A look at the economic future of Ethereum

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This article originally appeared in Valid Points, CoinDesk’s weekly newsletter describing Ethereum 2.0 and its huge impact on the crypto markets. Subscribe to valid points here.

While weeks and months in crypto often look like years, it’s only been 60 days since the hard fork that contained EIP 1559 was implemented on Ethereum’s mainnet. A world of data regarding EIP 1559 has surfaced, but ultimately the upgrade is only in its infancy.

In fact, a few weeks ago, I wrote about Nic Carter’s slightly over-enthusiastic take-out on Ethereum and the fact that it was probably too early to estimate the impact of EIP 1559 on the network. However, this week I’m changing my tone a bit and looking at the potential implications of the upgrade base fee burn and its effect on Ethereum’s longevity.

At a very high level, under Proof of Work (PoW) and Proof of Stake (PoS), Ethereum uses block rewards to entice miners and validators in the chain. This incentive helps to properly secure the network by paying for those beneficial for confirming transactions and recording chain status, which in turn encourages the competition to develop a large and distributed base of miners / validators. .

Issuing Rewards: Bitcoin vs. Ethereum

Bitcoin uses a similar model, but every four years the amount paid in block rewards decreases until the reward is extremely negligible and the supply of bitcoin reaches 21 million. With block rewards becoming negligible, bitcoin miners will be forced to rely on transaction fees to stay profitable. Reasonably, the network will have to maintain a sufficiently high level of activity to pay miners for their services.

Ethereum and EIP 1559, on the other hand, now take a reverse approach to Bitcoin’s security budget. EIP 1559 took away the vast majority of transaction fee revenue that miners previously received, but Ethereum will continue to issue block rewards to miners (and possibly validators), indefinitely. As Ethereum takes an uncapped sourcing approach, the further lower fees will help counter ether inflation.

Bitcoin’s role as an inflation hedge has certainly been a big part of the asset’s success. However, its ‘digital gold’ narrative leads to weaker network activity as the asset is seen as a store of value rather than a medium of exchange, at least for now. This issue has led some to question whether the transaction fees will be sufficient to maintain the interest of the miners, whether the miners will adapt, or whether the network will have to switch to an updated compensation model.

It is probably wrong to say that EIP 1559 “solved” this problem of paying miners in perpetuity, because again, the fixed supply of bitcoin is what makes investing in the asset so attractive. Ether supply, on the other hand, will be extremely dependent on network activity and demand for block space. The Bitcoin network is years away from becoming a reality and will probably surprise me with its ability to adapt and survive.

My comparison between the two networks is strictly how they approach incentives for minors, which I think EIP 1559 may have solved with its fee reduction mechanism. A future in which Ethereum can continue to subsidize validators without diluting those that hold ether holds great promise for the network.

Pulse control

The following is a snapshot of network activity on the Ethereum 2.0 beacon chain over the past week. For more information on the metrics presented in this section, see our explainer 101 on Eth 2.0 metrics.

Disclaimer: All profits made from CoinDesk’s Eth 2.0 staking business will be donated to a charity of the business’s choice once transfers are activated on the network.

Validated sockets

  • The Altair upgrade moved validator rewards to newly created “timing committees” of 512 randomly selected validators. BACKGROUND: Synchronization committees are responsible for providing support to thin clients and signing the last block header. The odds of a validator being chosen for the committee are currently 1/489 and attestation rewards / penalties are magnified for the 24 hour period they are on the sync committee.
  • An NFT CryptoPunk appeared to sell for $ 530 million after a chain transaction prompted price bot alerts last Thursday. BACKGROUND: While CryptoPunks have sold for up to 4,200 ETH in the past, the false sell would have been the largest by order of magnitude. It appears the owner used a flash loan to make the fake Punk purchase, borrowing and paying back 124k ETH. This decision was probably a marketing stunt.
  • Cream Finance was operated by a flash loan for over $ 260 million in depositor assets. BACKGROUND: Cream is a leading decentralized peer-to-peer finance (DeFi) lending platform with a history of achievement. The flash loan manipulated the price of Cream’s defective “yUSD” collateral, making the price artificially high and allowing the operator to borrow significant borrowing power. The exploiters have shown significant knowledge of DeFi, maximizing the return of their loot and hiding their tracks with the Ren Bitcoin Bridge.
  • Aave was rumored to be the victim of a similar exploit to the one targeting Cream, which prompted Justin Sun to withdraw more than $ 4 million in collateral. BACKGROUND: A vulnerability with the xSushi warranty scared off Aave’s depositors and resulted in an approximately 20% decrease in total locked-in value (TVL). The governance process prevented the team from making an immediate fix and the bug is still exploitable to this day. The analysis of the Aave team showed that the manipulation would not be profitable for a hacker.

Factoid of the week

Open communications

Valid points integrate information and data about CoinDesk’s own Eth 2.0 validator into a weekly analysis. All profits from this staking business will be donated to a charity of our choice once the transfers are activated on the network. For a full overview of the project, see our announcement article.

You can check CoinDesk Eth 2.0 validator activity in real time with our public validation key, which is:

0xad7fef3b2350d220de3ae360c70d7f488926b6117e5f785a8995487c46d323ddad0f574fdcc50eeefec34ed9d2039ecb.

Look for it on any Eth 2.0 block explorer site.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


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