By Kyle, Investment Manager@Bing Ventures

Ethereum launched its Beacon Chain on December 1, 2020. The goal of the Beacon Chain was to coordinate the Ethereum network and act as the Ethereum consensus layer after the merge, thus bringing PoS mechanism into the Ethereum ecosystem. On August 5, 2021, Ethereum underwent a London upgrade that included the EIP-1559, a mechanism that provides for burning ETH in every transaction. The introduction of this burning mechanism officially transformed ETH into a deflationary asset.

 

The Merge, Source: ethereum.org

This month’s upcoming merge represents the long-term sustainability and scalability of the global computing network. The key points are:

1. From proof of work (PoW) to proof of stake (PoS) to make Ethereum more sustainable. Ethereum energy consumption is expected to be reduced by 99.95%, which is because the main cost of protecting the network in a proof-of-stake system is pledging tokens, which do not require much power at all.

2. ETH issuance rate is reduced by 90%, which makes Ethereum likely to be a deflationary asset. In the context of today’s inflationary environment, Ethereum’s transformation into a potentially deflationary asset will become the new growth narrative.

These two shifts will reshape the power dynamics within the Ethereum ecosystem. The goal of Ethereum 2.0 is to find a Nash equilibrium, which is the best outcome of the game. The Nash equilibrium of ETH is one in which users provide liquidity and generate consistently high returns. This paper will re-examine the price effect of Ethereum 2.0 from the perspective of boxed pigs game.

Dawn or fire in a dark forest?

The “boxed pigs game” theory was put forward by Nash in 1950. The main theories are as follows:

There are two pigs in the pen, a big and a little pig. There was a pedal on one side of the pen, and every time you stepped on the pedal, a small amount of food would fall into the feeding slot on the other side away from the pedal. If one pig steps on the pedal, the other pig has a chance to get to the food that falls on the other side first. When the little pig presses the pedal, the big pig eats all the food just before the little pig reaches the trough; If it’s a big pig that moves the pedal, there’s still a chance that the pig can get to the trough and eat the other half of the food before they finish the food they’ve left behind.

 

Source: blogs.cornell.edu

In fact, the piglet stayed put, let the big pig press the pedal, and chose to “hitchhike” for a simple reason: given that the big pig chose to act, the net benefit of the piglet choosing to wait was far greater than the net benefit of the piglet’s own action. So it is better for the weak to wait than to act, especially if the big pig chooses to wait. If the pigs act, the benefits will not outweigh the costs.

The change from PoW to PoS will completely change the benefit distribution landscape of Ethereum. Miners will be completely removed from the revenue model of the Ethereum network, and the Ethereum network value will be returned to ETH pledges and verifiers in the following ways.

1. Block Rewards: Block rewards will be slashed by 60–90% after the merge, depending on the number of ETH pledged, benefiting all ETH holders. The remaining block reward is paid to the ETH staker/verifier and is expressed in the form of staking rate.

2. Transaction fees and MEV: Since the implementation of EIP-1559, the basic cost of trading has been burned. The additional revenue generated through Tips and MEV is paid to the ETH staker/verifier and is expressed in the form of staking rate.

While miners are forced to sell ETH collected through block rewards, Tips, and MEVs to cover costs, the staker/verifier incurs much less cost in comparison, thus reducing ETH forced selling instead. Moreover, since ETH verifiers/stakers already have a large amount of ETH, it can be assumed that they will be more likely to hold these ETH awards than the miner group.

ETH verifier/staker will be the benchmark for pricing

All of these changes will increase the value accumulation of ETH. The “boxed pigs game” means that in the Ethereum market group, the group with the leading market share will take the lead in pricing and form the pricing benchmark, and other groups have to follow the pricing. If the miner group with weak pricing power and ETH verifier/staker with strong pricing power simultaneously introduce liquidity lock-in program to the market, the verifier/staker with strong pricing power will gain more than the relatively backward miner group due to their higher bargaining power.

 

Source: dune.analytic

Ethereum tries to facilitate all participants locking up their liquidity in the agreement. ETH is more liquid when users maintain their liquidity lock-in, thereby maximizing efficiency. More users = more value of the agreement. Let’s say the payoffs are 5 and 1; If the group with strong pricing power does not implement the liquidity lock-in plan and the group with weak pricing power bifurcates first, due to the depression effect, liquidity will flow back to the group with strong pricing power and bring incremental effect.

Let’s say they get 8 and -1; If the pledgeer/verifier group with strong pricing power continues to support the liquidity lock-in plan, while the miner group with weak pricing power chooses to wait and see the market reaction after the merger before following through, then the market price increase can be shared with them. Let’s say the payoff is 4 and 4; If neither player makes a move, the payoff is 0 and 0, respectively. It is clear that the current balance of consolidated gains is in the ETH pledge/verifier group.

The role of the Boxed Pigs Game in ETH pricing

With the “Ethereum Merge” scheduled to take place this month, Ethereum is expected to continue siphoning effects from attractive pledge yields and a sharp reduction in issuance. Since the research and development of Ethereum merge is cost, and the imitation of fork is low cost, so the merger of Ethereum is in the leading position of technology, there is no reference, can only choose and God as the opponent, is a very costly and highly uncertain thing.

 

Source: glassnode

Once the merge has progressed, by the time the payoff phase comes around, the cost to mimic the fork is much lower than the cost to merge the developer. So will the fact that the miners took advantage stop the Ethereum team? Will not. Because the best strategy for big pigs is to run back and forth and never stop. No matter how mean the little pig is, the big pig must keep on running.

At the current rate of ETH burning, it is still not pure deflation. However, there is no doubt that, as the merged Ethereum, it can fully assume the responsibility to achieve low and stable issuance, so as to achieve basic price stability unconditionally. At the same time, the merged Ethereum’s expectation management of future deflation plays the role of “anchor”, that is, it basically anchors the liquidity growth range of the Ethereum network.

Metaphorically speaking, ETH, as a big pig, will eat more grain, while those forked piglets will only continue with stunted growth.