pools, with which they interact using Stratum v1, a messaging system that organizes the construction of blocks and the submission of hashes by the miners. If mining pools band together to censor transactions, the community has no redress. With Stratum v2, miners will be able to choose their own transaction set, giving them more control over the block building process and preventing rogue pool operators from trying censorship.

Solution 3: Free market

Bitcoin supporters argue that the economic incentives of proof-of-work mining provide the best kind of protection against transaction censorship. As block rewards halve with each cycle, transaction fees will approach 100% of a miner's earnings. As a result, even if a legal compliance pool or miner censors a fee-paying transaction, there will be other miners/pools in various countries eager to capitalize. In a free market, these regulatory-compliant pools or miners will eventually be forced out of business, resulting in declining market share and profitability.

The result

Bitcoin can manage weak censorship issues caused by centralized block building better than Ethereum. Bitcoin is now better able to deal with censorship that might result from block building centralization. If specific transactions are censored by mining pools, the ability to switch mining pools with little to no delay affords enormous liberty to the honest miner.

While Ethereum has possible solutions to the censorship problem, they are mostly in the research phase and have not yet been deployed due to the necessity to prioritize other features in order to compete with other programmable blockchains.

Low budget for security

The consequences of a low security budget lead to the possibility of a 51% attack. When this occurs, the attacker gains control of the blockchain. They will be able to prevent incoming transactions, arrange all new transactions, and even alter blockchain history to undo their own transaction, resulting in a double spend.

Ethereum

In the case of Ethereum, when a 51% attack is underway, the attackers can censor all new deposits or unstakes, making it impossible to rebalance the network. As a result, it is critical that staking within the network be as decentralized as possible in order to avoid instances where staking may be purchased or coerced.

At the time of writing, about 15 million ETH were staked on the beacon chain. The economic security of Ethereum may be computed as 15m ETH multiplied by the ETH price multiplied by c. 51%, the minimum amount necessary for an attacker to begin filtering transactions. At the current price of ~ $1,200 per ETH, this equates to around $9.18 billion in economic security. In fact, the acquisition cost will be significantly greater since ETH prices will climb non-linearly as demand grows.

Given that nation-states can overcome this, what preventative measures may be implemented?

Solution 1: More amount of staked ETH

Only about 11% of ETH is now staked, compared to other POS networks (e.g., Solana at 77%, Cosmos at 66%, and Avalanche at 65%), indicating that there is clearly an opportunity for growth. With a larger stake, the amount necessary for an attacker to achieve 51% of the entire stake becomes much more difficult.

However, the opportunity cost of DeFi returns on a user's ETH is a barrier to persuading more individuals to invest. If users are supposed to prioritize financial incentives, there is less motivation to stake if they can obtain higher yields via DeFi. The remedy is therefore liquid staking procedures, which puts us back to the centralization issue in Lido. While we acknowledge that the stake is being dispersed to a whitelisted set of 29 validators, this list of authorized validators remains in Lido's control. As a result, selection criteria and the ability to add or exclude validators will be important, implying the necessity for robust governance inside the Decentralized Autonomous Organization.

Lido has been examining the adoption of a Dual Governance proposal to vote on crucial governance matters with involvement from both stETH and LDO holders, in order to preserve alignment between both groups of holders. The capacity to adjust how the stake is allocated among node operators in a potentially detrimental or unanticipated way is one such crucial problem pertinent to censorship resistance. Once the original proposal has been passed by the LDO holders, governance in this case will involve stETH holders, who may be able to depart the protocol if all potential negotiation fails.

Solution 2: Diversified validators

If obtaining ETH on the market is impractical, the other option for gaining control of the network is to force the largest validators (51%).

As a result, the answer would be to enhance the diversity of validators in the form of:

Jurisdictional/geographic variety is required to ensure that no single jurisdiction/country may take validators offline.
Diversification of operators and stakes, to guarantee that coercion is exceedingly difficult if the stake is broadly spread.
Client variety ensures that no single defect in the validator client is able to knock validators offline.
Low specs for participation ensure that anybody may run a validator if they wish to.
A large number of validators with complete transaction replicates

Solution 3: Layer intervention

If the preventative measures fail, Ethereum will be forced to rely on the social layer to act. The design objective is to automate a forking process if censorship is detected while allowing enough time for social consensus on the fork option. In an ideal future, online full nodes would detect censorship by watching the mempool, recognize a non-censoring minority chain, and immediately split off to penalize the censoring entities, all without the need for social interaction.

However, forking away is seldom simple since censoring can sometimes be unintentional, such as owing to a flaw in the validator client. In such cases, the capacity of the social layer to intervene and distinguish between true and inadvertent censoring is critical.

There are many additional factors to consider, such as how a new chain should be chosen, which checkpoint should be used to begin the new chain, how attackers should be punished/slashed on the new chain, and so on, all of which might impact the economic worth of the new chain. These are all essential to ensure that users are fully informed when choosing a new chain and that they can unwind any positions on the censored chain if they choose to join the new uncensored chain. While there are currently no laws and procedures in place in the event that social intervention is required, it is vital that the decision-making process be as decentralized as possible.

Bitcoin

In the case of a major censorship attack on Bitcoin, miners will be able to mine all of the rewards and reorganize the chain as they see proper. Given the present hash rate of 230m TH/s, an attacker will need to collect more hash rate than that to rule the network, provided that the existing miners do not engage in the attack. Employing the most efficient ASIC on the market currently, the Antminer S19 PRO (110 TH/S), the attack requires a total of 2.09m ASICs. With today's prices of $4,400, the overall cost of acquiring the hardware to attack the network is around $9 billion, not including energy expenses.

Solution 1: Inherent friction in obtaining ASICs

While the costs are not prohibitively expensive for dedicated attackers, there is substantial friction in acquiring ASICs because just a few businesses manufacture these ASICs. Every year, there is insufficient supply to allow attackers to launch a quick strike.

Solution 2: Miners with low switching costs

Given the exorbitant cost of acquiring the necessary hardware to obtain control of the network, the attack will most likely take the form of coercion or control over the current mining pools. This takes us back to the minimal switching costs that miners may use to divert their hash power and rebalance the system.

The result

In terms of thwarting a 51% strong censorship attempt, Bitcoin outperforms Ethereum. The solution of Ethereum's social layer as the last line of defense gives the minority greater power, yet numerous concerns with social consensus remain.

On the surface, Ethereum appears to have a larger security budget than Bitcoin. However, the expense of obtaining machinery to take over the Bitcoin network is a more effective deterrent than the cost of getting a majority stake in Ethereum.

If attackers choose to compel centralized pools into taking control of the network, Bitcoin's answer is significantly easier in that honest miners may assist equalize the hash rate by moving to a non-attacking pool.

While the social layer may intervene in the case of Ethereum, numerous issues remain regarding how the move to a user-activated soft fork might function. First, how can non-attacking people reach social consensus? Does the new minority's majority get to vote? Or does the core team get to make the call? The decision-making procedure is analogous to an "Ethereum DAO" voting to obtain a majority conclusion. Should the majority of voters or the majority of stakeholders decide? A typical issue leveled about DAO voting is when an overwhelming majority of holders vote for an outcome, only to be overridden by a single holder with a larger stake.

This is not intended to depict the real process of determining forking rules, but rather to illustrate the problematic parts of social governance that the Ethereum community has yet to adopt. Finally, the social consensus layer necessarily allows for politicization, which might lead to Ethereum suffering the same destiny as a confiscating national government.

As a result, we feel Bitcoin is more robust today. It should also be noted that this may not be the case in the long run. What if Bitcoin's transaction activity fails to pick up as block rewards approach zero? This is one possible situation to watch out for. The absence of activity results in a lack of fee income for miners, who may subsequently struggle to stay stable. As a result, miners would shut down and the hash rate would plummet, reducing Bitcoin's security budget. As a result, it is critical that Bitcoin continues to attract new users in order for it to function as a healthy network.

Dependency on stablecoins

When it comes to the denomination of each cryptocurrency, Bitcoin and Ethereum have a similar external dependency: the usage of stablecoins. A simple survey of stablecoin market capitalization reveals that the top three are backed by fiat collateral stored by centralized custodians. This brings them under the jurisdiction of regulation, which raises the issue of what if you are incapable of off-ramping your stablecoins into fiat simply because the government instructs these custodians not to? While these are improbable scenarios, the consequences can be disastrous. It doesn't help that Circle, the USDC issuer, cooperated with the OFAC penalties by blocking over 75,000 USDC in money tied to the Tornado Cash addresses.

Solution 1: Overcollateralized stablecoin (for both Bitcoin and Ethereum)

Overcollateralized stablecoins are a common alternative in which a fiat-pegged token is issued in return for crypto collateral. DAI by MakerDAO is now the largest decentralized stablecoin in crypto, and they maintain a peg by selling pledged crypto collateral when asset prices decrease. They have shown to be resilient in the face of Bitcoin and Ethereum price fluctuations since 2017. However, as part of their collateral, they have more than 30% exposure to USDC. Following the recent experience with USDC and Tornado cash, they are presently debating whether to free-float Dai with the establishment of negative interest rates in order to come closer to their aim of becoming a public, neutral financial utility.

Vitalik also prefers RAI by Reflexer as a choice. Users of this protocol can deposit up to 2/3 of the amount of their ETH deposit in RAI. The main distinction is that RAI's peg varies in accordance with market volatility since RAI does not follow a set peg like the US Dollar. Additionally, they permit negative interest rates, which can aid in creating an equilibrium where excessive growth can be restrained in return for the stablecoin's volatility being decreased.

But overcollateralized stablecoins have a fundamental flaw in that they naturally drain market liquidity. What types of collateral are deemed "hard" enough to serve as base money is another issue to take into account.

Feasibility for Bitcoin: If it is backed by collateral other than Bitcoin, it is almost certainly not feasible for Bitcoin. Even if a current solution exists on the market, the nature of over-collateralization drains market liquidity, which is not ideal if we want the financial activity to take place on-chain.

Feasibility for Ethereum: Stablecoins that employ ETH as collateral may not be the best course of action in terms of Ethereum's viability. These stablecoins will have a redemption problem in the event that ETH is subject to censorship since users may want to sell their ETH stake. Although using Bitcoin as collateral might reduce this correlation risk, it still has a liquidity extraction issue.

Solution 2: Algorithm stablecoins

The Algorithmic stablecoin is another alternative, but one that has become rather infamous as a consequence of the Luna disaster. The idea is to develop a pegged stablecoin that does not require physical collateral and instead makes use of a governance token. The peg is then sustained by arbitrage opportunities. However, the system architecture is highly weak because it relies on rational actors and trusts that the governance token is reliable and hence valuable.

When confidence is lost, it can cause a death spiral in which the peg breaks, resulting in a loss of value in the governance token, and instead of fixing the peg, market players dump their holdings of governance tokens, worsening the decline in the price of the governance tokens.

In theory, algo-stablecoins may serve the same function as our current fractional banking system without requiring liquidity. However, no prospective contenders appear to have mastered the system design and implementation necessary.

What if Bitcoin evolved into a decentralized "stablecoin" free of censorship? This appears to resolve the difficulties that both Bitcoin and Ethereum are experiencing.

Bitcoin feasibility: This appears to be something Bitcoiners can get onboard since 1 BTC = 1 BTC. This might possibly solve the problem of a shrinking security budget due to a lack of transaction activity (recap: block rewards are trending to zero = all miners' revenue is dependent on transaction fees = adequate transaction activity is required to be solvent and maintain hash rate high). If BTC was extensively utilized on Ethereum (or any other programmatic blockchain), transaction activity would increase since it would serve as the base layer currency for DeFi and many other applications. Economic incentives for miners may therefore be maintained, enhancing censorship resistance against every attacker.

Ethereum feasibility: Consider a scenario where USDC or USDT are restricted, leading to a chain fork where neither fiat-pegged stablecoin exists. What percentage of users would opt to reside in such a "minority bubble"? When faced with severe censorship attacks, chain splits would become a more viable choice if Bitcoin were employed as the decentralized stablecoin instead of a fiat-pegged stablecoin. Users won't then need to be concerned about the loss of economic value since they would know that Bitcoin, the base layer currency, has excellent censorship resistance features.

The result

External dependencies like the dependency on stablecoins are evident dangers to the base layer protocol's censorship resilience.

The most important issue to solve, in our opinion, is the choice of base-layer money; otherwise, the economic worth of Bitcoin and Ethereum is related to USDC and USDT, both of which are subject to US restrictions. Other difficulties that potentially jeopardize censorship resistance also include the RPC layer and protocol developers, although we think current solutions exist to minimize and eventually eradicate those issues.

Conclusion

While we thoroughly compared Bitcoin and Ethereum in this article, we firmly feel that there is no reason to prefer one over the other. The features of Bitcoin make it suited for base-layer money, but the programmability of blockchains such as Ethereum is critical for us to enjoy on-chain applications.

At the end of the day, our primary purpose should be to strive for the qualities of decentralization, censorship resistance, and self-sovereignty, which Bitcoin, Ethereum, and many other blockchains are pushing for.

Disclaimer:
This article is intended for and only to be used for reference purposes only. No such information provided constitutes advice or a recommendation that any investment or trading strategy is suitable for any specific name.

A comparison of Ethereum and Bitcoin censorship resistance