BitMEX: ETHPoW fork chain vs ETH2 Who is the final winner after the Ethereum merger

summary

In this article, we discuss the possibility of a chain fork when Ethereum merges, which will produce ETH2 coins and new ETHPoW coins. We study the feasibility of the ETHPoW chain and almost certainly determine that the ETHPoW chain is a niche chain, considering the price of the coin and the economic chain application. We conclude that although the ETHPoW chain may have many technical challenges and its long-term viability is questionable, it may provide an exciting opportunity for traders and speculators in the short to medium term.

Overview

After several delays, it looks like Ethereum will finally start the merge process in September 2022. At least Ethereum core developer Tim Beiko proposed Monday, September 19, 2022 as a possible merge date during a developer call on July 14, 2022. The first major part of the merge is the shutdown of proof-of-work mining. At that time, Ethereum will choose which blockchain to support, and the consensus part will migrate to the existing proof-of-stake beacon chain. However, the date of September 19, 2022 is far from final, and the exact time of the merge remains uncertain until clients with merge time parameters are released.

After the merger, two Ethereum clients will need to be run: 1. The staking client or consensus layer client; 2. The execution layer client, such as Geth. The execution layer client will still verify and process Ethereum smart contracts and transactions. It is worth pointing out that even after the merger, stakers cannot withdraw their staked ether back to the execution layer, and this "second round of merger" may take another 6 to 12 months.

When discussing the merger, there was a lot of feedback that the Ethereum community generally supports shutting down proof of work. In a recent meeting, Vitalik mentioned that if someone doesn't like this, they can always use Ethereum Classic (a survivor of the 2016 DAO incident). However, as one might expect, PoW miners generally oppose shutting down proof of work. Why? They will be completely excluded from the Ethereum system. Forget about the EIP-1559 protocol, this time their income in Ethereum will drop to zero in an instant. For months, some miners have been speaking out behind the scenes against the merger and expressed the hope that "something can be done." Finally, on July 29, 2022, Chandler Guo, one of the largest players in the Chinese mining ecosystem, said that he may plan to continue mining on the Ethereum PoW chain.

If the PoW chain survives and continues to scale, some have speculated that the token could be called ETHPoW. In our opinion, it is likely that this chain will extend beyond the merge point, however, it is an open question whether this chain will make any economic sense. Of course, there are arguments that the chain could survive for the long term. PoS may have its own weaknesses compared to PoW (e.g., staking derivatives is a natural monopoly), which ultimately makes PoS chains less attractive than PoW chains for certain use cases. All competing smart contract platforms to Ethereum (with the possible exception of Ethereum Classic) have already gone the PoS route, so it is possible that a PoW smart contract chain will gain significant traction. There are no real candidates other than ETHPoW.

All in all, ETHPoW is a throwback to the days of the Bitcoin and Ethereum forks of 2016/17, and looks likely to spark interest among market participants.

Ice Age

Seven years ago, when Ethereum’s PoS system was just a series of oddball ideas on the drawing board, Vitalik foresaw this potential problem (persistent chain forks after the transition to PoS). A solution was proposed, called the Ice Age. In this system, the difficulty of the PoW mining network would increase exponentially over time, and eventually the chain could no longer be extended effectively. Ethereum’s first major network upgrade after the original Frontier client was called the Ice Age and included the first difficulty bomb. The bomb was set to “go off” in 2017, when the Serenity upgrade prepared to transition the network to PoS. However, the PoS upgrade was delayed, and so the difficulty bomb was also postponed by the hard fork.

The so-called difficulty bomb has actually exploded several times in the past. For example, in the first few days of October 2017, Ethereum's average block time was around 30 seconds, after which the difficulty bomb system was reset and the block interval returned to the normal 13 seconds or so. In the history of Ethereum, the difficulty bomb has been reset 6 times and there have been 6 hard forks.

The most recent reset was proposed in June 2022, and the bomb is now expected to "explode" in mid-September 2022, which is the perfect time to switch to PoS, as planned as early as 2015. Although the bomb will be detonated in September, based on previous bomb explosions, it may take several months for the impact of this bomb explosion on the average block interval to be apparent. For example, some calculations estimate that it may take 175 days for the block interval to reach around 30 seconds. After this, the situation will deteriorate exponentially.

Another interesting factor is that this transition to PoS is serious. As a result, the price of ETHPoW may be low relative to ETH (noticeable price collapse), and the price may be very volatile. This may reduce the incentive to mine ETHPoW, so accurately assessing how the ice age will work, which already constitutes a rather complex circular dependency between miner incentives, hash rate and block time, may be very challenging.

New ETHPoW Hard Fork Client

The arrival of the Ice Age means that the PoW chain may only survive for a few hundred days after the fork. If the PoW chain is to exist for a long time, a new hard fork client may be required to permanently eliminate the characteristics of the Ice Age. This brings several problems to ETHPoW, which may be exactly what the Ice Age was designed to produce. It removes a layer of legitimacy from ETHPoW. ETHPoW can no longer claim to be the existing or original rule chain. It also requires a hard fork. However, not many Ethereum users today really care about this, which seemed to make more sense 7 years ago.

At the same time, any ETHPoW community will need to find developers with the technical expertise to produce new clients. They will also need to solve the Schelling point problem and reach consensus on the new client and new parameters to activate and implement a hard fork to eliminate the ice age. Exchanges and custodians may need to be persuaded to run and support this new client, which may be slightly more difficult than convincing them to continue running old Geth nodes on the new ETH2 infrastructure. However, in practice, these problems can be overcome fairly easily, and the size of the ETHPoW community is unlikely to be particularly large, so this may not be a major problem. It may only be a behind-the-scenes guess by a few large miners.

Locking up staked coins

Currently, there are approximately 13.2 million ETH staked on the beacon chain, and if the actual balance is counted, it is close to 14 million (accumulated Ethereum staking income plus any deposits above the 32 ETH threshold). As far as we know, on the original ETHPoW chain, these funds will be lost forever without a hard fork. In contrast, on the ETH2 chain, these tokens can be sent back to the execution layer at some point in the future. This has some implications for the ETHPoW chain. First, some people may say that the smaller supply of ETH on the ETHPoW chain may increase the price of ETHPoW. In addition, because users have lost large amounts of money on the ETHPoW chain, it may cause the reputation of the chain to be damaged, ultimately damaging ETHPoW.

If a new hard fork ETHPoW client is issued to solve the ice age problem, a decision may need to be made on how to deal with these staked coins. This is the dilemma that the ETHPoW community will face. One possible outcome is that because the key is that this is a PoW coin, they may lock up these staked coins forever. In the world of ETHPoW, staking is a wrong decision. At the very least, the accumulated staking income of about 800,000 on the ETHPoW chain before the merger should be considered completely illegal. Therefore, if you are a validator, or you hold stETH, you may not perform particularly well on the ETHPoW chain.

Stablecoins

Many speculate that if a contentious Ethereum fork occurs, it will no longer be the Ethereum Foundation or Vitalik Buterin who makes the decision. It is said that in this case, the new king may be the stablecoin custodian. These custodians have to choose a chain to support, and considering the popularity, prevalence of these tokens, and their relevance to Defi, their decision will determine the winning chain. Therefore, perhaps the most powerful person in Ethereum becomes Jeremy Allaire (CEO of Circle, the issuer of USDc), and no longer Vitalik Buterin.

Of course, Jeremy is the CEO of a company and has a responsibility to his customers, and to do otherwise would mean that he is acting in a manner that is not in the best interest of shareholders and may be illegal, so in practice he may not have such power. However, the most likely way this obvious risk would manifest itself is if a government authority ordered Circle to support a certain chain for some regulatory reason. This issue is a potential weakness of Ethereum.

If there is a chain fork after the merger, Circle, Tether, Binance and other stablecoin custodians are likely to support ETH2. Therefore, even if the Ethereum Foundation and the community strongly support ETH2, the result of this fork is clear, ETH2 will be the winner and ETHPoW will fail. On ETHPoW, many Defi applications that rely on USD stablecoins will show economic collapse in many catastrophic ways. However, there are many other effects of the position of stablecoin issuers, which we will discuss below.

Sell ​​ETHPoW

Many Ethereum maximalists strongly support the transition to PoS and dislike ETHPoW. Therefore, they may hope that the ETHPoW chain will die as soon as possible.

There is another layer of thinking on top of this. Ethereum maximalists should actually (somewhat perversely) want the ETHPoW chain to survive, at least for a while, so that they can trade their ETHPoW coins on the market for more ETH (or USD). This way they can make money from what they consider to be "stupid" ETHPoW supporters, all before ETHPoW slowly dies in the next few years. So, probably a lot of people will sell their ETHPoW as soon as possible, and the price may be very low.

But wait… there’s another layer of thinking on top of this, a third layer of thinking. What everyone should actually do (Ethereum maximalist or not) is buy ETHPoW as soon as the merge happens. I’ll explain this in more detail below.

Snap up ETHPoW

In order to sell ETHPoW for ETH, you may need to wait for a centralized exchange to support ETHPoW after the merger. While centralized exchanges like FTX and Binance may launch products soon, it may take some time to support ETHPoW deposits, at least a few hours or days. No matter how well prepared they are, the hash rate and block time on ETHPoW are likely to be unstable, and they need to protect themselves from double spending attacks.

On the other hand, in theory, people should be able to buy ETHPoW on decentralized on-chain exchanges once the merger occurs. Whatever your opinion on ETHPoW, you must think it is a better bet than all the other ERC-20 coins on the ETHPoW chain?

Let’s take a look at how some of the tokens on Ethereum today would perform on the ETHPoW chain:

* USDc on ETHPoW — worthless since Circle will choose ETH2, so the token will not be redeemable as we discussed above.

* USDT on ETHPoW — also worthless.

* WBTC on ETHPoW - no value as the custodian will choose ETH2, so the coin will not be redeemable for Bitcoin.

* BNB on ETHPoW — still worthless, as Binance will choose ETH2.

* Uniswap on ETHPoW — The long-term viability of this token on the ETHPoW chain is questionable. This coin may collapse faster than ETHPoW.

* stETH on ETHPoW - since there is no stake on this chain, these coins may be worthless, as described above.

* All other ERC-20 tokens on the ETHPoW chain — likely have very limited value on the ETHPoW chain.

Therefore, the best strategy may actually be to buy as much ETHPoW as possible before it can be traded on centralized exchanges. Later, when it can be traded on centralized exchanges, you can sell ETHPoW. This is like a free option on ETHPoW.

Merger Trading Strategies

With these potentially contentious chain forks, Ethereum mergers present an exciting trading opportunity. Here is a potentially “risk-free” trade idea:

1. Before the merger, convert all USD in your Ethereum wallet to USDc.

2. Once the merger occurs, sell your USDc on the ETHPoW chain and buy ETHPoW coins on on-chain decentralized exchanges such as UniSwap or Curve.

3. Once centralized exchanges enable ETHPoW deposits, sell all your ETHPoW and convert it to USD.

4. Profit

By doing the above transactions, you may get more USD for free with almost zero risk! The zero risk mentioned only applies to certain types of risks, such as price fluctuations.

Of course, executing the above trade in reality is actually quite complex and risky, with several issues to manage:

* You need to trade quickly as there will likely be a race to take advantage of this opportunity. The liquidity pool for selling ETHPoW may dry up quickly.

* You will need to manage your own keys rather than use custodianship. It is unlikely that any third-party custodian will support ERC-20 coins on ETHPoW so soon after the fork.

* Any infrastructure you use to interact with decentralized exchanges may support merges and only run on ETH2. Therefore, you may need to run your own Ethereum node and interact directly with smart contracts on ETHPoW. This may be quite complicated for some traders, but this difficulty is the opportunity for profit. It may be beneficial to practice more on ETH1 before the fork.

* You may need to ensure your USDc sell/swap orders are not replayed on the ETH2 chain. May require creating a forked smart contract.

* It is possible that liquidity providers were aware of this potential risk and withdrew liquidity before or soon after the merger. However, it is also possible that some liquidity providers were too lazy to do so, thus creating an opportunity.

* Many DeFi protocols rely on price oracles, and it may not be clear how to handle the ETHPoW side of the chain.

There are some more advanced strategies that one might try to apply in DeFi, including leverage, lending, or providing liquidity, however, we’ll leave it at that for now.

in conclusion

Any chain fork that occurs at the Ethereum merge point could be an interesting throwback to the 2016/17 era. While ETHPoW faces many technical challenges, as long as the chain survives, there is a high likelihood of a positive narrative surrounding the coin and major centralized exchanges may list it. The crypto world is still very much a narrative and noise. ETHPoW could generate a lot of exciting opportunities, and we predict ETH-ETHPoW to become a popular trading pair after the fork, at least until another interesting situation emerges. May the game start soon!