details the progress of the Ethereum merger and the merged MEV and miners

feed

  • The merger significantly changed Ethereum’s monetary policy, reducing the issuance of Ethereum by about 90%. In 6-12 months, both the validator’s principal (32 ETH) and newly issued will also be illiquid and will be “stuck” on the beacon chain. Deflationary monetary policy and increased demand for staking ETH could lead to a significant contraction in the supply of ETH in circulation.
  • Comments from the ethereum community hint at a soft target for the September merger. A range of market indicators show that the market expects the merger to happen at least by the end of the year. Binance Rate’s pricing suggests that the market expects the merger to happen by the end of September.
  • Ethereum MEV changes after a merger. Most validators will be running MEV-boost — free open source software that democratizes receiving MEV rewards. However, due to several factors (MEV smoothing, multi-block MEV potential, DoS mitigation), validator pools and centralized entities may continue to gain validator market share in the near term. Ethereum developers are working on developing solutions to solve this problem at the protocol level.
  • Miners have been a key component of Ethereum since its inception. It’s hard to “kick” them out. Ethereum Classic, the largest GPU-minable blockchain after the merger, cannot handle the influx of ethereum hash power. Due to the lack of alternatives, some miners have already expressed support for the ETHPoW fork. We expect that the fork may generate a lot of headlines, but its value will be negligible in the long run.

introduce

Merger is coming. Ethereum will transition from Proof of Work to Proof of Stake while improving its security and sustainability. However, questions remain about what the merger actually does, how it affects various stakeholders, and when it actually arrives. This report covers the current state of the merger, key pre- and post-merger impacts, and a range of measures to gauge market sentiment.

The current state of the merge

Two live testnets, Ropsten and Sepolia, have been successfully merged. Additionally, there are ten largely successful shadow forks on the mainnet. These practical runs exposed several small bugs, most of which have been fixed. Goerli will be the last testnet to undergo a merger, which is expected to take place around August 6-12.

If all goes well, the mainnet merger is expected to take place the week of September 19th. But it’s not a firm date. The timeline proposed by Tim Beiko in the Ethereum consensus layer call is a soft goal, not an end goal. Furthermore, estimating the merge time is difficult. On the testnet, merge activation was happening faster than expected. Nonetheless, the timeline presented below can serve as a good rough approximation.

details the progress of the Ethereum merger and the merged MEV and miners

Source: PoS Implementer’s Phone #91

What Consolidation Can and Can’t Do

Consolidation does not significantly increase transaction throughput and reduce gas costs. It just changes the consensus mechanism from Proof of Work (PoW) to Proof of Stake (PoS). Other things being equal, fees will be slightly lower as block production speed will increase from about 13 seconds to 12 seconds.

The ETH staked after the merger cannot be withdrawn. The Shanghai hard fork is expected to start within 6-12 months after the merger, and only after the fork can the pledged ETH be withdrawn and new ETH issued on the beacon chain. However, transaction tips and MEV fees will flow immediately after the merger. We will clarify how withdrawals work later in this report.

Merge does not support on-chain governance. Some PoS blockchains have on-chain governance where rules and upgrades are governed using some form of on-chain voting (e.g. Cosmos and Polkadot). But that’s not the case with the merged ethereum. Similar to Bitcoin or the current version of Ethereum, protocol changes are discussed and decided off-chain through a social layer with a broad range of stakers.

The merger does not mean that stakers get their funds for free. Under PoW, the Ethereum protocol must provide enough incentives to compensate miners for their operating expenses, and on top of that, earn them a small profit. A common view is that by transitioning to PoS, validators have little ongoing cost and stakers can easily enjoy high yields.

But staking is not free. Validators have an opportunity cost of capital when choosing to invest their funds in ETH and staking their ETH in the beacon chain compared to other ETH returns. If staking is free, people will continue to acquire and hold more capital until a similar equilibrium is reached. In fact, this has already occurred in stETH leveraged trades that were closed in May-June.

The merger significantly changed Ethereum’s monetary policy. Ethereum is currently rewarding miners (at a rate of 2 ETH per block) and validators on the beacon chain. After the merger, rewards for miners will cease, which will result in a roughly 90% reduction in ETH issuance, known as the “triple halving.”

The merger significantly reduces Ethereum’s energy consumption and carbon emissions. In the PoW model, entities need to purchase energy-intensive mining equipment to secure the Ethereum network, which results in high power consumption and hardware waste. Ethereum’s current energy consumption is comparable to Chile’s; carbon footprint is similar to Hong Kong’s.

After the merger, the physical staking collateral secures the network. There is no longer competition for access to more powerful mining equipment, resulting in a significant reduction in energy bills. Most predictions suggest that Ethereum’s energy consumption will be reduced by more than 99.95%.

Estimated annual energy consumption (TWh/yr)

details the progress of the Ethereum merger and the merged MEV and miners

Source: Ethereum.org, Digiconomist

Focus – key areas

“Triple Halving”

The merger is expected to significantly alter the flow of capital in and out of the Ethereum ecosystem.

On the supply side, Ethereum is currently incentivizing miners (under PoW) and validators (under PoS). Miners produce new blocks at 2 ETH per block, for which they will receive seigniorage and rewards will be distributed to validators on the beacon chain. After the merger, the rewards for miners will stop and the issuance of Ethereum will be reduced by about 90%. That’s why this merger is also colloquially known as the “triple halving” — a nod to Bitcoin’s halving cycle.

Ethereum can reduce the issuance of ETH because PoS is a more effective way of network security compared to PoW. Under PoW, Ethereum needs to issue enough ETH to cover the cost of miners (buying mining equipment and paying for electricity) and a small profit. Under PoS, Ethereum only pays the opportunity cost of funds. Additionally, PoW can only incentivize well-behaved miners by rewarding them, while PoS also allows Ethereum to curb misbehavior by slashing.

Ethereum Will Be Deflationary After Merger

details the progress of the Ethereum merger and the merged MEV and miners

Source: Ultrasound.money

Demand for Ethereum is also expected to increase after the merger due to a number of factors. First, staking rewards for validators will increase immediately. Validators will receive transaction tips currently earned by PoW miners, potentially increasing APR by about 2-4%. Also, since they are able to reorder transactions, they will also start earning MEV (Maximum Extractable Value). According to researchers at Flashbots, a research and development agency that studies MEV bursts, validators could see an additional 60% increase in yield due to MEV (assuming 8 million staked ETH). So, if the merger happened today, due to all the factors mentioned above, validators can expect to earn about 8-12% APR in total.

Total Staking Yield if the Merger Happened Today

details the progress of the Ethereum merger and the merged MEV and miners

Source: @StakeETH, @eth2calculator, Etherscan, Beaconcha, Flashbots

Note: The estimate of MEV reward is conservative as it is a lower bound estimate from Flashbots.

Of course, such yields are unsustainable. Therefore, we expect a significant increase in staked ETH post-merger. If staking as a percentage of total ETH is comparable to the alternative L1 (Solana and Tezos: 75%, Cosmos: 64%, NEAR: 39%), then the Ethereum staking yield will compress below 2% APR.

Sensitivity analysis of total pledge income after merger

details the progress of the Ethereum merger and the merged MEV and miners

Source: @StakeETH, @eth2calculator, Etherscan, Beaconcha, Flashbots

Other factors expected to affect ETH supply and demand include:

  • After successfully transitioning from PoW to PoS, ETH has reduced its risk.
  • Remove criticism of energy use and network energy spending will drop by 99%.
  • Due to its staking returns, Ethereum will increasingly be seen as a financial instrument, similar to equity or perpetual bonds.
  • Beacon Chain withdrawals will not be enabled until after the Shanghai hard fork, which is expected to start within 6-12 months of the merger.

Shanghai hard fork

Withdrawals in the beacon chain are often misunderstood. The withdrawal of ETH staked on the beacon chain and the issuance of new ETH will not be enabled at the time of the merger. Instead, it will be enabled in the Shanghai upgrade, tentatively 6-12 months after the merger.

However, priority fees and MEV fees (which may account for more than half of the total staking rewards) can be withdrawn immediately after the merger.

Post-merger capital outflow?

Two separate withdrawals are allowed after the Shanghai hard fork. The first is partial withdrawals — allowing active validators to withdraw cumulative rewards and reduce their staked balance to 32 ETH. These are important because it allows validators to withdraw the revenue they generate without completely shutting down and reactivating validators. It also allows validators to maximize efficiency, as excess tokens are not efficient when a validator’s balance exceeds 32 ETH. If some of the funds are not withdrawn, the earned returns become idle capital.

The maximum number of partial withdrawals per epoch is currently set to 256. Each day contains 225 epochs, so 57,600 validators can withdraw their rewards each day. Currently, the average balance of all active validators is 33.66 ETH. We can expect that number to climb to around 34 ETH when Shanghai upgrades, which means there will be partial withdrawals from the market:

(34-32) x (57600) = 115200 ETH / day

(If ETH = $1500, about $173 million)

This could last from 7 days (based on the current 410k validator set) to 14 days (if the validator set increases to 800k).

Validators can choose to withdraw in full. To ensure the security of the Ethereum network, full withdrawals and withdrawals are limited per epoch, currently set to about 6 per epoch. If all currently active validators want to withdraw, it will take more than a year.

We expect that most of the returns from partial withdrawals will create new validators rather than sell to the market, and that demand for new deposits will outweigh potential selling pressure from full withdrawals. Nonetheless, we point out this dynamic as it works differently than PoS-based blockchain networks and can cause confusion.

result

  • ETH issuance decreased by about 90%.
  • For a period of 6 months to 1 year, the validator’s principal (32 ETH) and issuance rewards will be illiquid and stuck on the beacon chain.
  • Circulating ETH supply may continue to be reduced through deflationary monetary policy and the need to stake ETH.

building blocks

MEV has grown from a niche topic a few years ago to the focus of blockchain research today. MEV affects all areas of blockchain. The full impact of MEV is beyond the scope of this report, so we will only briefly describe how MEV affects validators after the merger.

Maximum Extractable Value (MEV), broadly defined, refers to the total amount a miner or validator can increase their balance in a series of blocks given the available operations. These actions can include reordering transactions, censoring blocks, or even attempting to reorganize the chain. Some common forms of MEV include sandwich attacks, arbitrage, and liquidations.

History and current status of MEV

In the current state of Ethereum, most users send their transactions to a public mempool via wallets. Seekers constantly monitor mempools for potential profit opportunities. In the early days of MEV, searchers seized on these opportunities by bidding high gas prices to gain transaction priority.

As MEVs became more competitive, this led to Priority Gas Auctions (PGAs), which increased network load, which in turn led to gas price volatility, inefficient use of block space, and more. Other negative externalities also began to emerge. The team started building infrastructure globally to provide faster and broader access to various memory pools. Miners provide services that allow searchers to bypass public mempools and execute transactions privately.

Several solutions have emerged to mitigate these negative externalities. Most prominent are Flashbots.

These solutions have largely democratized MEV. Searchers who discover unique MEV opportunities can avoid revealing their strategies to other searchers and get the lion’s share of the profits. For more competitive strategies (such as arbitrage), miners earn MEV revenue through bids submitted by searchers.

Merged MEV

After the merger, validators will replace miners. But there is no built-in mechanism at the protocol level to help validators capture MEVs. If left unchecked, this structure will allow specialized companies and larger entities to better capture MEV by setting up multiple validators and strategies for building the best blocks. Other validators will not be able to compete effectively.

Luckily, Flashbots also created a merged alternative called MEV-boost. MEV-boost allows validators to auction their block space to the open market and maximize their staking rewards.

MEV supply chain

details the progress of the Ethereum merger and the merged MEV and miners

Source: Flashbots

Under this framework, searchers will continue to seek monetization opportunities from MEVs and bid for their bundles to be included. The builder aggregates all these bundles to build the best full block that pays the highest. When it is the validator’s turn to propose a block, they pay the MEV-Boost relay query with the highest payload and include it in their proposed block.

However, MEV rewards are subject to change. For example, periods of high volatility tend to result in higher MEV fees. Validators who propose during these periods may be rewarded with higher MEV. A study by Flashbots last year confirmed that inequality between validators increases when MEV is factored in.

Inequality between validators without MEV (left) and with MEV (right)

details the progress of the Ethereum merger and the merged MEV and miners

Source: Flashbots

Note that the distance between the green and red lines widens significantly with MEV extraction.

Therefore, large institutions and validator pools that are able to socialize/smooth MEV by running thousands of validators will benefit. This dynamic is similar to why GPU miners working from home join mining pools today – stability and predictability of income. The potential of multi-block MEVs is a further source of strength.

Validator allocation for staking pools

details the progress of the Ethereum merger and the merged MEV and miners

Source: Beaconcha.in

Validator pools and centralized entities will likely continue to gain market share until Ethereum smoothly builds MEV into the protocol layer (which is currently a work in progress).

Miners, forks, etc.

Miners are an important part of the Ethereum ecosystem. In total, they spent about $15 billion on GPUs. After the merger, all their equipment and infrastructure will be idle and will need to find alternative uses. In anticipation of the merger, GPU resale prices have halved since the beginning of the year.

As such, what miners do before and after the merger remains highly uncertain. Some arguably adversarial behavior has been observed. In May, before the Ropsten beacon chain went live, a miner significantly increased the hash rate to hit TTD, forcing developers to retest the merge on Ropsten.

The rationale, in the miners’ words: “This is a stress test of the ROPSTEN network to see what happens if the merger goes beyond plan.”

Sudden spike in Ropsten hash rate caused by miners

details the progress of the Ethereum merger and the merged MEV and miners

Source: bordel.wtf

Miners may react more violently before the merger, which will seriously degrade the user experience on Ethereum.

For example, miners can steal MEV. When a searcher sends a bundle to a miner via Flashbots, the searcher trusts that the miner will not steal/expose/preempt. Miners can start doing this as the merger gets closer, as the cost of getting caught will decrease.

Miners could also theoretically start running clients, reorganizing the Ethereum blockchain to retroactively capture MEVs. These tools have been proposed in the past but have been largely opposed by the community. Large mining pools have not adopted them, mainly for their reputation and to avoid harming the Ethereum network.

details the progress of the Ethereum merger and the merged MEV and miners

Source: @ethermine_org

We hope that the largest mining pools like Ethermine will not behave maliciously. F2pool, the second largest mining pool in the world, merged with its sister company Stakefish long ago. Ethermine also launched a beta version of the staking pool service.

Nonetheless, smaller miners may try to smuggle as much revenue as possible before merging through malicious behavior.

Where will the miners go?

After the merger, if these machines try to operate within the crypto ecosystem, the most likely candidate is Ethereum Classic, the Ethereum fork that resulted from the 2016 DAO hack. Just this week, the eighth-largest Ethereum mining pool, Antpool, pledged to invest $10 million to develop the Ethereum Classic ecosystem.

But Ethereum Classic’s daily fees are orders of magnitude smaller than Ethereum’s. Furthermore, if miners use GPU hashrate heavily, especially if prices do not rise, the profitability of mining these networks will inevitably decline.

GPU mineable blockchain

details the progress of the Ethereum merger and the merged MEV and miners

Obviously, other GPU-minable blockchains cannot handle a large number of idle GPUs after the merger. Additionally, Bitpro estimates that for GPU miners to remain profitable in the crypto ecosystem, about 95% of GPUs need to be turned off. This is unlikely to happen immediately after the merger.

Therefore, it is possible for miners to try to keep the PoW fork after the merger. Some miners have already gained support for the ETHPoW fork. If some exchanges support the fork and a small group of miners continue to use the fork, the fork may live longer than expected.

Even if this happens, almost all users and developers will stick to the canonical PoS Ethereum. The ETHPoW fork has no meaningful philosophical or ideological backing. Also, the Ethereum ecosystem is very different now than it was in 2016 (when the ETH/ETC fork happened). Real-world asset issuers, such as Circle (USDC) and Tether (USDT), will only support minting/redemption on the canonical chain. Packaged assets such as wBTC will do the same. L2 and bridges will also only support assets bridged from the main chain. DeFi on the ETHPoW fork became a strange being, billions of assets would be rendered useless overnight.

Therefore, we expect that the fork may generate a lot of headlines, but its value will be negligible in the long run.

Pricing?

Liquid Collateral Derivatives

Liquid collateralized derivatives can be used as a measure of market sentiment. The three largest are Lido (stETH), Binance (bETH) and Rocket Pool (rETH).

stETH and bETH are adjusting their token bases – the ratio of token balances to ETH is 1:1, and token balances are regularly updated to reflect rewards. Therefore, after the Shanghai hard fork, stETH and bETH should converge to the price of 1 ETH, as users will be able to arbitrage between ETH and their liquid collateral derivatives.

In contrast, rETH is designed as an appreciation token. Therefore, the exchange rate of rETH-ETH will increase over time. However, trading rETH back to ETH requires protocol liquidity, which is limited until withdrawals are enabled. As a result, the market price of rETH has fluctuated over the past year.

Price Performance of Liquid Collateral Derivatives

details the progress of the Ethereum merger and the merged MEV and miners

Source: CoinGecko

Before May of this year, stETH traded largely on par with ETH due to high demand for staking ETH. This further reinforces the (incorrect) notion that stETH is “pegged” to ETH in the same way that 1 USDC is pegged to 1 USD, which gives market participants the confidence to leverage their yields. In such a transaction, participants deposit their stETH into a money market protocol (most commonly Aave) as collateral to borrow ETH, pledge the borrowed ETH to obtain stETH, and cycle the transaction again.

Several products have emerged that offer leveraged ETH staking

details the progress of the Ethereum merger and the merged MEV and miners

The market turmoil that began in May forced large market participants, notably Celsius and Three Arrows Capital, to sell their stETH collateral. The lack of stETH-ETH liquidity and crowded leveraged trades led to many people trying to exit through a small door.

Crowded deals go through the same door

details the progress of the Ethereum merger and the merged MEV and miners

Source: Dune (@LidoAnalytical)

market pricing

bETH is currently trading at a 2.2% discount to ETH, while its “flexible” staking yield is 2.4%.

The developers have pointed out that the Shanghai hard fork occurs 6-12 months after the merger. Assuming the midpoint of these estimates, that means the merger will happen around September 30, 2022.

details the progress of the Ethereum merger and the merged MEV and miners

This approximation is not perfect, taking into account liquidity factors and market technical factors, but it can be used to gauge market sentiment. The same operation can also be used for stETH, but we use bETH and Binance’s flexible yield to exclude the impact of counterparty risk and also more easily offset the opportunity cost of capital.

ETH / BTC

The ETH/BTC ratio is also often used as a sentiment indicator for Ethereum, while filtering out broader macro swings that can affect the overall cryptocurrency price. Since May, major crypto events — such as Terra and Three Arrows Capital — have made the situation even worse, as both assets were allegedly forcibly sold during this period. However, ETH/BTC has gained 20-30% since the beginning of July, spurring further consolidation narratives.

details the progress of the Ethereum merger and the merged MEV and miners

Source: Binance, TradingView

beneficiaries of the merger

The price performance of some publicly traded tokens benchmarked against ETH also provides another reading of market sentiment.

The beneficiaries of the merger include:

details the progress of the Ethereum merger and the merged MEV and miners

Most of the coins in the above categories have outperformed ETH since June, with a few exceptions.

Price performance of select tokens (based on ETH)

details the progress of the Ethereum merger and the merged MEV and miners

Polymarket

Polymarket has the largest combined prediction market. While incredibly low liquidity undercuts its predictive power, it provides an alternative, simpler way to gauge market sentiment toward a merger.

details the progress of the Ethereum merger and the merged MEV and miners

Currently, Polymarket participants believe that there is a 66% chance that the merger will happen according to the proposed schedule, and a 95% chance that it will happen by the end of the year.

Merger risks

execution risk. Good communication between all stakeholders is the key to a successful merger. Before merging, validators on the consensus layer need to perform multiple operations, such as updating the correct TTD value, keeping nodes updated and in sync. User errors or incorrect information can lead to node loss. Clients of the consensus layer may also have undiscovered bugs. If enough nodes fail, Ethereum may stop temporarily. There is also execution risk for applications or exchanges running on Ethereum.

The Ethereum community has been actively working to mitigate these risks. For example, the community came together to improve customer diversity, dropping Prysm’s validator share from 68% in April to 41% today. This way, the consequences of potential bugs are greatly reduced.

Miner risk. As mentioned in the previous section, the incentives for miners will change before and after the merger.

Validator Risk. A new set of cyber risks emerges after the merger. One attack is a potential denial of service (DoS) attack. The proposer will be known in advance, which will incentivize some participants to maliciously DOS the validator. This also acts as a kind of centralization, favoring institutional verification pools for handling and mitigating DoS risks.

complexity risk. Ethereum will effectively merge two separate networks, expanding technical complexity. To join the beacon chain, an individual needs 2 clients. To run a validator, you need 3. To get MEV rewards, you need 4. The risk is that as Ethereum becomes modularized and specialized, this trend will continue to the point where it becomes difficult for anyone to understand the full picture.

Vitalik also addressed this issue in his recent EthCC presentation, calling on the community to start thinking about reducing the complexity of Ethereum.

Ideal long-term goals for Vitalik (for complexity, not price)

details the progress of the Ethereum merger and the merged MEV and miners

Summarize

details the progress of the Ethereum merger and the merged MEV and miners

Posted by:CoinYuppie,Reprinted with attribution to:https://coinyuppie.com/details-the-progress-of-the-ethereum-merger-and-the-merged-mev-and-miners/
Coinyuppie is an open information publishing platform, all information provided is not related to the views and positions of coinyuppie, and does not constitute any investment and financial advice. Users are expected to carefully screen and prevent risks.

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