OKEx Insights: Transform or Exit? The Life and Death Decision of Miners in the ETH 2.0 Era

According to Coindesk on November 4, the deposit contract of ETH2.0 is now effective. At the same time, Vitalik Buterin posted a post on Twitter on November 6, 2020 titled: "Why Proof of Stake?
(Nov 2020)" expresses that the adoption of PoS by ETH2.0 is a foregone conclusion. The frequent news about ETH2.0 indicates that it is coming soon.

In this regard, users are eagerly looking forward to the upcoming launch of ETH2.0, and are making certain analysis and popularization on the online interactive platform.

Image source: Weibo

In addition, the price change of ETH tokens is the most representative of users' expectations and concerns. According to OKEx data, since the news was released on the evening of November 4, ETH has risen sharply, reaching a high of $467, and then stabilized at $450. As of November 9, the increase was as high as 24.8% compared with November 4.

Image source: OKEx

The discussion among followers and the rise in ETH price undoubtedly reflect the expectations of investors for ETH2.0. However, in addition to technical optimization, the ETH2.0 update also changes the mining reward algorithm. Do miners who directly contact ETH2.0 have the same expectations?

The answer is uncertain.

Since the advent of ETH, it has adopted the same mining reward algorithm as BTC - PoW. PoW (Proof of Work) proof of work requires all nodes to solve cryptographic puzzles. That is, the more cryptographic puzzles a miner solves in the same amount of time, the more rewards he will receive. In short, PoW is distribution according to work, the more work you do, the more you get.

As ETH gradually approaches the public's view, the disadvantages of PoW are becoming more and more prominent. First, PoW cannot perfectly reflect the ability of miners, but requires miners to spend a lot of money to buy larger and more powerful mining machines. Only when the mining machines calculate faster can miners solve cryptographic problems faster and get more mining rewards; secondly, ETH will adjust the difficulty at important nodes. As the cost of mining gradually increases, when the cost of mining is higher than the mining income, people's enthusiasm for mining will be greatly reduced, resulting in a significant reduction in computing power, and the network security of the public chain using the PoW mechanism will be threatened.

Taking the above defects into consideration, when upgrading ETH2.0, Vitalik's team proposed that after ETH is fully upgraded to 2.0, the PoS mechanism will be used to reward miners for mining.

PoS (Proof of Stake), Proof of Stake is a form of election, in which any node is randomly selected to verify the next block. There are no miners in Proof of Stake, but new blocks are created by validators. Validators are not completely randomly selected. To become a validator, you need to deposit a certain amount of tokens in the node network as equity, which can be understood as a deposit.

The size of the stake determines the probability of being selected as a validator, which is linearly related. We can assume that Lily deposits $100 and Jackson deposits $1,000. Then, when the election is held, Jackson has a 10 times higher chance of becoming a validator than Lily. In short, PoS is about distributing money and making money with money.

Image source: OKEx Insights

In his latest article published on November 6, Vitalik also stated the reason for choosing PoS:

First, compared to PoW, PoS is more secure at the same cost. Taking the cost of attacking a network at a block reward of $1 per day as an example, the total cost of a PoW attack based on GPU mining is about $0.26 (assuming the attack time is 6 hours), and it may drop to zero as the attacker obtains the block reward; the total cost of a PoW attack based on ASIC chip mining is $486.75 (consisting of $486.67 ASICs and $0.08 electricity and maintenance fees); and the total cost of a PoS attack is $2189 ($0.9 per day * 6.667 years). In the long run, as the stake increases, the cost will also increase. However, in the solution proposed by the Vitalik team, there are two ways to achieve a 5-20 times security gain at a low cost. One is to keep the block reward unchanged and benefit from the improved security; the other is to massively reduce the block reward (thereby reducing the "waste" of the consensus mechanism) and keep the security level unchanged. Overall, both have been achieved, and PoS is more secure at the same cost.

Image source: OKEx Insights

Secondly, under the PoS consensus mechanism, it is easier to recover from attacks. In a GPU-based system, without any defense measures, a persistent attacker can easily paralyze the entire chain permanently (or switch to PoS or PoA).
In a system without ASICs, the community can handle the first attack, but then becomes helpless. The community will first respond to the first attack by hard forking to change the PoW algorithm, thereby "locking" all ASICs (attacker's and honest miners'). But if the attacker is willing to bear this initial cost, after that the situation will return to the same as with GPUs (because there is not enough time to build and distribute the new algorithm for ASICs), so the attacker can continue to spawn attacks cheaply, which is inevitable. However, in
PoS is much better. For some types of 51% attacks (especially rolling back finalized blocks), there is a built-in "slashing" mechanism in Proof of Stake, by which the majority of the attacker's stake (not including others) is automatically destroyed. For other attacks that are more difficult to detect (51% coalition censoring everyone
Otherwise, the community can coordinate on a soft fork (UASF) activated by a few users, and the attacker's funds are again mostly destroyed. There is no need for explicit "hard fork currency elimination". Except for the requirement to coordinate the selection of a few blocks on the UASF, everything else is automatic and only needs to be executed according to the protocol rules.

Likewise, Vitalik Buterin said that PoS also has certain flaws:

First, PoS is more like a "closed system", and it takes a long time for wealth to be concentrated. In PoS, if the validator has some, they can use it to stake them to get more income, but in PoW, miners can continuously get more rewards through external resources. Therefore, in the long run, the distribution of coins in PoS is likely to become more and more centralized. However, in PoS, the general reward (validator income) is very low, and the more people verify, the less income each person gets, and centralization may take a long time to double.

Second, PoS requires "weak subjectivity", while PoW does not. In PoS, when a node comes online for the first time, or any node comes online after being offline for a long period of time (i.e., many months), the node must find some third-party source to determine the correct chain head. This may be their friends, exchanges, block search websites, client developers, etc. That is, PoS has some subjectivity and requires a certain trust foundation to proceed. But PoW does not have this requirement.

However, compared with PoW, the PoS mechanism is closer to decentralization and consistent with the original design concept , which will also be the biggest advantage for the team to choose it.

Image source: OKEx Insights

Judging from the concept and advantages and disadvantages of the reward mechanism, it is undoubtedly beneficial for ETH2.0 to transform PoW into PoS, but is this really the case?

It has been 7 years since the release of ETH's white paper.

For ETH miners who have already entered the market , this is a long journey. They have experienced the difficulties of Ethereum not being optimistic, the silence of not being paid attention to by the market, the huge costs and the expending of great efforts. As the mining costs continue to increase, the miners' income from ETH in the mining pool has gradually decreased.

Will the shift to PoS change their situation?

I think maybe it will or maybe not. For some miners who entered the market early, they may have made a lot of money in several big booms in the early days of Ethereum. For the PoW mechanism, they only need to update their equipment regularly or pay a certain amount of electricity, and the investment cost is much lower than the early income. The conversion of PoS has little impact on them.

For miners who enter the market later, this may be a hardship. They have already spent a huge amount of money to buy expensive mining machines in the early stage. The change of PoS mechanism may make it difficult for them to recover the cost of ETH in the short term. Therefore, a large number of miners may switch from mining ETH to mining other small coins in order to recover the cost of mining machines. ETH will lose a group of supporters. For miners who leave, this is not necessarily a relief or the best way to recover costs. With the launch of ETH2.0, the benefits it brings may be far higher than the benefits of small currencies. Miners need to spend more time to recover the mining costs, or they may miss opportunities. At the same time, miners will need to invest new costs in the PoS mechanism to get better opportunities, which requires miners to have enough savings and patience to invest, but perhaps after a period of time, they will have income that exceeds the investment.

For new validators who plan to enter the market based on market conditions , this is a good entry opportunity. Compared with old miners, they save the expensive mining machine costs in the early stage, and can use the saved costs to invest more money in PoS, so as to have a higher chance of being selected for verification. However, according to the article published by Vitalik Buterin, in Ethereum 2.0, the team expects the annual validator reward to be equivalent to about 0.5-2% of the total supply of ETH, and the more validators there are, the lower the interest. As more validators invest in ETH2.0 and more coins are put into the ETH2.0 fund pool, the rewards received by validators will also decrease, and the benefits earned by users through verification will decrease.

The transformation of ETH2.0's reward mechanism from PoW to PoS mechanism has advantages in design concept and investment cost, which brings both opportunities and challenges to miners. At the same time, market investment is uncertain, and the price of coins will fluctuate according to any factors. Investors need to carefully consider how to enter the market at the right time.