Data analysis of the role of miners in the Ethereum ecosystem: What are the key impacts?

Data analysis of the role of miners in the Ethereum ecosystem: What are the key impacts?

The Ethereum community has always had a somewhat strained relationship with miners. The network’s proof-of-work algorithm, Ethash, was explicitly designed to resist ASIC mining, thereby resisting the professionalization of miners. Since then, the network has begun migrating to POS, with the ultimate goal of completely eliminating the role of miners in the network.

The network will continue to be supported by proof of work before the transition to Ethereum 2.0. However, even before this transition, the economic structure of mining on the network will change. The biggest impact is that miners will receive less block rewards.

It also manifests itself in the increasing compensation miners receive in Miner Extractable Value (MEV), which is the extractable rent for ordering trades. As on-chain arbitrage and clearing trades become increasingly profitable to execute, successful MEV executions begin to play a more important role in miner economics.

In addition to Ethereum's current volatile monetary policy and the growing importance of MEV, Ethereum's upgrades also have the potential to change miners' profitability. One of the proposals, called EIP-1559, burns a portion of the fees instead of sending them to miners. Another proposal under discussion, EIP-969, modifies Ethash to reduce the usefulness of ASICs on the platform, while a third proposal, EIP-1557, proposes changing the proof-of-work algorithm entirely. EIP-1559 is scheduled to be included in the upcoming London upgrade, while EIP-969 and EIP-1557 seem unlikely to be adopted.

At this critical point in the network's development, understanding the role that miners play in the Ethereum ecosystem is more critical than ever. In this article, we build on our work in Parts 1 and 2 of our "Follow the Flow" series and analyze Ethereum miner activity using data from Network Data Pro version 4.9. We find that Ethereum miner activity has increased significantly over the last year, likely as a result of increased MEV extraction, and that miners are primarily selling on Binance and Huobi.

supply

The metric works by dividing mining activity into two categories. 0-hop activity corresponds to mining pools, and 1-hop activity corresponds to miners. Addresses that receive block rewards are classified as 0-hop addresses, while addresses that receive payments from 0-hop addresses are classified as 1-hop addresses. This reflects the typical flow of funds in mining, where mining pool operators receive block rewards and miners receive payments from operators.

Applying the same methodology to Ethereum, we see that miners are controlling more and more Ethereum (ETH), while mining pools hold a relatively small supply. In particular, in 2020, the amount of Ethereum held by miners has increased significantly.

Due to the premise of Ethereum, most of the native token supply is not generated by miners. Therefore, miners' share of the total ETH supply has always been low. As their original value increases, the proportion of miners' holdings to the total network supply has generally increased over time.

This is completely different from Bitcoin, where proof of work has always been the primary method of issuing coins, and as the network matures, miners' share of the native token supply has generally declined.

Mining pool traffic

In addition to observing miner holdings, we can also analyze flows in and out of pool addresses. While these flows are largely insignificant, they are useful for contextualizing the broader miner flows discussed in the next section. Like Bitcoin, Ethereum pool addresses process relatively small volumes of transactions, and inflows and outflows generally occur in sync.

0-hop outflows are more volatile than inflows, and are primarily made up of block rewards. Due to the network’s volatile monetary policy and high fee volatility, miners’ income from block rewards is somewhat unpredictable.

While mining pool spending is far from all-time highs in native units, it continues to surge in USD terms, reflecting the rapid appreciation of ETH’s price.

Miner traffic

Mining pools account for a relatively small portion of total miner activity. As with Bitcoin, Ethereum miners play a wide range of roles in the ecosystem that cannot be fully captured in 0-hop traffic alone. 1-hop traffic is an order of magnitude larger than its 0-hop counterpart and has increased dramatically over the past year.

The rapid increase in inflows and outflows appears to be part of a broader trend over the past three years or so, with miner activity accounting for an increasing proportion of the value transferred across the network. Mining pool flows remain relatively insignificant, further highlighting the importance of taking a longer-term view when evaluating miner activity.

There are several reasons why this broader increase is occurring, including greater network maturity. However, the recent gains may be related to MEV: entities with relationships with mining pools may engage in on-chain arbitrage and liquidations to earn money outside of the protocol-mandated block rewards. If these addresses have received at least one payment from a mining pool, they are marked as 1-hop addresses by our heuristics, and their inflows and outflows are classified as miner activity. Because of the wide range, it is likely that this activity is actually carried out by traders and arbitrage bots that are not directly affiliated with miners.

Like total value, 1-hop net flow has grown significantly in size over the past year. This can also represent the growing role of MEV extraction in the miner economy.

ETHASH and Exchanges

In "FOLLOWING FLOWS II: WHERE DO MINERS SELL?", the Coin Metrics team announced the release of flow metrics that measure interactions between miners and exchanges. These metrics iterate on our standard miner flows, providing a more granular view of miner activity.

Miners’ deposits on exchanges can be used to measure miners’ sales and positions. Like Bitcoin miners, Ethereum miners generally tend to deposit coins on Binance and Huobi. These large Asian markets have good connections with miners, and these two exchanges also operate mining pools.

Huobi and Poloniex have outsized market shares among miners compared to their total network share inflows, though Binance’s share is almost as large as both combined.

The exchange miner withdrawal share chart is similar to the miner deposit share chart, but with greater fluctuations. For some reason, Huobi's miner on-chain withdrawal share seems to have been surpassed by Kraken recently: the reason is unclear, and the result is likely an anomaly rather than an indication of real changes in the market.

The total miner-exchange flow is also a valuable source of information. As expected, miners are usually net depositors: this is intuitive, as they can earn coins outside of exchanges through mining.

Since they are natural sellers, miners are often blamed for market volatility. In Ethereum, as with Bitcoin, these accusations are unfounded, as miners typically account for only a small, single-digit percentage of exchange inflows. While a large amount of miner selling occurs over-the-counter (OTC) and therefore does not immediately reach exchanges, the changes in miner activity are rarely large enough to cause concern.

Correlation analysis seems to support the lack of a substantial relationship between changes in miner selling and market volatility.

Over a one-year time span, Ethereum price has a low to moderate negative correlation with exchange pool deposits of -0.42, and a low to moderate positive correlation with overall pool outflows of 0.40. Price also has low positive correlations with miner deposits and overall miner outflows, at 0.20 and 0.31, respectively.

If miners were responsible for the price drop, we would expect a consistent moderate to strong negative correlation between spending and price. Currently, there is little evidence that miners are causing the market correction.

in conclusion

Ethereum mining is at a critical juncture, with the community considering several proposals that would fundamentally change the network’s mining economics, with MEV playing an increasing role in miners’ profitability. More importantly, these changes are happening against the backdrop of a broader plan to migrate the network to POS, further complicating the situation.