A Brief Analysis of the Value and Success Probability of Ethereum Fork Tokens
ETHPoW may provide exciting opportunities for traders and speculators in the short to medium term.Written by: BitMEX Research, “ETHPoW vs ETH2”
Compiled by: BlockBeats
Abstract
In this article, we discuss the feasibility of a new chain splitting off during the Ethereum merge, resulting in an ETH2 Token and a new ETHPoW Token.
In terms of token price and the economic chain's usage, it is almost certain that ETHPoW will be the chain supported by a minority.
Although the ETHPoW chain may face many technical challenges and has questions regarding long-term viability, its existence may provide exciting opportunities for traders and speculators in the short to medium term.
Overview
After several delays, Ethereum seems poised to finally merge in September 2022. Ethereum core developer Tim Beiko suggested July 14, 2022 during a developer call that September 19, 2022, could be a possible merge date. The first major part of the merge involves stopping proof-of-work (PoW) mining. Ethereum's consensus layer will choose which blockchain to follow and then transition to the already existing proof-of-stake beacon chain. However, the September 19 date is far from finalized, and clients with merge timing parameters have not yet been released, leaving significant uncertainty regarding the exact timing of the merge.
After the merge, two Ethereum clients will need to be run: a consensus layer client and an execution layer client, such as Geth, which will continue to validate and process Ethereum smart contracts and transactions. It is worth noting that even after the merge, stakers will not be able to withdraw their staked Ethereum back to the execution layer, and a "second merge" may still take 6 to 12 months.
When discussing the merge, many report that there is broad support within the Ethereum community for shutting down PoW. In a recent meeting, Vitalik mentioned that if anyone dislikes it, they can always use Ethereum Classic (i.e., ETC, a product of the 2016 DAO Wars). However, as expected, PoW miners will certainly not support shutting down PoW. Why would they? They would be completely shut out of the Ethereum system. EIP-1559 pales in comparison; this time, their potential revenue from Ethereum could drop to zero. For months, some miners have been voicing opposition to the merge behind the scenes, expressing a desire for "someone to step up and do something." Ultimately, on July 29, 2022, one of the largest participants in the Chinese mining ecosystem, "Baoyi Ye" (Guo Hongcai), indicated that he might plan to continue mining on the Ethereum PoW chain.
If the PoW chain continues to exist and expand, some speculate that this coin might be called ETHPoW. In our view, whether this chain has any economic significance remains an open question. There is a perspective that this chain could exist long-term. Compared to PoW, PoS may have some weaknesses (e.g., staking derivatives becoming natural monopolies), ultimately making the PoS chain less attractive in certain use cases than the PoW chain. All smart contract platforms competing with Ethereum (perhaps only excluding ETC) have taken the PoS route, so the emergence of a new PoW smart contract chain may attract significant interest. Aside from ETHPoW, there are no other real candidates.
In any case, in a nostalgic reflection on the 2016/17 Bitcoin and Ethereum split era, ETHPoW may pique some interest among market participants.
Ice Age
More than seven years ago, when Ethereum's PoS system was just a series of quirky and fragmented ideas on the drawing board, Vitalik foresaw this potential problem. He proposed a solution called "Ice Age." In this system, the difficulty of the PoW mining network increases exponentially over time, eventually making it impossible to effectively expand the chain. After the initial Frontier client, Ethereum's first major network upgrade was called "Ice Age," which included the first difficulty bomb. This bomb was set to "explode" in 2017, when the Serenity upgrade would transition the network to PoS. However, the PoS upgrade was ultimately delayed, and thus the bomb was also postponed via hard fork.
In fact, the difficulty bomb has become a "dud" many times in the past. For example, in early October 2017, Ethereum's average block time was about 30 seconds, after which the difficulty bomb system was reset, and the average block time fell back to a normal 13 seconds or so. The difficulty bomb has been reset six times in Ethereum's history, across six hard forks.
The most recent reset was proposed in June 2022, and the bomb is now expected to "explode" in mid-September 2022, which is a perfect time for the switch to PoS, just as originally planned back in 2015. Although the bomb is set for September, based on the previous bomb explosion timings, the impact on average block intervals may take months to become significant. Estimates suggest that it may take 175 days for the average block time to reach 30 seconds, after which conditions should deteriorate exponentially.
Another interesting factor is that this transition to PoS is "really happening." Compared to ETH, the price of ETHPoW may be lower and could fluctuate wildly. This may reduce miners' desire to mine ETHPoW, making it quite challenging to accurately assess the situation during the Ice Age.
New ETHPoW Hard Fork Client
With the arrival of the Ice Age, the previous PoW chain may only survive a few hundred days post-fork. If the PoW chain is to exist long-term, it needs to hard fork a new client to permanently remove the effects of the Ice Age. This presents some challenges for ETHPoW, perhaps underscoring the very purpose of the Ice Age. It somewhat undermines the legitimacy of ETHPoW. ETHPoW cannot claim to be the orthodox or rule-compliant chain. It also requires a hard fork. However, today, there may not be many Ethereum users who genuinely care about this, which seemed to be more valued seven years ago.
At the same time, any ETHPoW community will need to seek developers with technical expertise to write the new client. They will also need to resolve a Schelling point issue to reach consensus on the new client and new parameters to remove the Ice Age and activate the hard fork. Then the community needs to persuade exchanges and custodians to run and support this new client, which may be slightly more challenging than convincing them to continue running old Geth nodes alongside the new ETH2 infrastructure. However, in practice, these issues can be easily overcome, and the ETHPoW community is unlikely to be particularly large, so this should not be a major problem. Perhaps some large miners will fund the entire operation behind the scenes.
Locked Staked ETH
Currently, there are about 13.2 million ETH staked on the beacon chain, and if we include actual balances (Ethereum earned through staking plus any deposits exceeding the 32 ETH threshold), it approaches 14 million. As we understand it, during the initial phase of the ETHPoW chain, these funds will be permanently lost if no hard fork occurs. In contrast, on the ETH2 chain, these ETH can be returned to the execution layer at some point in the future. This has several implications for the ETHPoW chain. First, one might argue that since the ETH supply on the ETHPoW chain is reduced by a portion, this could drive up the price of ETHPoW. Alternatively, the loss of significant funds for users could undermine the chain's credibility and damage ETHPoW.
If a new ETHPoW client is hard forked to address the Ice Age issue, the community will face a dilemma on how to handle these staked ETH. This is a catch-22. One possible outcome is that, since it is a PoW coin, the community could permanently lock the staked tokens. In the ETHPoW world, staking is the wrong choice. The accumulated staking rewards of about 800,000 ETH earned before the merge should be deemed completely illegitimate on the ETHPoW chain. Therefore, if you are a validator or hold stETH, you may not earn additional rewards on the ETHPoW chain.
Stablecoin
Many speculate that if a controversial Ethereum fork occurs, the decision-making power will no longer belong to the Ethereum Foundation or Vitalik. They believe that in this scenario, the new kingmakers may be the custodians of Stablecoins. These custodians must choose a chain to support, and considering the popularity and prevalence of these Stablecoins, as well as their interconnections with DeFi, their decisions will determine the winning chain. Thus, perhaps Jeremy Allaire (CEO of Circle, issuer of USDC) is the most powerful person in Ethereum, rather than Vitalik.
Of course, Jeremy is the CEO of a company that must respond to its clients; failing to do so could mean he is not acting in the best interests of shareholders, which could be illegal, so he may not actually have this power in reality. However, if the authorities order Circle to support one chain or another for regulatory reasons, that would change the situation. This is also a potential weakness for Ethereum at present.
If a chain fork occurs after the merge, it seems that Circle, Tether, Binance, and other Stablecoin custodians will support ETH2. Therefore, even excluding the strong support from the Ethereum Foundation and community for ETH2, the outcome of this split is clear: ETH2 will be the winner, and ETHPoW will be the loser. Many DeFi apps relying on dollar Stablecoins on ETHPoW will economically collapse in a disastrous manner. However, this position of Stablecoin issuers has other implications, which we will discuss later in this article.
Selling ETHPoW
Many Ethereum extremists strongly support the transition to PoS and therefore will not favor ETHPoW. They may wish for the ETHPoW chain to disappear quickly.
Then there is a layer of thought on top of this. Ethereum maximalists should actually (somewhat paradoxically) hope that the ETHPoW chain can survive, at least for a while, so they can sell ETHPoW tokens on the market and acquire more ETH (or dollars). This way, they can profit from what they consider "foolish" ETHPoW supporters before ETHPoW slowly fades away in the coming years. Therefore, many may sell their ETHPoW tokens as quickly as possible, which could weaken the price.
On top of this, there is a third layer of thought. In fact, everyone should (regardless of whether they have Ethereum) buy ETHPoW tokens as soon as possible after the merge occurs. This will be explained below.
Value of ETH Fork Tokens
To sell ETHPoW for ETH, one must wait for centralized exchanges to support ETHPoW after the merge. While centralized exchanges like FTX and Binance may quickly launch related products, it will still take some time, at least several hours or days, to support ETHPoW deposits. No matter how well-prepared they are, due to the potential instability of hash power and block times on ETHPoW, they need to protect themselves against double-spending attacks.
On the other hand, theoretically, regardless of what happens, once the merge occurs, users should be able to purchase ETHPoW on decentralized exchanges on-chain. No matter how you view ETHPoW, you surely believe that this token is better than all other ERC-20 tokens on the ETHPoW chain, right?
Let’s consider some tokens currently on Ethereum:
USDC on ETHPoW -- worthless, as Circle will choose ETH2, making the token non-redeemable, as mentioned above.
USDT on ETHPoW -- also worthless.
Wrapped Bitcoin on ETHPoW -- worthless, as custodians will choose ETH2, making the token non-redeemable for Bitcoin.
BNB on ETHPoW -- worthless, as Binance will choose ETH2.
Uniswap on ETHPoW -- the long-term viability of tokens on the ETHPoW chain is questionable. Tokens may collapse faster than ETHPoW.
stETH on ETHPoW -- these tokens may be worthless due to the lack of collateral on this chain, as mentioned above.
All other ERC-20 tokens on ETHPoW -- the value on the ETHPoW chain may be very limited.
Therefore, before trading on centralized exchanges, the best strategy may actually be to buy as much ETHPoW as possible. Then sell ETHPoW on centralized exchanges. This is like a free call option on ETHPoW.
Merge Trading Strategy
Like past potentially controversial blockchain forks, the Ethereum merge presents an exciting trading opportunity. One possible "risk-free" trading idea is as follows:
Before the merge, convert all your dollars into USDC in your own Ethereum wallet.
After the merge, immediately sell your USDC on the ETHPoW chain, exchanging it for ETHPoW tokens on decentralized exchanges like UniSwap or Curve.
Once centralized exchanges open ETHPoW deposits, sell all ETHPoW for dollars.
Take your profits.
By executing the above trades, you have the potential to profit with almost zero risk. Zero risk only considers certain types of risks (such as price fluctuations).
Of course, executing the above trades is actually quite complex and risky, and there are several issues to manage:
Trades need to be executed quickly, as there may be a race to capitalize on this opportunity. The liquidity pools supporting the sale of ETHPoW may deplete rapidly.
You need to manage your own keys instead of using custodians. If there are any, third-party custodians are unlikely to quickly support ERC-20 tokens on ETHPoW after the split.
The infrastructure fundamentally used to interact with decentralized exchanges may only support the merge and run solely on ETH2. Therefore, you may need to run your own Ethereum node and interact directly with the trading platform smart contracts on ETHPoW. For some traders, this may be quite complex, but this difficulty is where profit opportunities may arise. Practice may be needed before the ETH1 fork.
You may need to ensure that your USDC sell/swap orders do not execute again on the ETH2 chain. Creating a split smart contract may be necessary.
Liquidity providers may quickly realize this potential risk before and after the merge and withdraw liquidity. However, some liquidity providers may not do so, creating opportunities.
Many DeFi protocols rely on price oracles, and it may be unclear how these will handle the ETHPoW chain.
There may be more advanced strategies to try in DeFi, including leverage, lending, or providing liquidity, which we will not discuss here.
Conclusion
Any chain fork occurring during the Ethereum merge could be an interesting return to the 2016/17 era. Although ETHPoW faces many technical challenges, as long as the chain survives, there will be a positive narrative surrounding its tokens, and leading centralized exchanges may open trading for them. The crypto space remains full of narratives and noise. ETHPoW will bring many exciting developments, and we predict that the ETH/ETHPoW trading pair will become a popular trading pair post-split, at least until another interesting dynamic emerges. Looking forward to the race starting!
