Why do we say that Ethereum miners will ultimately accept EIP-1559?

This article was published on Deribit Insight, authored by Hasu, Georgios Konstantopoulos, and translated by Gong Quanyu, Alyson.

The congestion on the Ethereum network is becoming increasingly severe, and the EIP-1559 proposal aimed at addressing this issue has garnered significant attention from the market, but it is still facing resistance from many mining pools.

Recently, well-known crypto researcher Hasu and Paradigm Capital research partner Georgios Konstantopoulos published a blog on Deribit Insight, pointing out that after examining various potential solutions to resist miners, they believe that any form of active protest from miners will lead to greater long-term revenue losses compared to collaborating with users, and thus they will ultimately accept the EIP-1559 proposal. EIP-1559 is one of the most anticipated upgrades in Ethereum's history, fundamentally changing the way users bid for transactions and bringing other major benefits.

EIP-1559 has received overwhelming support from the community and is technically ready to be included in the hard fork after passing the evaluation process by Ethereum core developers at the Berlin meeting. Recently, miners have begun to oppose this proposal. This is not surprising, as the mechanism will consume some of the transaction fees that miners have already received.

Although this seems counterintuitive, our hypothesis is that the best strategy for miners is to support the deployment of EIP-1559.

We test this hypothesis by examining the two most effective methods for miners to oppose the proposal: (1) forking Ethereum to create a fork without EIP-1559; (2) preventing the implementation of EIP-1559 on Ethereum by driving the base gas fee to zero.

After considering feasibility and opportunity costs, we find that any form of active protest will lead to greater long-term revenue losses for miners than collaborating with users.

I. Miners are Long-Termists for ETH

EIP-1559 will affect miners' revenues, which currently come from three sources:

First, a subsidy of 2 ETH per block and additional rewards from uncle blocks;

Second, user fees from bidding for block space (regardless of their final outcomes in the block).

Third, a difficult-to-quantify but highly valuable component, which miners can extract by inserting transactions at specific points in the block. This is known as "Miner Extractable Value" (MEV), which most miners currently "outsource" to front-running arbitrage bots that bid in the mempool.

After the launch of EIP-1559, miners will continue to earn the same revenue from block subsidies and MEV. As long as the system is not congested (demand is below the maximum gas limit), the value of the base fee will be burned. When demand exceeds the maximum gas limit, additional first-price auctions will occur among traders, and the proceeds will belong to the miners.

To earn these rewards, miners must invest in mining hardware, electricity agreements, and other capital expenditures. These investments require them to hold a significant amount of Ethereum and be part of the Ethereum economy, as they must mine to earn returns.

While we do not deny that EIP-1559 could reduce one of these three revenue sources, miners will still have sufficient revenue sources in the future to support Ethereum and its users. Even without the entire base fee, MEV and block subsidies will remain important revenue sources for miners. The deployment of this upgrade may also mark a turning point in user demand for Ethereum, ultimately promoting the development of the entire Ethereum economy.

II. Users are Part of the Ethereum Economy

To understand the driving mechanism behind Ethereum's development, it is essential to recognize that all three revenue sources come from users and the applications and businesses serving them.

Users create demand for ETH, which miners then sell to them in exchange for fiat currency and other tokens within the Ethereum ecosystem. Their trading, lending, and other demands for these tokens generate congestion fees. Their use of DeFi applications like DEX creates MEV and other opportunities for miners in the form of fixed-price arbitrage.

Users are the Ethereum economy. Miners provide them with services in the form of network security. This is a transactional relationship—miners do not provide this service out of their own will but in response to the economic incentives created by users.

Users have no obligation to pay miners more than the fees necessary for Ethereum's security, just as miners have no obligation to continue mining when it is unprofitable for them.

Ultimately, the driving mechanism between users and miners can be explained by substitutability. Miners are nearly irreplaceable as the primary source of income for current Ethereum users, but users are likely to replace some or even most of the current Ethereum miners.

III. Five Potential Evolution Scenarios

After clarifying the basic framework of the relationship between miners and users, we will apply this framework to various scenarios of how it will play out after the activation of the EIP-1559 proposal.

Scenario 1: Miners Maintain an Old Chain Without EIP-1559

In many other blockchains, upgrades face the daunting challenge of inherent miners. This is because it is usually more economical for miners to do nothing and remain on the existing blockchain, making it the norm to block new proposals.

Due to the severity of congestion, this will not happen on Ethereum. In short, if there is no hard fork to improve congestion, mining difficulty will increase until Ethereum itself comes to a standstill. This makes it impossible for users to remain on the old chain for long—any opponent of the EIP-1559 proposal will need to incur the same costs to fork in order to resolve this issue.

Scenario 2: Miners Create a Forked Coin Using Ethereum's State

A more viable suggestion is for miners to simply fork Ethereum and create their own altcoin, similar to how ETC forked from ETH or BCH forked from Bitcoin. Whether the fork makes sense depends on the opportunity cost of doing so; in the case of EIP-1559, miners must decide between mining a new altcoin and continuing with the existing Ethereum.

Opportunity costs are no joke, as the blockchain must first create value for users to pay miners any revenue, in order to obtain valuable block subsidies, congestion fees, and MEV (Miner Extractable Value). Bitcoin and Ethereum have been forked dozens (if not hundreds) of times, but most of these forks have never gained favor with users.

In Bitcoin, the state is merely a list of ownership of currency. BCH forked this list to leverage Bitcoin's existing supply distribution and airdrop new coins to all BTC holders.

However, Ethereum's state is more complex, containing not only the distribution of ETH but also thousands of different tokens, smart contracts, applications, etc. These will also be copied to the forked blockchain, but they will merely be a skeleton on another chain.

For example, many tokens on Ethereum (such as stablecoins or WBTC) are claims on assets in the real world. Copying tokens does not copy the assets. These claim tokens will continue to operate on the EIP-1559 Ethereum chain but will be worthless on the forked chain.

As a result, the remaining DeFi applications that rely on collateral will also dissolve on the forked chain, such as collateral-backed stablecoins like DAI or any form of AMM pools. In short, everything except ETH, including important off-chain infrastructure like oracles, liquidation bots, etc., will collapse and cause significant chaos on the forked chain.

While ETC was able to fork from Ethereum in 2016, a similar event is no longer possible today. The emergence of tokenized assets and DeFi has made Ethereum's state non-forkable.

Scenario 3: Miners Create an Altcoin with a New State

If Ethereum's state cannot be forked, what about an altcoin that merely copies the security elements of Ethereum's state (such as the distribution of ETH) or starts from a completely fresh state?

This is more feasible than Scenario 2, as evidenced by other "stateless" branches of Ethereum (such as Tron and the recent Binance Smart Chain (BSC)). The success of the latter, in particular, demonstrates that leveraging Ethereum's virtual machine (EVM), existing wallet infrastructure (like Metamask), and developer tools will have tremendous value. Additionally, while DApps will not be automatically copied, their deployment is straightforward and can be filled with new assets later.

Given BSC's rapid success, will there be market demand for a "permissionless" version of a blockchain that uses PoW mining instead of centralized operators? The new chain could even raise the gas limit to target the user base that cannot afford Ethereum due to high gas prices.

However, further consideration reveals that this approach is also fraught with issues, particularly regarding supply distribution.

If the new chain decides to reset the ETH supply distribution and start from zero, it will lose the existing supply distribution. Guiding a new supply distribution would require years of high inflation, making the assets unattractive. In contrast, BSC does not face this issue because Binance is the sole block producer and does not require additional mining incentives.

However, if the new chain replicates the distribution of ETH, then a lot of new ETH will be in the hands of potentially hostile users who may use it for a long time to drive prices down. This would render any block rewards obtained by miners on the new chain worthless and indicate that even a "stateless" fork requires some support from existing users.

Scenario 4: Miners Join the New Chain but Block EIP-1559 There

As we have already discussed, any attempt to create an altcoin is essentially doomed to fail. This leaves another possibility, which is also the most discussed among miners. In this case, miners will join the new Ethereum blockchain but then suppress the EIP-1559 mechanism by controlling the base fee to zero, preventing any ETH from being burned.

This method would work as follows: EIP-1559 controllers determine the next block's base fee by observing the size of the previous block; if the previous block exceeds the target gas limit (50% of the maximum limit), the base fee will increase to limit transaction demand. If it is smaller than the target gas limit, the base fee will decrease to stimulate demand.

Miners can technically control the number of transactions, thus controlling block size and the base fee. If they only mine less than half of the blocks, the base fee will never increase above zero, and thus no fees will be burned. However, competition among different miners makes this strategy unfeasible in practice.

First, assume a single mining pool with 5% hash power attempts to implement this strategy; they will only mine half or smaller blocks, even if demand far exceeds that level. Meanwhile, the other 95% of hash power will mine larger blocks, earning more revenue from fees, and the base fee will increase regardless. The 5% pool will quickly realize it is wasting money and losing all its hash power. This indicates that selfish miners want as many transactions as possible when there is competition among them.

So what if competition decreases? Imagine that instead of 5%, 60% of miners agree to implement this strategy. The result would be the same, as the 60% cartel miners would mine half a block, while the remaining 40% cartel miners would mine entire blocks, earning all additional revenue from congestion fees and MEV, and the base fee would continue to increase over time. We call this an unstable alliance.

This strategy can only work if hostile miners find a way to eliminate competition so that others cannot mine large blocks. With 60% hash power, they could do this by implementing what is known as a miner-activated soft fork (MASF).

The MASF would indicate that more than half of the blocks are invalid, so the 60% of miners should simply ignore them. Technically, the 40% of miners could still mine larger blocks, but the 60% of miners would refuse to mine on larger blocks, causing all transactions and block rewards allocated to the minority cartel to disappear.

MASF is not a new concept. Nowadays, miners can already form such cartel groups, for example, by limiting the gas limit to increase fees, charging higher fees from larger transactions, or setting minimum prices. All these strategies initially seem more profitable, but there are good reasons why miners have not attempted to implement them.

First, they require many mutually distrustful parties to cooperate, which is difficult to achieve. More importantly, MASF would be an unprecedented attack on the Ethereum network and its users. This would not only undermine the network's stability at the consensus level but also damage users' trust in Ethereum. This already threatens future miner revenues, but users could also actively oppose such behavior. For example, we hope users will start broadcasting transactions directly to a friendly mining pool to deduct fees and MEV from the censoring pool.

In summary, for miners without MASF, manipulating the base fee is not a stable strategy. However, if miners do implement MASF, it would be an unprecedented suicidal attack on Ethereum and their own investments.

Scenario 5: Miners Join the New Chain and Successfully Implement EIP-1559

Given the low satisfaction of miners in scenarios 1 to 4, we believe their primary choice is to collaborate with users.

Even if miners' revenues on the new blockchain decrease (which is not predetermined), this will still be much more than the revenue from attempting to create an altcoin. Any such altcoin will have a value close to zero relative to ETH, will not generate transaction fees due to congestion, and will not generate MEV from DeFi arbitrage opportunities.

Furthermore, implementing MASF to suppress the base fee would be an unprecedented transparent attack on Ethereum and its users. We have never had such an attack, and there are good reasons for this. It could undermine user confidence and the value of Ethereum, as well as the economic activities occurring within the system, thus directly harming miners' interests.

IV. Possible Concessions and Conclusion

In addition to the five scenarios discussed above, we also discussed various concessions that users might make to appease miners. Primarily:

First, increasing block subsidies on the new chain to compensate miners for burning the base fee.

Second, changing Ethereum's PoW algorithm through EIP-969 to remove ASIC miners from the network.

Third, rather than burning the base fee, distributing it to the miners of the next N blocks.

However, we reiterate that collaborating with users for the upgrade is already in the best interest of miners. Therefore, users do not need to meet miners' demands or make any further concessions.

This is how we hope the upcoming EIP-1559 transition will play out, and we are confident in this analysis. We look forward to discussing these points with the community at the upcoming EIP-1559 roundtable (February 26, 2021).