New Model of Ethereum Mining Cycle: MEV, Dark Forest and Block Space
MEV creates new revenue streams for the mining industry, which in turn impacts how the mining industry interacts with buyers of block space.
Original title: "Ethereum block space, dark forest and MEV, and new trends in the future! "
Original author: Georgios Konstantopopos & Leo Zhang
Original editor: Nanfeng
“A market that is free to operate is like a wheel that is free to turn: it needs a shaft and well-lubricated bearings. How to provide such a shaft and keep the bearings in good condition Lubrication is the focus of market design."
- Alvin E, Nobel Laureate .Roth
Blockspace Market Overview
Blockspace is the commodity that powers all cryptocurrency networks. In the block space market, miners are producers, mining pools are auctioneers, and users are bidders. The impact of the block space market is so pervasive that it touches almost every aspect of the cryptocurrency ecosystem.
We know that in the blockchain network, after a user initiates a transaction, the transaction will be broadcast in the memory pool of each node in a peer-to-peer (P2P) manner . Every transaction comes with a transaction fee (fee). This transaction fee indicates a trader's willingness to buy block space so that his transaction can be processed (by miners) and included in a block.
Every moment, there will be countless blocks proposed by miners in the "Schrödinger state", that is, between "unconfirmed" and "Confirmed" status. These blocks race to find the first hash output that meets the difficulty target. Each proposed block has a probability of being the next block on the blockchain. Through billions of calculations per second, miners will collapse this probability wave to form the history of the blockchain ledger.
Since the size of each block has an upper limit, that is, the number of transactions that can be packaged into it within a given time is limited, so This gives the block space an implicit time value. If a transaction is not confirmed for a long time, it may be affected by market (price) volatility, or be front-run by arbitrage bots. The transaction fee (fee) that users pay to have their transactions confirmed reflects their willingness to bid for block space. The block space market connects miners and users together.
On the surface, the block space market looks complex and chaotic because of its lack of central coordination. It relies on detailed rules, procedures, and a confluence of supply and demand to self-regulate. How do we know if the current market design is optimal? Get a glimpse of it with Nobel laureate Alvin E. Roth.
Alvin E. Roth is considered a pioneer in the field of market design. In his seminal book "Who Gets What - and Why", he states that in order to function properly, markets need at least three things:
Market Depth: There is a sufficient number of potential buyers and sellers to interact with. In the block space market, suppliers (miners) are motivated by block rewards to provide hash rate (computing power); on the other hand, as more and more people (users) use the network for transactions, the block Block space requirements are also increasing.
Security: Market participants must feel safe before disclosing or acting upon confidential information they may hold. Due to the transparency of transactions on the chain, transaction users who submit sealed quotations may not always get the results they want (that is, transaction users cannot know each other's transaction fee bids, and transactions with high bids are often confirmed by miners first) . Furthermore, transactions require a high degree of settlement assurance, that is, there should be enough computing power to make block reorganizations costly.
Overcoming congestion: Transactions should be completed or canceled in a timely manner. When the market cannot effectively handle the congestion caused by transaction volume, participants (users) may experience significant delays in transaction confirmation. Just as due to the recent popularity of Ethereum Dapps (decentralized applications), transaction congestion has led to a surge in Gas prices.
In the history of Bitcoin and Ethereum, how to optimize the design of the block space market structure has often sparked many heated debates. In the following sections, we will explain the structure of the Ethereum block space market from the perspective of supply side (miners) and demand side (users). We will look at whether the current blockspace market design provides depth, eases congestion, or is safe and easy to participate in. After that, we will discuss some popular proposals to optimize the structure of the block space market and how the block space market may develop in the future.
Supply side: the structure of Ethereum mining
The whole mining The ultimate goal of the mining industry is to provide a decentralized transparent clearinghouse for a commodity, namely block space.
This task is by no means trivial. In a distributed blockchain system that does not have a central authoritative coordinator and operates around the clock globally, the block space is auctioned anonymously, and miners need to provide a strong settlement guarantee for the block space, by investing a lot of money in hardware and energy To perform a large number of calculations to ensure the security of the blockchain network.
Despite widespread concerns about the centralization of computing power (such as triggering so-called 51% computing power attacks), the mining industry is not a single organism. The fluctuations in the block space market affect the various participants to different degrees; and each miner is heavily affected by factors such as location, mining machine type, temperature, maintenance and mining strategy.
Bitcoin and Ethereum mining have very different market structures: Bitcoin and some PoW coins have almost completely migrated to the ASIC mining era. On the other hand, despite Ethereum being the second largest market capitalization, there is almost no ASIC mining in the Ethereum mining space, and although there are rumors of new ASIC manufacturers every once in a while, it is estimated that there are currently about 80 -90% of Ethereum computing power is dominated by GUP mining.
So structurally speaking, the block space supplier market mainly composed of GPUs mining is different from the block space market mainly composed of ASICs mining How is it different?
GPU mining started with NVIDIA and AMD. They either sell discrete graphics cards directly, or wholesale GPU chips and memory to downstream graphics card manufacturers. Instead, these manufacturers removed features not related to mining, hence the name "mining graphics cards." There are many brands of white label custom mining cards.
Compared to ASIC market, the number of OEMs in the GPU market is much larger. As a result, Ethereum has a more diverse hashrate composition than a typical network of ASICs such as the Bitcoin network. This also brings challenges to the monopoly channel of mining machine distributors. GPU miners have more options as they don’t have to wait for ASIC makers like Bitmain, Whatsminer, etc. to address equipment supply chain constraints.
This means that the supply of GPUs is generally not as bottlenecked as ASICs that use advanced back-end processes. Furthermore, GPU miners are not tied to any particular blockchain network (you can switch between different PoW blockchain networks to mine), and miners engaged in speculative mining almost exclusively use GPU miners. And, consumer GPU graphics cards are also valuable in other areas of computing, such as gaming, data centers, and artificial intelligence work. In general, GPU miners have more flexibility in their choice of hardware.
The structure determines the characteristics. The hardware composition determines the capital expenditure and energy consumption of the mining industry. These two factors are key to calculating the cost of mining, which has knock-on effects on the rest of the mining ecosystem: from equipment manufacturing, distribution, hosting facilities, fluctuations in Gas costs, to EIPs (Ethereum improvement proposals), to the defining characteristics of the mining cycle.
Based on the relative rate of change between Bitcoin price and network computing power, the following diagram shows four typical phases of the Bitcoin mining cycle (this cycle will Cyclic occurrence): (1) The Rising Bpl (rising stage) → (2) Mining Goldrush (mining gold rush stage) → (3) Inventory Flush (mining machines reduce production, clear inventory) → (4) Shakeout (major reorganization) → Repeat (1) The Rising Bpl (rising stage) → ......
The picture above: the historical change of Bitcoin price (red curve) and Bitcoin network computing power (green curve), and the cycle of Bitcoin network mining cycle
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Due to the inherent illiquidity of mining hardware, changes in network hashrate often lag behind price changes. "Hardware reaction time" is determined by various external factors, such as the manufacturer's supply chain constraints, foundry wafer backlog, equipment performance, and even transportation logistics.
This lag has been especially pronounced this year as the market is heading full steam ahead into a wild bull trend. Miners and investors are scrambling to order new machines; on the other hand, mining machine manufacturers are just recovering from supply chain disruptions during the COVID-19 outbreak, and a global shortage of integrated circuits has forced all industries that need semiconductors (chips) - mining Mining, automotive, consumer electronics, etc. — all waiting in long lines for wafer allocation.
In addition, NVIDIA (NVIDIA) recently announced that they will artificially weaken the performance of their latest graphics cards running Ethash (PoW mining algorithm) to prevent miners from buying all GPU inventory. This means that by the time the backlog of miners finally come online, the "clearing inventory" and "major reshuffle" phases could be very painful for many miners, unless prices or fees continue to rise significantly.
In Ethereum, there are three main sources of mining revenue:
Built-in Block Reward (2 ETH per block + Uncle Block Reward)
Transaction Fee
Miner Extractable Value (MEV)
The percentage of transaction fees in Ethereum to the total block return (that is, the percentage of transaction fees in a single Ethereum block to the total revenue brought by the block to miners) Much higher than Bitcoin (see chart below). This means that Ethereum miners not only pay attention to the currency price, but also pay attention to the trend of Gas. Even if the currency price remains unchanged, the increase in transaction fees will be enough to incentivize Ethereum miners to increase their computing power.
The picture above : The yellow line represents the percentage of transaction fees in the total return of Bitcoin blocks, and the purple line represents the percentage of transaction fees in the total return of Ethereum blocks. It can be seen that the proportion of the latter is obviously higher. Data source: Coinmetrics
Also, as mentioned earlier, GPUs have flexibility in choice and distribution compared to ASIC networks Making it easier to scale up or down the computing power. Therefore, the cycle of Ethereum mining is often shorter than that of Bitcoin:
The shorter the mining period, it means that when the mining income is high, the competition will intensify faster; and the flexibility of GPU hardware selection Sexuality means that when the mining income is low, the computing power is easier to release.
The significant increase in currency prices and transaction fees has attracted more miners to participate. However, unlike most commodity markets, more producers (miners) do not mean an increase in the supply of block space - the supply of block space is determined by the block size and the average block time. This means that the increase in network computing power does not reduce network transaction fees, but increases the security budget of the network: as more and more miners join the competition, the cost of reorganizing historical blocks becomes higher, This improves the settlement assurance of the network.
Demand side: users want transaction fees to be minimized
Since the block size is limited, it means Users need to compete for the system's resources. The transaction fee model defines the core user experience for any user who initiates an on-chain transaction. Currently, the transaction fee model of the Ethereum network is the "highest price auction model".
As the most popular platform for storing and executing smart contracts, Ethereum is rapidly rising in utility. DeFi's "currency Lego" has enabled many DeFi products and services to combine with each other in a permissionless manner, and has greatly promoted the innovation of new financial projects.
Today's Ethereum users participate in the bidding of the block space market through the "highest price auction model". This is a simple auction model where users submit an offer for their transaction and pay miners in the form of transaction fees to have their transaction included in a block.
Users can bid by setting the "Gas price" of the transaction, and the price is denominated in gwei/gas (1gwei = 0.000000001 ETH). Our empirical observations on mining pool transactions show that more than 75% of mining pools follow the default strategy of only packaging transactions in descending order of transaction fees (transactions with higher transaction fees are included first, and transactions with lower transaction fees are included later) , without prioritizing transactions for any particular address. See the picture below:
The market structure on the demand side of block space is simple: users want to minimize the fees paid to miners to enjoy a smooth experience, while miners want to maximize their income because they are entities pursuing profitability.
The fees paid by users always follow the law of supply and demand, which is an indisputable fact: block space is the most scarce resource, so those who want their transactions to be more Users who are about to be included in a block are often willing to pay higher transaction fees than those who are willing to wait until the next block is included.
Blockspace is the closest thing to “digital real estate” in the crypto space. Block space has intrinsic value as "real estate" where economic activities take place.
Network congestion and transaction fees
The value of the block space translates directly into fees paid by users. Under this fee model, it is difficult to estimate the "correct" gas price, which can be seen from the volatility of gas prices within a single block, see the figure below:
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Above: The average gas price of Ethereum blocks in a week Fluctuating from 100 Gwei to 400 Gwei
Review Nobel Laureate Roth's three requirements for successful market design: Market Depth , safety, overcoming congestion. Obviously, during times of congestion, gas prices tend to rise too high for ordinary users. Where is the bottleneck?
The unpredictability of the gas fee stems from the fact that the user is not able to "proper transaction" contained in the next 1, 5 or 10 blocks Fees" for coordination. Today, most users use a "one-shot bid" approach: they only broadcast the transaction once, and then wait for the transaction to be included.
The first version of a new technology is always rough. Over the years, different versions will appear to solve the congestion problem. The market design of the block space involves balancing the interests of all parties in the ecosystem. At this juncture, three possible avenues to address congestion are discussed:
Short-term: increase block size, but may compromise security;
Mid-term: change the block space auction mechanism and require community consensus;
Long-term: implement scalability Solutions, such as Rollups and Eth2.0.
First of all. Some might want to increase the block size so that more transactions can fit in a single block (i.e., increase the supply of block space, assuming demand remains the same). But this change only provides temporary relief from the pain of high transaction fees, as new demand quickly fills up blocks, pushing fees up again. In addition, the increase in block size makes the blockchain node software more resource-intensive, so this approach should be avoided to keep the system decentralized.
Second, another approach is to restructure the bidding process. Today, the fee mechanism of all blockchains implements a "highest price auction". The EIP-1559 proposal proposes to change the fee mechanism to a fixed price sale when the system is not congested, allowing users to easily choose the "best" offer to meet their preferences. Variants of EIP-1559 have already been deployed in blockchain networks such as Near, Celo, and Filecoin. This proposal is also scheduled to be activated in the Ethereum London upgrade in July 2021, which will be the largest fee market mechanism change ever to occur on a public blockchain.
EIP-1559 is also one of the most controversial topics in Ethereum right now. More than 60% of the mining pools have expressed their opposition to the proposal, and EIP-1559 has evolved into a "trade war" between users and block space producers (ie miners). Although it is still difficult to quantify the exact impact this proposal will have on miners’ transaction fee income, the mining industry generally believes that Gas prices need to rise significantly to make up for the losses. A Jian of the Chinese Ethereum community "Ethereum Enthusiast" is an outspoken critic of the proposal, arguing that EIP-1559 "will lose the loyalty of miners." Kevin Pan, founder of ethereum mining pool Poopn, believes the proposal won’t actually have much impact on mining revenue, but is “very insulting.”
However, not all miners think so. The founders of Ethereum mining pool F2Pool (Fish Pond), who are active users of DeFi products, support this proposal. Even Jihan Wu, the notorious instigator of the Bitcoin block size “civil war” that led to the Bitcoin Cash fork, expressed support for Ethereum’s EIP-1559 proposal. Fundamentally, human coordination in an open ecosystem rooted in different parts of the world remains one of the greatest challenges.
Finally, in the long run, the appropriate solution is to allow the supply side to scale without creating trust requirements for Layer1 (first layer) systems Tremendous influence. After all, users want low fees, and low fees are not an economic mechanism design issue, but a fundamental blockchain scalability issue. Notably, scalability also allows more demand to enter the system, which will offset the decline in average fees per transaction. Chief among these are so-called Layer2 (Layer 2) solutions such as Optimistic Rollup and ZK Rollup.
Dark Forest and Dark Pool of Ethereum
If we are in the context of Bitcoin, the discussion around the demand side (users) ends here. In Ethereum, however, a financial system is being built that bends the rules of the game.
We know that for a limited period of time, there may be certain "opportunities" in the Ethereum network that exist in the form of arbitrage, or A high-demand asset is sold in the form of a limited number of participants (such as an ICO). Similar to the way people line up to buy limited-edition clothing, developers have created software that intelligently competes for on-chain opportunities (such as arbitrage bots, or front-running bots), even competing with other peers through gas bidding. Robots compete with each other.
This concept is called "Priority Gas Auction" (PGA for short), which was first published in Phil Daian et al. Flash Boys 2.0". The "unconventional" revenue stream generated by PGAs is called "Miner Extractable Value" (MEV for short).
Currently, MEV on the Ethereum ecosystem is mainly obtained by DeFi traders through structured arbitrage strategies (through arbitrage robots); while miners obtain These traders benefit indirectly from the transaction fees they pay.
Robots participating in PGAs have a potentially very lucrative opportunity to bid at exorbitant Gas prices so that transactions are confirmed and packaged as quickly as possible , to achieve the profits they will be able to earn. By reordering transactions by gas fee when packaging transactions, these excessive gas fees end up in the hands of miners.
This has led to the development of a dark forest (Dark Forest) in the Ethereum ecosystem. For example, Phil Daian described a value capture in this paper, About $12,000 worth of tokens fell into the hands of the Predator. These predators are arbitrage bots that constantly monitor the activity of the Ethereum transaction mempool and attempt to run certain types of transactions ahead of time (front-running) according to a predetermined algorithm. DEX platforms such as Uniswap are likely to be flooded with arbitrage bots.
As a result, some service providers have started offering "dark pools" that allow transactions to bypass These transactions are invisible to the public until they are packaged on-chain. Instead of broadcasting transactions to the network, these dark pools forward transactions directly to miners so that these transactions are not broadcast to other nodes on the network.
These dark pools are not entirely used for the purpose of maximizing profits, and may also be used to escape from the black forest of Ethereum. For example, during escaping the dark forest, security researcher samczsun recorded his team How to save 25000 ETH from a buggy smart contract using this technique.
Front-running and dark pools are not unique to the cryptocurrency market. They represent a financial driver as old as time: concealment. Wall Street has long embraced this controversial approach to investing. It is estimated that after 2015, dark pools accounted for 15-18% of trading activity in securities listed on U.S. exchanges.
The "total addressable market" of MEV (miner-extractable value) is growing exponentially (see chart below), at least 350 million since the beginning of 2020 USD MEV was withdrawn, a third of which occurred in February 2021. Most of the MEV withdrawn was concentrated in arbitrage activities between popular automated market makers such as Uniswap, Sushiswap, Curve, and Balancer, and liquidations on Compound and Aave also accounted for a small portion.
Above: Cumulative extracted MEVs since January 1, 2020. Source: https://explore.flashbots.net
This butterfly effect is amazing: arbitrage and liquidation opportunities create MEV. The fee estimator uses the PGA auction-adjusted gas price as a reference, causing users to overpay for their transactions.
The core of this problem is that users and robots are in the same transaction memory pool.
Ideally, transactions involving MEV should be in a separate transaction pool from non-MEV transactions. This will allow bots withdrawing MEV to compete with each other; while all other transactions, such as transfers of cryptocurrencies, will take place in non-MEV transaction pools, which will allow users to enjoy a more stable gas market.
Unfortunately for Ethereum, such breaking changes are difficult to implement. A simpler solution to this problem is to introduce a new API endpoint for miners, where they will accept transaction bundles involving only MEV. In this way, arbitrage traders would submit their trades directly to the terminal, while users would continue to use the rest of the system as they do today. This is the approach Flashbots is taking.
How will miners fit into MEV?
In the past, When fees are a negligible percentage of a block's total revenue, miners' main focus is to get as much block reward as possible (for example, the current Ethereum block reward is 2 ETH per block). Miners tend to choose a mining pool with enough computing power to host their computing power. After years of development, mining pools have been more or less optimized to the same performance range, and mining pools that lag behind their peers will be easily identifiable and soon be squeezed out by competitors.
Except for some basic parameters of the mining pool (such as income distribution plan, handling fee for joining the mining pool, etc.), miners do not care which mining pool they join ; users also don't really care which mining pool processes their transactions; and mining pools don't care who the users are as long as transaction fees are attractive.
But as MEV (miner extractable value) as a percentage of total block revenue grows, the considerations of miners, mining pools and users start to become more nuanced. With MEV, the block space market mechanism will change from a purely commodity market to include some elements of a matching market. When users submit transactions, they should be aware of the mining pool's ability to process their transactions in a timely manner.
Other things being equal, MEV will result in a higher gas price than it would have been without MEV. This means that miners already indirectly capture a fraction of the total value of MEV extracted by arbitrage traders, currently estimated at around 12%. A recent analysis also suggests that fees earned by miners via MEV will eventually exceed “regular” revenue streams. That said, miners are profit-seeking entities that may wish to capture more MEV. By leveraging their power over the order in which transactions are processed, miners can choose to insert, reorder, and even censor transactions to maximize the profits of their transaction operations.
Theoretically, in extreme cases, miners will keep reorganizing the blockchain as they try to extract MEV from blocks that have been included in the past value. While possible, this scenario is not clearly credible: miners are (mostly) structurally long-term holders of ETH, and such a reorganization would have a direct negative impact on their ETH investments.
A more optimistic view is that miners decide to outsource the extraction of MEV to arbitrage traders. Miners can use the Flashbots method described above, or rent out their computing power to specialized trading companies.
We expect that Ethereum mining pools will inevitably start to become more active in the MEV extraction process as they seek to get the best yield for the hashrate they provide . As the MEV extraction race heats up, it remains to be seen how the (de)centralization of the Ethereum mining ecosystem will be affected by this change in market structure.
How will users in the ecosystem participate in MEV?
The financialization of computing power is an important potential of the mining industry trend. For miners, selling their hashpower through hashpower instruments is a way for them to lock in future income. Similar to renting computing power on a cloud mining platform, forward contracts allow miners to sell a fixed amount of computing power for a certain period of time at a prepaid price. If the block space is similar to real estate, then the computing power is the equity of the real estate, and the forward contract of computing power is similar to mortgage.
Those expected networks The active DeFi users that MEV activities will increase can speculate by purchasing these computing power tools. For example, a trader anticipating a surge in MEV activity on the network over the next 15 days can purchase x amount of computing power at an upfront price for the next 15 days. During the contract period, the mining revenue plus the MEV income earned by the miner will then occur to the trader.
Both this computing power tool and MEV represent cutting-edge developments in the mining capital market. New tools are actively being developed in these directions. MEV and computing power tools close a complete loop for users and miners.
Summary
Ethereum blockspace market structure is an interesting topic to study, and for good reason. In this analysis, we observed major differences between the GPU and ASIC computing power markets. We also identify key mechanisms that create demand-side dynamics and tie together the supply and demand sides of blockspace in terms of MEV (miner extractable value).
MEV is a corollary of the growing complexity of Ethereum transaction types. As tools and knowledge bases for MEV become more mainstream, more interesting MEV patterns will emerge.
Changing the way a good is sold in the market also changes the way that good is produced. MEV creates new revenue streams for the mining industry, which in turn affects how the mining industry interacts with buyers of block space (i.e. transaction users). A new pattern will emerge in the Ethereum mining cycle.
Thanks to Tina Zhen, Tarun Chitra, Hasu and Alex Obadia for their comments on an early draft of this article.
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