The potential approval of spot Ethereum (ETH) exchange-traded funds (ETFs) in the US, which includes plans for staking, might amplify concentration risks within the Ethereum network, S&P Global Ratings highlighted in a recent analysis.

According to the report, the SEC could approve ETH ETFs as early as May. However, as financial heavyweights vie for a stake in this emerging sector, the entry of ETFs could significantly sway the balance of validator power in Ethereum, posing new challenges and opportunities.

The SEC has to decide on VanEck’s application by May 23 and could rule on other ETH ETF applications by that deadline.

Concentration risks

Spot Ethereum ETF proposals from Ark Invest and Franklin Templeton aim to generate additional yield by staking ETH. However, if those staking-enabled ETFs see sufficiently high inflows, they could impact participation rates in Ethereum’s validation network, S&P Global analysts wrote.

According to the report, Lido currently accounts for a little under one-third of staked ETH and is the largest Ethereum validator. However, the report casts doubt on the likelihood of these ETFs opting for decentralized staking protocols such as Lido.

Instead, a preference for institutional crypto custodians seems more probable, suggesting a different impact on validator concentration depending on the diversification strategies of issuers.

Validator ETH concentrations via S&P Global

The report also highlighted that Coinbase — which serves as a custodian for some funds — could also pose a concentration risk if it takes in new ETH on behalf of US ETFs.

The exchange is currently responsible for roughly 15% of staked ETH, making it the second-largest validator overall. It also serves as the custodian for three of the four largest non-US staking Ethereum ETFs.

The report said these issues are critical because reliance on a single entity or software client can introduce risks of validator outages and attacks. It called for greater monitoring of concentration risk and emphasized its importance.

The emergence of new digital asset custodians could offer a pathway for ETF issuers to distribute their stakes more broadly, which could also mitigate concentration risk.

JP Morgan echoes concerns

S&P Global’s report echoes the concerns recently raised by JP Morgan in a similar analysis about spot Ethereum ETFs. The lender’s report also concluded that the dominance of Lido and Coinbase poses significant concentration risks to the ecosystem.

JP Morgan argued that a concentrated number of validators could become a single point of failure, jeopardizing the network’s stability and security. Such centralization also presents lucrative targets for malicious attacks, ranging from hacking attempts to coordinated disruptions of network operations.

Additionally, the analysts at JPMorgan cautioned against the potential for collusion among major validators. An oligopoly of validators could manipulate the network’s governance and operational parameters to their advantage at the expense of Ethereum’s broader user base.

This could manifest in censoring transactions, engaging in preferential treatment of certain operations, or front-running — practices that would erode trust in Ethereum’s fairness and transparency.

Ensuring that Ethereum remains a robust, secure, and decentralized platform requires a collective effort to mitigate concentration risks and to foster an environment where no single validator or group of validators can wield disproportionate power.