ETH is the most popular cryptocurrency recently. On the one hand, it has the top market performance among all major cryptocurrencies. On the other hand, the long-discussed upgrade seems to reach the final step. Today, a report is sourced in the Ethereum community for all ETH investors to understand the change of Ethereum 2.0 from 1.0, from Proof of stake to proof of work and its potential impact on the market.
The ETH 2.0 network upgrade is to gradually move towards the grand goal of the PoS consensus algorithm and incentive mechanism. In turn, the PoS incentive mechanism also has a profound impact on the economic properties of the Ethereum network. The design of the PoS incentive mechanism is very complicated. On the one hand, it must reward honest participants who verify transactions and finalize the historical state of the network, and on the other hand, punish those offline or malicious verifiers.
First of all, in order to facilitate the study of the economic model of ETH2.0, we used Excel to construct an economic model to explain the output of the ETH 2.0 system under the current specifications and specific scenarios. Throughout the course of the project, we gradually developed and used this model to calculate expectations, and based on the data, we reached conclusions about the verifier’s income, costs, benefits, and currency issuance.
In the ETH 2.0 system, there are nearly 100 variables that have a significant impact on the output value. Through this model, we dynamically show the impact of ETH price changes and the total amount of ETH staking on the return of validators, highlighting the impact of variables on network security.
We used a series of assumptions surrounding the cost of cyber attacks to define the level of economic security that ETH 2.0 Phase 0 must achieve. The meaning of this security level is to make the cost of the attack higher than the potential benefits that the attack can obtain and to make ETH 2.0 Phase 0 achieve the same level of security as ETH 1.0 (the current Ethereum blockchain).
We have identified two main types of economic attack vectors. Each type of attack vector has different variants and different degrees of risk: Supermajority Attack and Finality Attack. In Phase 0, we mainly focus on attacks designed to disrupt the network.
We found that the network is at risk of such attacks in Phase 0, but we are more worried about the subsequent phases. Based on the historical price and computing power of ETH, we estimate that a staking rate of 13.8% can provide sufficient security.
The security of ETH 2.0 is closely related to the ETH staking amount, and the staking amount itself has a functional relationship with the income. We constructed a model to understand the motivations of investors who are committed to high capital utilization. We call it the RSAVY (Required Serenity Active Validator Revenue) model, which is used to determine the risk and cost of staking, and the corresponding required rate of return (RRR).
Based on our research results, we predict that in an optimized (endogenous and exogenous) network, the validator will consider joining the network if the necessary rate of return (ie, the minimum rate of return) is not less than 3.3%. In a bearish but stable market environment, the necessary yield would increase to 11.6%.
In addition to calculating the necessary rate of return, the RSAVY model can also be used to outline the panorama of the network in a specific scenario. In these scenarios, we used different parameters and drew some conclusions and recommendations, see below for details.
1. The PoS mechanism of ETH 2.0 is much more complicated than the PoW mechanism. ETH 2.0 is a highly complex and thorough system. This system has been carefully designed and constructed, but it is difficult to understand from the verifier's point of view, which leads to uncertainty and unpredictability and increases the difficulty of understanding potential verifiers pursuing capital efficiency.
2. The security of the ETH 2.0 network depends on three key variables: ETH staking amount, ETH price, and volatility. Each variable will have a direct or indirect impact on the cost of attacking the network. The total amount of ETH staking is the most controllable variable, and the price of ETH has a great direct impact on network security, but it is not controlled by the system. Volatility may be caused by different factors, which will indirectly affect the amount of ETH staking and the price of ETH.
3. Attacks on ETH 2.0 are easier to scale than attacks on ETH 1.0. In ETH 2.0, the hardware cost required to participate in the network is reduced, so the (attack) hardware and power consumption will also be minimized. In addition, the boom of DeFi and the connectivity of ETH 2.0 will greatly accelerate this trend.
4. The behavior of verifiers pursuing capital efficiency becomes more predictable. Although the participation of Ethereum fans is essential to the successful launch of the beacon chain, it is not enough to allow the network to achieve a sufficiently high-security level. Attracting validators who pursue capital efficiency will help achieve the ETH staking amount goal.
5. According to the historical price of ETH, when the ETH staking rate reaches 13.8%, the security of ETH 2.0 is comparable to that of ETH 1.0. Based on the volatility of the historical price of ETH, we calculated that only when the ETH staking rate is not less than 13.8%, ETH 2.0 can obtain sufficiently high security.
6. There are economies of scale in verification activities, but as the value of ETH increases, the effects of scale will weaken. Under the PoW mechanism, if you want to increase revenue, you can only expand the scale of operations; under the ETH 2.0 PoS mechanism, the cost of verification activities will gradually decrease as the price of ETH increases. We found that, in general, network economics is very suitable for improving the decentralization of the network and achieving the design goals of Eth2.
7. 77.7% of the current ETH supply is concentrated in qualified validator wallets (holding more than 32 ETH). There are approximately 86.6 million ETH (77.7% of the current total supply) held by non-trading wallets (holding more than 32 ETH).
Another 18.7 million ETH is managed by the exchange. This is a highly attractive serviceable target market. In order to maximize network participation, the main goal of the incentive mechanism should be to convert these wallets into active validators.
8. Compared with ETH 1.0, the cost of ETH 2.0 to achieve security is much lower. Assuming that under the current beacon chain specification, the amount of ETH staking is 15.5 million (13.8%), we estimate that the annual inflation rate is 0.55%, which is much lower than the current 4-4.5% inflation rate of the PoW network.
9. Network security largely depends on the price stability of ETH. As far as the economic stability and security of ETH 2.0 are concerned, our main concern is whether the entire network is sufficiently resistant to attacks when the price of ETH is low. Considering the ability of attackers to rapidly expand the scale of their attacks, we believe that we really need to pay attention to price stability.
10. Lack of liquidity in Phase 0 and Phase 1 may lead to unpredictability and centralization. In view of the lack of interoperability between ETH 1.0 and ETH 2.0, and the ETH 2.0 network cannot be traded in Phase 0 and Phase 1, we expect a secondary market around derivatives in centralized exchanges. The verifiers using these platforms will be highly concentrated, resulting in centralization risks and unpredictability.
11. Beware of derivative attacks. With the rapid development of the Ethereum ecosystem, ETH as an asset class is also developing rapidly. The number of option products continues to increase, and special financial instruments such as "flash loans" are also used for evil. Under this momentum, derivatives may become the attackers' first choice.
Sourcing from twitter @thomasborgers @tehoban1