Valid Points: The Problem With MEV on Ethereum
The new frontier of miner/maximal extractable value (MEV) on Ethereum may have negative consequences for network finality and immutability. Key to defending Ethereum against these MEV forces is the upcoming transition to Eth 2.0 and proof-of-stake (PoS). But will the transition come soon enough?
This article originally appeared in Valid Points, CoinDesk’s weekly newsletter breaking down Ethereum 2.0 and its sweeping impact on crypto markets. Subscribe to Valid Points here.
Pulse check
Bitcoin dominance tends to fall every crypto bull market cycle. As background, BTC dominance is a metric tracking the percentage of total cryptocurrency market capitalization made up by BTC.
Related: Bitcoin Is Already Incentivizing Renewable Energy
During the most recent bull market cycle, BTC dominance dropped from roughly 70% in January to as low as 40% in May. While the volatile crypto markets have since turned bearish over the latter half of Q2 2021, causing BTC dominance to pick back up again, the metric continues to trend between the range of 40% and 50%.
Among the alternative cryptocurrencies eating up the market share of BTC, the native cryptocurrency of Ethereum, ether, is the next largest coin, making up roughly 18% of total crypto market share. While ETH is the second-largest cryptocurrency next to BTC and has been since as early as 2016, it is not the fastest-growing altcoin on the market.
In 2021 Q2, the fastest-growing altcoin, excluding stablecoins, by monthly market cap growth, was the native token of Chiliz, a blockchain services network for sports and entertainment providers.
The chiliz token (CHZ) is the exclusive marketplace currency on Socios.com. Socios.com aims at decentralizing fanbase interaction with sports teams by leveraging blockchain infrastructure to facilitate payments for team merchandise, voting rights and other rewards. The marketplace has partnered with over 20 sporting and esports organizations including FC Barcelona, Juventus and Atletico de Madrid.
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Related: Ether Erases Early Losses, Faces Resistance Above $2K
Fans for each of these teams can purchase branded “Fan Tokens” on Socios.com that allow them to vote on certain team decisions such as renaming facilities or changing entrance songs. Since the CHZ is the exclusive means of exchange in the marketplace, the token accrues in value alongside demand for voting rights and rewards provided by the entertainers on the Socios.com platform.
The sports industry alone has a yearly value in the hundreds of billions of dollars and could gain further value through strong customer loyalty programs like the ones being experimented on through CHZ and Socios.com. The Chiliz token is one way to speculate on the use of Ethereum-based tokens for fan engagement and the continued growth of the Socios.com marketplace as the main platform to do this.
Teddy Oosterbaan
New frontiers: Does Ethereum need a stronger defense against MEV?
Block subsidies, transaction fees and miner/maximal extractable value (MEV): These are the three main revenue streams of Ethereum miners.
In efforts to combat currency inflation, protocol developers lowered block subsidies from 5 ETH to 3 ETH in 2017, and again from 3 ETH to 2 ETH in 2019. Starting in August 2021, transaction fees are also expected to decline as a result of Ethereum Improvement Proposal 1559 and its fee-burning mechanism. The only revenue stream that is expected to grow larger and more lucrative for miners in the months to come is MEV.
MEV refers to the income a miner receives as a direct result of their ability to insert, leave out and reorder transactions within a block. The order of transactions is of utmost importance in the context of high-frequency trading on decentralized exchanges (DEXs) where automated bots can identify buy or sell orders waiting for execution on Ethereum and front-run these trades before they get executed.
The higher the liquidity and value being moved on-chain through these DEXs, the greater the profit opportunity for miners to earn additional income through MEV.
*Missing values for daily extracted MEV appear in this chart as interpolated dotted lines that connects the plot points immediately preceding and succeeding the missing value
The larger MEV rewards become in comparison to block subsidies and transaction fees, the greater the financial incentive for miners to adjust not only the order of transactions but also the order of blocks themselves. In what is known as a “time bandit” attack, miners may begin to identify MEV opportunities in blocks that have already been finalized and reorganize the blockchain in their favor if potential rewards from frontrunning are larger than earnings from honest mining (i.e., block subsidies and transaction fees).
Speaking to the potential for miners to reorganize Ethereum blocks and disrupt chain finality, Georgios Konstantopoulos and Leo Zhang from Paradigm Research wrote in a blog post back in March, “This scenario is not obviously plausible: Miners are (for the most part) structurally long ETH, and such an action would directly negatively impact their ETH investment.”
Theory manifesting into reality
However, it would appear the tools for MEV extraction by way of block reorganization are actively being built and already being executed in primitive forms.
Edgar Aroutiounian of Flashbots tweeted on Thursday, July 8, that he had created a personal GitHub repository codifying how payments to miners can be facilitated in exchange for destabilizing blockchain consensus. Shortly thereafter, on Saturday, July 10, Twitter user “0xbunnygirl” announced their own code repository for MEV extraction through block reorgs called “Request for Reorg.”
While the possibility of MEV negatively impacting chain finality and immutability has been a long-running concern, discussed as early as November 2020 among Ethereum researchers, the reality of this happening appears to be manifesting today.
In light of this reality, there are a handful of defense mechanisms that researchers insist will protect the integrity of Ethereum’s blockchain. First, there is the collective will of the Ethereum community to censor this kind of behavior. Users can leave mining pools that are using their computational power, also called hashrate, to reorg blocks. Honest miners can resist accepting blocks they know to be from hostile miners engaging in these MEV practices.
Second, there is the forthcoming upgrade to a proof-of-stake (PoS) consensus protocol with Eth 2.0, after which miners will no longer have the ability to propose blocks or reorder transactions within blocks. These two responsibilities will fall into the hands of validator node operators, who are required to own a large investment of ETH, worth roughly $63,600 or 32 ETH, and have skin in the game in order to participate in blockchain consensus.
Weak lines of defense
Neither of these two defenses is convincing. The former assumes the collective will of the community is homogeneous and aligned on resisting MEV extraction through block reorgs despite clear evidence to the contrary. For some, such as Aroutiounian, if block reorgs can be done on Ethereum and there is a clear financial incentive for them to happen, they should – regardless of how it impacts public perception of the network.
The upgrade to Eth 2.0 and PoS as a defense against block reorgs for MEV extraction does not address the present reality and the impact these events can have on the value of Ethereum in the interim before the upgrade is ready for deployment. The readiness checklist which outlines all the tasks needed for PoS activation remains in large part unfinished. The earliest that developers estimate Ethereum’s transition to PoS will happen is the beginning of 2022.
Ethereum needs a stronger line of defense to combat the reality of MEV extraction through block reorgs.
Validated takes
Short-term profitability proves more important for decentralized exchange (DEX) users on Polygon than Ethereum. TAKEAWAY : Polygon’s DEX trading volume and liquidity came and went with a spike in rewards during the month of June, while remaining comparatively more stable on Ethereum over the same time period. (Data, Glassnode)
Sygnum Bank becomes the first banking institution to offer staking services for Ethereum 2.0. TAKEAWAY : The Swiss bank built for digital asset custody, brokerage and tokenization is expanding its offering of yield generating products by offering clients up to 7% per annum on their ETH through staking. In today’s low or negative interest rate environment, the bank wrote in a blog post, digital assets offer an alternative to yield generation. (Article, Yahoo)
Gas prices on Ethereum have been on a downward trend since late April, dropping from roughly 150 gwei to 15 gwei. TAKEAWAY : A higher block capacity, the rising popularity of layer 2 scaling solutions and increased use of alternative payment channels between DEX traders and miners are all likely factors contributing to lower gas prices on Ethereum. (Newsletter issue, Coin Metrics)
Circle, the co-creator of dollar-backed stablecoin USDC, is set to go public at a $4.5 billion valuation. TAKEAWAY : USDC is the second-largest stablecoin on Ethereum by circulating supply next to tether. In a presentation on Circle’s plans to go public, the company predicted sevenfold growth in USDC’s market capitalization by 2023. The predicted circulating supply would be $190 billion, much higher than leading stablecoin, USDT, which currently is sitting around $63 billion. (Article, CoinDesk)
Weekly volumes in dollar markets for BTC and ETH reached new all-time highs in 2021 Q2. Notably, notional volumes in ether-dollar pairs consistently surpassed bitcoin pairs for the first time ever in the month of May. TAKEAWAY: Surging interest in NFTs and DeFi since the beginning of this year are likely factors contributing to the growth of ether trading volumes. (Report, CoinDesk)
Teddy Oosterbaan
Factoid of the week
Open comms
Valid Points incorporates information and data directly from CoinDesk’s own Eth 2.0 validator node in weekly analysis. All profits made from this staking venture will be donated to a charity of our choosing once transfers are enabled on the network. For a full overview of the project, check out our announcement post.
You can verify the activity of the CoinDesk Eth 2.0 validator in real time through our public validator key, which is:
0xad7fef3b2350d220de3ae360c70d7f488926b6117e5f785a8995487c46d323ddad0f574fdcc50eeefec34ed9d2039ecb.
Search for it on any Eth 2.0 block explorer site.
New episodes of “Mapping Out Eth 2.0.” with Christine Kim and Consensys’ Ben Edgington air every Thursday. Listen and subscribe through the CoinDesk podcast feed on Apple Podcasts, Spotify, Pocketcasts, Google Podcasts, Castbox, Stitcher, RadioPublica, IHeartRadio or RSS.
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Vitalik Buterin Is Involved in a New Documentary About Ethereum
A documentary film team is working on the first feature-length documentary about Ethereum – and they’re looking for ETH donations to fund it.
“Ethereum: The Infinite Garden” will feature interviews with various people involved in the development of the world computer, including the network’s co-creator, Vitalik Buterin, and Aya Miyaguchi, the executive director of the Ethereum Foundation.
The film production company Optimist is behind the documentary, with Carrie Weprin producing and Zach Ingrasci and Chris Temple co-directing. Weprin and Ingrasci had both been aware of the crypto ecosystem before getting involved in the project, but they said the interviews they’ve done for the film really turned them into Ethereum fans.
Related: Valid Points: The Problem With MEV on Ethereum
Funding for “Ethereum: The Infinite Garden” is taking place on Mirror until Friday, July 16, with a goal of raising 750 ETH (about $1.5 million at today’s prices). As of press time, 67 people had contributed a total of 60.3 ETH.
For the filmmakers, crypto crowdfunding felt like the most authentic way to raise funds for the film because it allows members of the community to get involved and shape the outcome of the project, which is still currently in the early stages of development.
“I think it’s so exciting that a DAO [decentralized autonomous organization] could be our executive producer,” Ingrasci said. “That would be the first time that’s ever happened for a film. For sure the executive producer will be someone from the community. This is why we wanted to involve the community as early as possible.”
Non-fungible tokens (NFTs) designed by crypto artist pplpleasr are available for purchase on Mirror, with each denoting a level of involvement in the project.
Related: Ether Erases Early Losses, Faces Resistance Above $2K
Morgan Beller, co-creator of libra and now an investor at NFX, connected the Optimist team to Buterin.
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“I’ve always thought Buterin deserved to have his story out there. The whole Ethereum team is just so pure, authentic, kind and wonderful,” Beller said, adding:
“If you’re first learning about Ethereum and you’re not a crypto person, you don’t necessarily see that side. But I always thought that if the world were able to somehow see and understand where this is all coming from, the heart and thoughts behind it, people would both understand it and be more supportive.”
Weprin said the team hopes to place the film in a major film festival in 2023 and will likely pursue distribution on major streaming platforms.
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Ethereum Network on Pace to Settle $8 Trillion in 2021
According to Messari’s second-quarter decentralized finance review, the Ethereum network has settled $2.5 trillion between April and June this year.
It added that this represents a gain of more than 65% quarter on quarter and almost 1,500% year on year. If the current pace continues, the Ethereum network could settle $8 trillion by the end of this year, Messari noted.
Researcher Ryan Watkins stated that the largest driver of this growth continues to be DeFi and stablecoin activity.
For the same quarter in 2020, when the DeFi sector was just starting to bubble up, $159 billion was settled on Ethereum. Going back a year to 2019 when markets were still largely bearish, just $73 billion was settled on the network.
Ethereum whales have also been increasing their holdings with the top ten ETH wallets now controlling more than 20% of the entire supply.
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Stablecoin Activity Surging
Stablecoins still made up about half of the total settlements for the quarter despite the decline in ERC-20 based ones on Ethereum.
Messari noted that in Q2 2021, the stablecoin monetary base reached over $107 billion, up 70% since Q1 and more than 800% year-over-year. The three-month period has facilitated $1.7 trillion in transaction volume for stablecoins, up 1,090% year-over-year and 59% since Q1, the report added.
The biggest growing stablecoins in Q2 were USDC, BUSD, and DAI which grew their market share to 23%, 9%, and 5%, respectively. USDT is still the market leader however its dominance is gradually fading as rivals eat into its share.
According to the Tether transparency report, its total supply is currently 62.4 billion – an increase of 197% since the beginning of the year. Of this total, less than half or 30.9 billion USDT are on the ERC-20 token standard. Slightly more are on the Tron network which has 32 billion USDT.
USD Coin has vastly outperformed Tether this year in terms of growth with a supply surge of 577% since the beginning of the year to a record 26.4 billion USDC circulating today.
Ethereum Price Weakens
Despite Ethereum’s bullish transaction figures, the underlying asset continues to weaken. ETH prices are still below the psychological $2K level, trading at $1,970 at the time of press. According to CoinGecko, Ethereum has taken a 15% hit over the past week and is currently down 54.7% from its mid-May all-time high.
On July 7, it was reported that Goldman Sachs still views Ethereum as bullish due to its use-cases and smart contract capabilities.