- A new analysis of the economic model behind Ethereum 2.0 suggests that validators can expect an annual reward of 4.6 to 10.3 percent to start with.
- The hardware costs for running the Ethereum 2.0 validation software may increase due to a new design proposal from founder Vitalik Buterin.
- Nevertheless, the Ethereum 2.0 economic model keeps inflation rates below 1 percent and a dynamically adapting reward scale for validators.
How could the economics of the second largest blockchain shift if Ethereum undergoes a major upgrade in 2020?
The next larger iteration of Ethereum, called Ethereum 2.0, is based on a PoS consensus protocol (Proof-of-Stake). This means that transactions on the blockchain are processed and validated by users who employ assets, as opposed to miners who use energy.
People involved in Ethereum’s PoS network – called validators – are rewarded by earning an annual interest in their trapped ether. Currently, the minimum amount of Ether required to become a Validator is 32 ETH, which is about $ 5,200.
Collin Myers, head of global product strategy at ConsenSys, the Brooklyn-based Ethereum Venture Studio, said validators with 32 ETH can expect an annual return of between 4.6 and 10.3 percent when the Ethereum 2.0 network launches.
Myers announced during the recent Ethereum developer conference, Devcon, that it is building a user application that will allow validators to calculate gross and net annual returns for different hardware and electricity costs.
“The ETH 2.0 computer [is being] Designed for protocol researchers, validators and enthusiasts to improve the transparency and education of the Ethereum 2.0 network economy, “Myers said in a Devcon presentation. He plans to launch the web tool in conjunction with the launch of Ethereum 2.0, which is tentatively planned for the first quarter of 2020.
Of course, the current numbers on Validator rewards for Ethereum 2.0 are by no means set in stone as the community is still debating the design parameters of the upgrade.
Kristy-Leigh Minehan, former CTO of the blockchain and AI startup Core Scientific, who proposed the controversial change to the Ethereum mining algorithm “ProgPoW”, said:
“These are suggestions from Ethereum research, but by the time we actually switch to Ethereum 2.0, none of us will know for sure. You’re always optimizing it right now. It can be pretty runny. “
Myers said community contributions to the design of Ethereum 2.0 are essential.
“This is an issue that we will continue to work on. It’s not finished yet, ”he said. “Vitalik suggested new things [Buterin] that would [change things] if accepted by the community. ”
What could change
One of the recent proposals from Ethereum co-founder Vitalik Buterin suggests a Greatly reducing the number of mini-blockchains or shards in the early stages of the Ethereum 2.0 deployment.
Instead of starting the entire network with 1,024 shards, Buterin suggests starting only 64 to improve cross-shard communication in the network.
This proposal has been well received by researchers and protocol developers who say that reducing the number of shards will reduce the complexity of the network. However, reducing the number of shards means fewer validators and less total effort required to secure the Ethereum 2.0 network.
“Essentially, if you go down the number of shards, you have to make a different compromise,” Myers said, adding:
“You will have to increase the power of the independents [validators] runs in the network. It’s higher hardware quality. It will be a bit more expensive for me to participate as a validator. “
With these reservations, Myers highlighted three important details of the Ethereum 2.0 economic model that will not change in the near future.
According to Myers’ calculationsEthereum 2.0 validators holding 32 ETH shares have the potential to earn 10.4 percent in annual interest, provided the network starts with 2 million ETH stakes.
This 10.4 percent target return for validators is unlikely to change, even if there is only one sixteenth of the shards originally intended for the network. However, the “net spend” (Myers term), which takes hardware costs into account, will likely need to be updated.
At launch, validators can expect to receive 5.60 percent of their share of rewards. If higher quality hardware is required to run Ethereum 2.0 software and there are only 64 shards, then the ROI will likely depreciate in value.
“Some say [net returns] will go down 20 percent, but those numbers are not accurate and I have not yet given my opinion, ”Myers said.
Validators in a proof-of-stake blockchain like Ethereum 2.0 have a similar responsibility as miners in a proof-of-work blockchain. These actors in a blockchain are used to process transactions and append new blocks.
The new model changes the center of gravity from calculation to control. PoW networks have external costs such as B. Computing power. Ensuring the honesty of the actors in a PoS network are internal mechanisms such as the use of values.
The more ETH people involved in Ethereum 2.0, the higher the level of security. The fewer shards there are in Ethereum 2.0, the fewer validators are needed to secure the entire network.
Jack O’Holleran, CEO and founder of the Ethereum scalability startup Skale Labs, said of this dynamic reward model:
“At a high level, Ethereum 2.0 tries to solve the ETH’s problems with elasticity as well as supply and demand. A really innovative and effective thing [about Ethereum 2.0] is its dynamic pricing. “
After the start of Ethereum 2.0 A larger number of validators are needed to secure the Ethereum 2.0 network and ensure the honesty of all actors.
This is because in the first deployment phase, called Phase Zero, only one PoS blockchain is introduced: the “beacon chain”. In a subsequent deployment phase, phase 1, developers plan to start 1,024 (or 64) other PoS blockchains, so-called shards. To secure all of these additional PoS networks, Myers says a higher number of validators and staked assets are required in the system.
The greater the total assets of the Ethereum 2.0 ecosystem, the lower the annual reward for each individual validator. The dynamic reward scheme for Ethereum 2.0 ensures that the network never over- or under-pays for its security.
Fredrik Harrysson, CTO of the Ethereum software client Parity, told CoinDesk in April:
“There is a tier of rewards that depends on how much ETH is at stake. In a system where very low stakes are locked in, you want to encourage more people to put more ETH and lock up to increase the security of the chain. “
According to Myers, the goal in phase 1 will be to reduce the issuance of rewards to 32 ETH for each validator around 7.2 percent interest and 2.39 percent net profit.
This is similar to other stakeout networks like Dash and Tezos returning to the top 5 percent interest annually.
The annualized rewards for Ethereum 2.0 validators depend on the total amount of assets invested as well as the total Percentage of online validators actively processing transactions.
If only 70 percent of the validators in the Ethereum 2.0 network are online at any given time, the interest rates of Myers’ estimate will drop from 7.2 percent to 5.81 percent, at least according to his calculations assuming 1,024 shards.
“[Ethereum 2.0] is a collective reward system. The more people are online, the more everyone earns. The less online, the less people make, ”Myers said, adding:
“This is one of the design parameters of Ethereum 2.0, which is very innovative and ingenious on a human level. It encourages people who don’t know each other to come together and do something. “
Even in the ideal scenario of all validators using 32 ETH in a 1,024 shard universe, the entire network emission from ether is designed in such a way that the annual supply growth of 1 percent is never exceeded. This is to protect against inflation and devaluation of the coins purchasing power over time.
However, controlling the growth of the ether supply in the current Ethereum mainnet has been an ongoing controversy for the Ethereum community since it started in 2015.
In contrast to Bitcoin, the ether supply of Ethereum with a hard supply cap of 21 million Bitcoins will continue to increase over time. Currently, according to the Ethereum information site, inflation in Ethereum is around 4.5 percent ETHHub.
Ethereum’s inflation rates were around 18 percent, but have fallen significantly recently thanks to a series of system-wide upgrades called hard forks, where developers reduce the issuing of block rewards in three steps from 5 ETH / block at startup to 2 ETH / have now block.
The last reduction from 3 ETH to 2 ETH was a compromise among Ethereum’s stakeholders who came up with conflicting proposals to reduce block rewards.
In Ethereum 2.0, a new monetary policy should ensure a constant inflation level below 1 percent and thus a stable ETH in the long term.
Of course, all of these metrics can be revised as developers run hard forks.
“In the early days of this system, we’re going to be putting a lot of hard work into it. That’s healthy because it means we crush old ideas and innovate new ideas, ”Myers said, adding:
“The more we fork hard, the healthier it means we are.”
Devcon 5 photo by Leigh Cuen for CoinDesk