Briefly describe the characteristics of Ethereum 2.0 economic incentive mechanism and security suggestions

Original title: "Viewpoint | A brief summary of the ETH 2.0 economic model analysis report"
By Tom Borgers
Translated and proofread by: Min Min and A Jian

In March 2020, we received funding from MolochDAO to research the economic model of ETH 2.0. This investigation was originally in response to a call for proposals:

Since then, we have been working hard to analyze the ETH 2.0 network and its PoS-based economic incentive mechanism. Our conclusions are based on our own research. We built an economic model to reflect the inputs and outputs of the ETH 2.0 network and interviewed many stakeholders representing the main players in the Ethereum ecosystem.

We have compiled all of our findings into the following report:

ETH 2.0 Economic Review: Analysis of Ethereum PoS Incentive Model

We would like to thank MolochDAO, the people we spoke with, and the Ethereum Foundation for their support of this project. Special thanks to Danny Ryan, Barnabe Monnot, Trent Van Epps, and Vitalik Buterin for their comments and suggestions on the initial draft.

While we highly recommend reading the full report, we’ve included a summary below. If anyone has any questions, please reach out to us on Twitter — @thomasborgers and @tehoban1 — PMs are welcome!

The ETH 2.0 network upgrade is a gradual move towards the grand goal of the PoS consensus algorithm and incentive mechanism. In turn, the PoS incentive mechanism has a profound impact on the economic properties of the Ethereum network. The design of the PoS incentive mechanism is very complex - on the one hand, it is necessary to reward honest participants who verify transactions and finalize the historical state of the network, and on the other hand, punish those offline or malicious validators. In this paper, we use a sophisticated economic model and a new economic evaluation tool to define, measure, and analyze the cryptoeconomic security of ETH 2.0.

First, to facilitate the study of the economic model of Eth2.0, we used Excel to build an economic model to explain the output of the ETH 2.0 system under current specifications and specific scenarios. Throughout the project, we gradually developed and used this model to calculate expectations and draw conclusions about validator income, costs, benefits, and currency issuance based on data. In the ETH 2.0 system, there are nearly 100 variables that have a significant impact on the output value. Through this model, we dynamically show the impact of ETH price changes and the total amount of ETH staked on validator income, highlighting the impact of variables on network security.

We defined the level of economic security that ETH 2.0 Phase 0 must achieve using a series of assumptions around the cost of attacking the network. This level of security is meant to make the cost of an attack higher than the potential benefit of an attack, and to give ETH 2.0 Phase 0 the same level of security as ETH 1.0 (the current Ethereum blockchain). We identified two main categories of economic attack vectors. Each of these attack vectors has different variants and different levels of risk: Supermajority Attacks and Finality Attacks. In Phase 0, we focus primarily on attacks that are intended to destroy the network. We find that the network is at risk of these attacks in Phase 0, but we are more concerned about subsequent phases. Based on the historical price and hashrate of ETH, we estimate that a staking rate of 13.8% provides adequate security.

The security of ETH 2.0 is tied to the amount of ETH staked, which itself is a function of returns. We built a model to understand the motivations of investors who are committed to high capital utilization. We call it RSAVY (Required Serenity Active Validator Return) model, which is used to determine the risk and cost issues of staking, and the corresponding required rate of return (RRR). Based on our results, we expect that in an optimized (endogenous and exogenous) network, the required rate of return (i.e., minimum rate of return) must be at least 3.3% before validators will consider joining the network. In a bearish but stable market environment, the required rate of return increases to 11.6%.

In addition to calculating the required rate of return, the RSAVY model can also be used to outline the overall picture of the network in specific scenarios. In these scenarios, we use different parameters and come to some conclusions and suggestions, which are detailed below.

in conclusion

The PoS mechanism of ETH 2.0 is much more complicated than the PoW mechanism. ETH 2.0 is a highly complex and well-thought-out system. This system has been carefully designed and constructed, but it is difficult to understand from the perspective of a validator, resulting in uncertainty and unpredictability, making it more difficult for potential validators who seek capital efficiency to understand.
*The security of the ETH 2.0 network depends on three key variables: ETH stake, ETH price, and volatility. Each variable will have a direct or indirect impact on the cost of attacking the network. The total ETH stake is the most controllable variable, while the ETH price has a large direct impact on network security, but is not controlled by the system. Volatility may be caused by different factors, which will indirectly affect the ETH stake and ETH price.
Attacks on ETH 2.0 are more scalable than attacks on ETH 1.0. In ETH 2.0, the hardware cost required to participate in the network is reduced, so the hardware and electricity consumption (of the attack) will also be minimized. In addition, the booming development of DeFi and the connectivity of ETH 2.0 will greatly accelerate this trend.
**The behavior of validators pursuing capital efficiency becomes more predictable. Although the participation of Ethereum supporters is crucial to the successful launch of the beacon chain, it is not enough for the network to reach a sufficiently high level of security. Attracting validators pursuing capital efficiency will help achieve the ETH staking target.
According to the historical price of ETH, when the ETH pledge rate reaches 13.8%, the security of ETH 2.0 will be comparable to that of ETH 1.0. According to the fluctuations of the historical price of ETH, we calculated that ETH 2.0 can only obtain sufficiently high security when the ETH pledge rate is not less than 13.8%.
* There are economies of scale in verification activities, but as the value of ETH increases, the economies of scale will weaken. Under the PoW mechanism, the only way to increase revenue is to expand the scale of operations; under the PoS mechanism of ETH 2.0, the cost of verification activities will gradually decrease as the price of ETH increases. We found that, in general, network economics is very suitable for increasing the decentralization of the network and achieving the design goals of Eth2.
77.7% of the current ETH supply is concentrated in eligible validator wallets (holding more than 32 ETH). About 86.6M ETH (77.7% of the current total supply) is held by non-exchange wallets (holding more than 32 ETH). Another 18.7M ETH is managed by exchanges. This is a very attractive and serviceable target market. To maximize network participation, the main goal of the incentive mechanism should be to convert these wallets into active validators.
**ETH 2.0 pays a much lower cost to achieve security than ETH 1.0. Assuming ETH stake is 15.5 million (13.8%) under the current beacon chain specification, we estimate the annual inflation rate to be 0.55%, which is much lower than the current 4-4.5% inflation rate of the PoW network.
The security of the network depends heavily on the price stability of ETH. In terms of the economic stability and security of ETH 2.0, our main concern is whether the entire network is sufficiently resistant to attacks when the price of ETH is low. Given the ability of attackers to quickly scale up attacks, we believe that price stability is indeed a concern.
* Lack of liquidity in Phases 0 and 1 could lead to unpredictability and centralization. Given the lack of interoperability between ETH 1.0 and ETH 2.0, and the inability of the ETH 2.0 network to trade in Phases 0 and 1, we expect secondary markets around derivatives to emerge on centralized exchanges. Validators utilizing these platforms will be highly concentrated, creating centralization risk and unpredictability.
*Beware of derivatives attacks. *As the Ethereum ecosystem develops rapidly, ETH as an asset class is also developing rapidly. The number of options products continues to increase, and special financial tools such as "flash loans" are also used for malicious purposes. Under this momentum, derivatives may become the preferred route for attackers.

suggestion

Increasing the base reward factor to 128 and beyond: We acknowledge that increasing network costs helps improve network security, but with a base reward factor of only 64, we believe the cost the network pays for security is insufficient - it is wise to be cautious during the Ethereum network's transition to a PoS mechanism.
* Find a more dynamic way to change rewards in the event of an emergency (ETH price crash), i.e., explore implementing a safety net. * We recommend exploring a more dynamic way to increase rewards or change the base reward factor in the event of an emergency, for example, introducing a threshold trigger mechanism, a step function, or a function directly related to the ETH price.