Wanting Into Ethereum’s Financial Future

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This article originally appeared in Valid Points, CoinDesk’s weekly newsletter, which breaks down Ethereum 2.0 and its far-reaching impact on crypto markets. Subscribe to valid points here.

While weeks and months in crypto often feel like years, only 60 days have passed since the hard fork, which contained EIP 1559, was implemented in the Ethereum mainnet. A world of data on EIP 1559 has emerged, but ultimately the upgrade is still in its infancy.

In fact, a couple of weeks ago I wrote about Nic Carter’s somewhat over-eager Ethereum food stalls and that it was probably too early to gauge the impact of EIP 1559 on the network. However, this week I’m changing my tone a bit and looking at the potential impact of the upgrade’s base fee burn and its impact on Ethereum’s longevity.

At a very high level, Ethereum uses Proof-of-Work (PoW) and Proof-of-Stake (PoS) block rewards to motivate miners and validators of the chain. This incentive helps adequately secure the network by paying those who do the job of confirming transactions and logging the state of the chain, which in turn encourages competition to build a large and distributed base of miners / validators.

Reward issue: 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 bitcoin supply exceeds 21 million. As the block rewards become negligible, Bitcoin miners will be forced to rely on transaction fees to stay profitable. Reasonably enough, the network must maintain a level of activity high enough to pay the miners for their services.

Ethereum and EIP 1559, on the other hand, now take a reverse approach to Bitcoin’s security budget. EIP 1559 has taken away the vast majority of the transaction fee revenue the miners previously received, but Ethereum will continue to give block rewards to miners (and eventually validators) indefinitely. While Ethereum has an unlimited supply approach, the newly introduced fee burning will help counteract Ether inflation.

Bitcoin’s role as an inflation hedge has certainly been a big part of the asset’s success. However, the narrative about the “digital gold” results in less network activity as the asset is viewed, at least for now, as a store of value rather than a medium of exchange. This issue has raised some questions about whether the transaction fees will be enough to keep the miners interested, whether the miners need to adapt, or whether the network needs to move to an updated compensation model.

It is probably wrong to say that EIP 1559 “solved” this perpetual payment problem from miners, because here, too, the bitcoin fixed offer is what makes investing in the asset so attractive. The supply of Ether, on the other hand, will depend extremely on network activity and the demand for block space. The Bitcoin network is still years away from the problem becoming a reality and will likely surprise me with its adaptability and survivability.

My comparison between the two networks is strictly how they approach incentives for miners, which I believe EIP 1559 may have addressed with its fee-burning mechanism. A future where Ethereum can continue to subsidize validators without watering down those who hold ethers looks very promising for the network.

Pulse control

Below is an overview of the network activity on the Ethereum 2.0 Beacon Chain over the past week. For more information on the metrics featured in this section, check out our 101 Eth 2.0 Metrics Explainer.

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

Validated takes

  • The Altair upgrade shifted the validation rewards to newly created “synchronization committees” of 512 randomly selected validators. BACKGROUND: Sync committees are responsible for supporting light clients and for signing the latest block header. The likelihood that a Validator will be elected to the committee is currently 1/489 and the confirmation rewards / penalties will be increased for the 24 hour period that they are part of the synchronization committee.
  • A CryptoPunk NFT appeared to be selling for $ 530 million after an on-chain transaction caused price bot alarms last Thursday. BACKGROUND: While CryptoPunks have been sold for up to 4,200 ETH in the past, the fake sale would have been orders of magnitude the largest. It appears that the owner used a flash loan to make the fake purchase of the punk and borrow and repay 124,000 ETH. The move was probably a marketing gimmick.
  • Cream Finance was taken advantage of through a flash loan for over $ 260 million in depository assets. BACKGROUND: Cream is a well-known peer-to-peer financing platform (DeFi) with a history of exploits. The flash loan manipulated the price of Cream’s flawed security “yUSD”, making the price artificially high and borrowing significant amounts of money from the recycler. The exploiters showed significant DeFi knowledge, maximized the return of their loot and hid their tracks with the Ren-Bitcoin bridge.
  • Aave was rumored to be vulnerable to an exploit similar to the one that targeted Cream, which prompted Justin Sun to remove over $ 4 million in collateral. BACKGROUND: An xSushi collateral vulnerability scared Aave depositors and resulted in a ~ 20% decrease in Total Value Locked (TVL). The governance process kept the team from fixing the bug immediately, and the bug is still exploitable to this day. The analysis by the Aave team showed that the manipulation would not be profitable for a hacker.

Factoid of the week

Open communication

Valid Points incorporates information and data into the weekly analysis via CoinDesk’s own Eth 2.0 validator. All profits from this staking company will be donated to a charity of our choice once broadcasts are enabled on the network. You can find a full overview of the project in our announcement post.

You can check the activity of the CoinDesk Eth 2.0 validator in real time via our public validation key, which is as follows:

0xad7fef3b2350d220de3ae360c70d7f488926b6117e5f785a8995487c46d323ddad0f574fdcc50eeefec34ed9d2039ecb.

Search for it on any Eth 2.0 Block Explorer site.

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