Ethereum’s OFAC compliance drops to 45% after the Merge upgrade.

Ethereum's OFAC compliance drops to 45% after the Merge upgrade.

The Impact of the Merge Upgrade on Ethereum’s Compliance with OFAC Standards

The blockchain industry has been evolving rapidly over the years, with Ethereum as one of the leading platforms. However, the historic Merge upgrade in September 2022, which transitioned Ethereum from proof-of-work (PoW) to proof-of-stake (PoS), had unintended consequences on the platform’s compliance with Office of Foreign Assets Control (OFAC) standards.

OFAC compliance is a crucial aspect of maintaining the neutrality and trustworthiness of the Ethereum ecosystem. It ensures that certain transactions are censored to prevent illegal activities such as money laundering and terrorist financing. However, the Merge upgrade led to a decline in OFAC compliance, raising concerns about the platform’s neutrality.

Before the Merge upgrade, Ethereum’s compliance with OFAC regulations was on the rise. Entities like crypto exchanges chose to run censoring MEV-Boost relays on their validators to enhance compliance. However, this approach proved to be flawed in terms of maintaining the credibility and neutrality of the Ethereum network.

MEV Watch data reveals that popular platforms such as Binance, Celsius Network, Bitfinex, Ledger Live, Huobi (HTX), and Coinbase were among the top censorship offenders. These entities actively ran censoring MEV relays on their validators, thereby compromising Ethereum’s neutral stance.

Since the Merge upgrade, the overall OFAC compliance of Ethereum blocks has declined significantly. In November 2022, approximately 78% of Ethereum blocks complied with OFAC regulations. However, as of September 27, the compliance rate has dropped to a mere 30%, reflecting a staggering 57% reduction.

To counter this decline in OFAC compliance, operators must utilize relays that do not censor transactions based on OFAC requirements. Several major MEV-boost relays are commonly used, including Flashbots, BloXroute Max Profit, BloXroute Ethical, BloXroute Regulated, BlockNative, Manifold, and Eden. Nonetheless, not all these systems adhere to OFAC compliance standards, as revealed by MEV Watch.

It’s important to note that not all blocks built by OFAC-compliant relays engage in censorship. However, when non-compliant transactions are broadcasted to the network, all blocks built by OFAC-compliant relays will censor them. This highlights the need for a comprehensive and uniform approach to compliance in order to maintain the credibility of the network.

While the primary focus of OFAC regulations is on organizations based in the United States, validators outside the U.S. should also consider running non-censoring relays for the benefit of the entire network. This global perspective ensures that Ethereum remains neutral and free from any undue influence.

In light of Ethereum’s reduced OFAC compliance, market players have made significant decisions. Grayscale, for instance, abandoned all rights to PoW Ethereum tokens (ETHPoW) due to a lack of liquidity in the market. On the other hand, some cryptocurrency investment firms, such as ETC Group, have attempted to launch dedicated EthereumPoW exchange-traded products (ETPs).

The decline in Ethereum’s compliance with OFAC standards post-Merge highlights the need for a comprehensive and robust framework to ensure neutrality and trustworthiness in the blockchain industry. Efforts should be made to establish better mechanisms that prevent censorship while still adhering to regulatory requirements. Only then can the blockchain industry thrive in an environment that promotes innovation, trust, and accountability.

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