What is Ethereum 2.0?Ethereum 2.0 Operation SimplifiedPhase 0: Beacon Chain and its ConditionsEconomics of Ethereum 2.0Impact of Ethereum 2.0 on ETHTo become a validatorConclusion
Thursday, 4 June, 2020
The Digital Investor
Phase 0: One Small Step for Ethereum, One Giant Leap for Decentralised Networks
As the Ethereum networks get ready to launch Phase 0 of Ethereum 2.0 at approximately the end of June, we discuss the importance of this new technology and its impact on the price of ETH1. During Phase 0, the Beacon chain will be released, which will play a crucial role in implementing the Proof of Stake Proof of Stake link1(PoS) protocol in the network. Its structure incentivises ETH holders to migrate to the new network and become transaction validators on Ethereum 2.0. We examined the price impact of Ethereum 2.0 release on ETH, both from the demand and supply side. According to the analysis, we expect to have an overall positive price impact on ETH in the short to medium-term. However, a long-term price prediction is difficult, as this transition is one of the most ambitious and challenging tasks in the blockchain industry with the potential to revolutionize decentralised networks.
What is Ethereum 2.0?
In simple terms, Ethereum 2.0 or Serenity, is a network update that aims to make Ethereum more scalable by introducing new PoS protocols along with upgrades such as, sharding, virtual machine, and more. In this article, we guide you through the updates and changes in Ethereum and the expected price impact. Ethereum was the first-ever blockchain designed for smart contract usage on its platform, enabling individuals to build decentralised apps (Dapps) on top of the blockchain platform, similar to an application on an Android or iOS system. Inspired by Bitcoin, Ethereum incorporated proof-of-workproof-of-worklink1 (PoW) as its consensus mechanismconsensus mechanismlink1; however, with a high rate of Dapp usage (Crypto KittiesCrypto Kittieslink1), PoW caused the Ethereum blockchain to bloat2 , slowing down the network. To overcome this scalability issue, Ethereum is set to transition from the PoW to PoS consensus mechanism along with other network upgrades such as sharding3 and eWASH. Ethereum 2.0 is set to be rolled out in phases (Figure 1), and the expected release date for Phase 0 is approximately June 30, 2020, whereas the dates of other releases have not been announced yet.
Figure 1: Ethereum 2.0 timeline
Source: SEBA Research
Ethereum 2.0 Operation Simplified
From an architectural standpoint, Ethereum 2.0 will appear similar to Figure 2. Each transaction and smart contract execution will occur via the Virtual Machine (eWASH). The execution results generated through the virtual machine will be kept in a block within a shard chain. Multiple4 shard chains will exist and operate in parallel. In the final stage, all shard chains will be connected to a beacon chain where different shards will be compiled and stored. In the following section, we learn about Ethereum 2.0’s beacon chain.
Figure 2: Ethereum 2.0 Architecture
Source: SEBA Research, Hsiao-Wei Wang
Phase 0: Beacon Chain and its Conditions
The Beacon Chain will be the first release of the Ethereum 2.0 update. It will implement PoS mechanisms and manage the registry of validators within the network. During this phase, both the Ethereum (current blockchain) and Ethereum 2.0 blockchains will exist in parallel. In Phase 0, the Beacon chain will be of limited use, as no transactions, smart contracts, or Dapps will be running. This is to ensure that the PoS mechanism undergoes rigorous live testing and attracts sufficient validators for the later phases. During this phase, anyone who intends to become a validator on the network can convert their 32 ETH to 32 ETH2. Validators must keep a minimum of 32 ETH2 in their staking wallets, and an excess number will result in no added return on investment. Therefore, validators are recommended to stake ETH in multiples of 32. The network also requires that at least 16,384 validators which translates to minimum 524,288 ETH2 are staked on the network before validators begin receiving staking rewards. Another network requirement is that once ETH is converted to ETH2, it cannot be converted back to ETH and all ETH2, and the rewards staked in the beacon chain cannot exit the system until Phase 2 (release date unknown). In the following sections, we describe Ethereum 2.0’s token economics and how it might affect the price of ETH.
Economics of Ethereum 2.0
During Phase 0, two Ethereum chains will exist simultaneously, one PoW and another as PoS, which will run independently. Both networks will have their own supplies and inflation rates; therefore, with the introduction of Ethereum 2.0 the overall inflation rate of Ethereum (i.e. Ethereum 1.0 and 2.0 combined) will increase until both chains merge (i.e., Phase 1.5). Ethereum 2.0’s rate of issuance will directly depend on the number of ETH2 staked in the network at any time. The relationship between the supply and number of ETH staked in Ethereum 2.0 is defined as follows:
S = 181 × √SETH2
where S is the number of ETH supplied and SETH2 is the number of ETH2 staked. A higher rate of initial supply (when there are few validators) will incentivise ETH holders to move to Ethereum 2.0’s Beacon chain and earn higher rewards. Figure 3 shows the relationship between the supply and number of ETH staked. The number of ETH2 staked is directly proportional to the validator reward (supply).
Figure 3: Validator Economics – Phase 0
Source: SEBA Research and Ethereum calculator (by Ethereum foundation and Consensys, /r/Ethereum)
Ethereum 2.0 staking can be performed either at home using a personal or dedicated computer or through cloud computing. Both methods have their advantages and disadvantages with respect to fixed costs, variable costs, uptime, reliability, etc. Figure 4 shows how much a validator is expected to earn under both home and cloud-based operations given various levels of total ETH2 staked and other assumptions5 . Readers can refer to the staking calculator sheetstaking calculator sheetlink1 to better understand and customize other assumptions according to their requirements. These rates are subject to variable changes, and the reader can refer to our February Digital Investor, Ethereum 2.0: Where the rubber meets the roadEthereum 2.0: Where the rubber meets the roadlink1, to better understand these variables.
Figure 4: Staking Return on Investment
Source: SEBA Research and Ethereum calculator (by Ethereum foundation and Consensys, /r/Ethereum)
Impact of Ethereum 2.0 on ETH
Now that we understand the working dynamics and conditions within the Ethereum 2.0 Beacon Chain, we discuss how the launch of Phase 0 can impact the price of ETH. Multiple factors may increase the price of ETH in the short run, some of which are described below.
Ethereum 2.0 requires validators to convert ETH to ETH2 and transfer them to the new PoS blockchain; further, ETH2 will be locked until Phase 2 is launched. This will result in a decrease in Ether’s circulating supply in the PoW chain. In the Ethereum community, the Ethereum Improvement Proposal (EIP) 1559Ethereum Improvement Proposal (EIP) 1559link1 suggests decreasing the supply of Ethereum on the PoW network by burning a major chunk of the transaction fee. Which will reduce the fee that miners receive for validating transactions, whilst the fee paid by users remains the same. This is intended to incentivise users to move to the PoS-based blockchain. However, this proposal has not yet been implemented. In case it gets implemented before Phase 1 is launched, a reduction in the supply rate may occur in the PoW-based Ethereum. Overall, a reduced circulating supply of ETH should put upward pressure on ETH’s price.
In Phase 0, the Beacon chain has zero real-world usage, as no transactions, smart contracts, or Dapps can be executed. Because of this, the demand for Ethereum will not decrease. On the contrary, the demand for Ethereum may show an increase in the short-term, as investors, speculators and validators begin purchasing ETH before the Beacon chain launches. This interest in accumulating Ethereum can already be observed: year-to-date, Grayscale Grayscale link1has purchased approximately 873,723 ETH.
Furthermore, the network currently shows a two-year high in terms of the network transaction count and at a lower price (Figure 5).
Figure 5: Ethereum daily transaction count and daily price
Source: SEBA Research and Coin Metric
In the short to medium-term, the demand side is creating bullish pressure. The supply side is also creating bullish pressure in the medium-term, assuming EIP 1559 will also be implemented. Therefore, ETH may show a price increase in the short- to medium-run. Table 1 shows estimates of the price impact on ETH given that the circulating supply decreases with the number of ETH converted and staked in Ethereum 2.0 and assuming that the total market capitalisation and demand remain constant.
Table 1: Possible price impact of Ethereum 2.0 staking on ETH
Source: SEBA Research
In the longer run (i.e., after Phase 2) the price impact of Ethereum 2.0 may be bearish on ETH, as PoW network's utility will decrease, when transactions, smart contracts, and Dapps are initiated on the PoS network. Note that migrating the Ethereum network to PoS will be time-consuming and difficult and result in the locking up of capital. Therefore, one should avoid staking all Ethereum holdings on Ethereum 2.0. For long-term investors, it would be prudent to stake some of their ETH in Ethereum 2.0 to benefit from the high initial returns while also keeping some ETH on the PoW chain. These investors should also consider that this transition is one of the most ambitious projects in the digital assets space. A failure to deliver or any delays can negatively impact ETH’s price and lead to the locking up of capital on Ethereum 2.0 for an indefinite time period. Investors and traders can also consider the option of holding Ethereum and benefiting from the likely short to medium-term price increase up until the Beacon Chain release on June 30, 2020.
To become a validator
The barrier to entry to becoming a validator on Ethereum 2.0 is relatively low. To become a validator, one must fulfil certain financial and hardware conditions. The entire process will be clarified by release of the Beacon chain. However, the following are basic requirements for becoming a validator on the Beacon chain.
Now that the Bitcoin reward halving is completed, many investors are eyeing Ethereum as the next trade and investment opportunity. A smooth release of the Beacon Chain will be a positive step towards the migration of Ethereum from PoW to PoS. In the medium- to short-term, we expect ETH’s price to increase, as the PoS-based Ethereum 2.0 will not be fully functional until Phase 2 is implemented. During this time, Ether’s reduced supply and increased demand should increase its price. In contrast, in the long-term, the launch of Ethereum 2.0 may lead to a price decrease as users migrate from the PoW to the PoS chain. However, predicting these changes is difficult, because of the many factors affecting coin swap and interoperability functions.
1ETH refers to the currency used in Ethereum 1.0 network and ETH2 refers to the currency used in Ethereum 2.0 network ↵
2Blockchain Bloat is a condition under which the size of stored data becomes very large because of increasing numbers of users and transactions. When blockchain bloat is severe, transaction speed suffers. ↵
3In a database management system, sharding is a type of database partitioning that divides or partitions information into smaller data, also known as shards. These shards are not only smaller, but also can be processed faster and hence are more easily manageable ↵
4Here, we show 100 shard chains but the actual number may vary, as the Phase 1 details have not been finalised. ↵
5Network Variables Assumptions- ETH Price (auto update): $238, Validator Deposit (ETH): 32, Average network % online (only >2/3 supported): 95%, Network Fees/Day (ETH) Proposer Surplus: 0, Network Fees/Day (ETH) Burned: 0, ETH Circulating Supply: 110,000,000, Shards: 64, Slot Time (sec): 12, Epoch Length (slots): 32, Base Reward Factor: 64 Validator Assumptions- Validator Uptime: 98%, Validators Run: 1, Cost of Computer Hardware: $225, Useful Life (years): 2.5, Cost Per kwh (Global Average): $0.20, Watts (Per Shard Validated): 10, Watts Per Machine: 40, ISP Per Month (Global Average): $51.42, Cost of Router Hardware (Global Estimate): $90, VPS Cost (Per Machine Per Month): $20, Unknown Cost (Per Machine): $25, Number of Machines (16 Validators Per): 1, Total Watts: 50, ETH Cost: $7, 629, Initial Investment (USD): $7, 969 ↵
6Based on Beacon chain’s testnet requirements ↵
Subscribe to the research newsletter and get weekly updates about the latest articles of SEBAresearch
Subscribe to newsletter↓
This document has been prepared by SEBA Bank AG (“SEBA”) in Switzerland. SEBA is a Swiss bank and securities dealer with its head office and legal domicile in Switzerland. It is authorized and regulated by the Swiss Financial Market Supervisory Authority (FINMA). This document is published solely for information purposes; it is not an advertisement nor is it a solicitation or an offer to buy or sell any financial investment or to participate in any particular investment strategy. This document is for distribution only under such circumstances as may be permitted by applicable law. It is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction where such distribution, publication, availability or use would be contrary to law or regulation or would subject SEBA to any registration or licensing requirement within such jurisdiction.
No representation or warranty, either express or implied, is provided in relation to the accuracy, completeness or reliability of the information contained in this document, except with respect to information concerning SEBA. The information is not intended to be a complete statement or summary of the financial investments, markets or developments referred to in the document. SEBA does not undertake to update or keep current the information. Any statements contained in this document attributed to a third party represent SEBA's interpretation of the data, information and/or opinions provided by that third party either publicly or through a subscription service, and such use and interpretation have not been reviewed by the third party.
Any prices stated in this document are for information purposes only and do not represent valuations for individual investments. There is no representation that any transaction can or could have been effected at those prices, and any prices do not necessarily reflect SEBA’s internal books and records or theoretical model-based valuations and may be based on certain assumptions. Different assumptions by SEBA or any other source may yield substantially different results.
Nothing in this document constitutes a representation that any investment strategy or investment is suitable or appropriate to an investor’s individual circumstances or otherwise constitutes a personal recommendation. Investments involve risks, and investors should exercise prudence and their own judgment in making their investment decisions. Financial investments described in the document may not be eligible for sale in all jurisdictions or to certain categories of investors. Certain services and products are subject to legal restrictions and cannot be offered on an unrestricted basis to certain investors. Recipients are therefore asked to consult the restrictions relating to investments, products or services for further information. Furthermore, recipients may consult their legal/tax advisors should they require any clarifications. SEBA and any of its directors or employees may be entitled at any time to hold long or short positions in investments, carry out transactions involving relevant investments in the capacity of principal or agent, or provide any other services or have officers, who serve as directors, either to/for the issuer, the investment itself or to/for any company commercially or financially affiliated to such investment.
At any time, investment decisions (including whether to buy, sell or hold investments) made by SEBA and its employees may differ from or be contrary to the opinions expressed in SEBA research publications.
Some investments may not be readily realizable since the market is illiquid and therefore valuing the investment and identifying the risk to which you are exposed may be difficult to quantify. Investing in digital assets including cryptocurrencies as well as in futures and options is not suitable for every investor as there is a substantial risk of loss, and losses in excess of an initial investment may under certain circumstances occur. The value of any investment or income may go down as well as up, and investors may not get back the full amount invested. Past performance of an investment is no guarantee for its future performance. Additional information will be made available upon request. Some investments may be subject to sudden and large falls in value and on realization you may receive back less than you invested or may be required to pay more. Changes in foreign exchange rates may have an adverse effect on the price, value or income of an investment. Tax treatment depends on the individual circumstances and may be subject to change in the future.
SEBA does not provide legal or tax advice and makes no representations as to the tax treatment of assets or the investment returns thereon both in general or with reference to specific investor’s circumstances and needs. We are of necessity unable to take into account the particular investment objectives, financial situation and needs of individual investors and we would recommend that you take financial and/or tax advice as to the implications (including tax) prior to investing. Neither SEBA nor any of its directors, employees or agents accepts any liability for any loss (including investment loss) or damage arising out of the use of all or any of the Information provided in the document.
This document may not be reproduced or copies circulated without prior authority of SEBA. Unless otherwise agreed in writing SEBA expressly prohibits the distribution and transfer of this document to third parties for any reason. SEBA accepts no liability whatsoever for any claims or lawsuits from any third parties arising from the use or distribution of this document.
Research will initiate, update and cease coverage solely at the discretion of SEBA. The information contained in this document is based on numerous assumptions. Different assumptions could result in materially different results. SEBA may use research input provided by analysts employed by its affiliate B&B Analytics Private Limited, Mumbai. The analyst(s) responsible for the preparation of this document may interact with trading desk personnel, sales personnel and other parties for the purpose of gathering, applying and interpreting market information The compensation of the analyst who prepared this document is determined exclusively by SEBA.
Austria: SEBA is not licensed to conduct banking and financial activities in Austria nor is SEBA supervised by the Austrian Financial Market Authority (Finanzmarktaufsicht), to which this document has not been submitted for approval. France: SEBA is not licensed to conduct banking and financial activities in France nor is SEBA supervised by French banking and financial authorities. Italy: SEBA is not licensed to conduct banking and financial activities in Italy nor is SEBA supervised by the Bank of Italy (Banca d’Italia) and the Italian Financial Markets Supervisory Authority (CONSOB - Commissione Nazionale per le Società e la Borsa), to which this document has not been submitted for approval. Germany: SEBA is not licensed to conduct banking and financial activities in Germany nor is SEBA supervised by the German Federal Financial Services Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht), to which this document has not been submitted for approval. Hong-Kong: SEBA is not licensed to conduct banking and financial activities in Hong-Kong nor is SEBA supervised by banking and financial authorities in Hong-Kong, to which this document has not been submitted for approval. This document is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in Hong-Kong where such distribution, publication, availability or use would be contrary to law or regulation or would subject SEBA to any registration or licensing requirement within such jurisdiction. This document is under no circumstances directed to, or intended for distribution, publication to or use by, persons who are not “professional investors” within the meaning of the Securities and Futures Ordinance (Chapter 571 of the Laws of Hong Kong) and any rules made thereunder (the “SFO”). Netherlands: This publication has been produced by SEBA, which is not authorised to provide regulated services in the Netherlands. Portugal: SEBA is not licensed to conduct banking and financial activities in Portugal nor is SEBA supervised by the Portuguese regulators Bank of Portugal “Banco de Portugal” and Portuguese Securities Exchange Commission “Comissao do Mercado de Valores Mobiliarios”. Singapore: SEBA is not licensed to conduct banking and financial activities in SIngapore nor is SEBA supervised by banking and financial authorities in Singapore, to which this document has not been submitted for approval. This document was provided to you as a result of a request received by SEBA from you and/or persons entitled to make the request on your behalf. Should you have received the document erroneously, SEBA asks that you kindly destroy/delete it and inform SEBA immediately. This document is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in Singapore where such distribution, publication, availability or use would be contrary to law or regulation or would subject SEBA to any registration or licensing requirement within such jurisdiction. This document is under no circumstances directed to, or intended for distribution, publication to or use by, persons who are not accredited investors, expert investors or institutional investors as defined in section 4A of the Securities and Futures Act (Cap. 289 of Singapore) (“SFA”). UK: This document has been prepared by SEBA Bank AG (“SEBA”) in Switzerland. SEBA is a Swiss bank and securities dealer with its head office and legal domicile in Switzerland. It is authorized and regulated by the Swiss Financial Market Supervisory Authority (FINMA). This document is for your information only and is not intended as an offer, or a solicitation of an offer, to buy or sell any investment or other specific product.
SEBA is not an authorised person for purposes of the Financial Services and Markets Act (FSMA), and accordingly, any information if deemed a financial promotion is provided only to persons in the UK reasonably believed to be of a kind to whom promotions may be communicated by an unauthorised person pursuant to an exemption under the FSMA (Financial Promotion) Order 2005 (the “FPO”). Such persons include: (a) persons having professional experience in matters relating to investments (“Investment Professionals”) and (b) high net worth bodies corporate, partnerships, unincorporated associations, trusts, etc. falling within Article 49 of the FPO (“High Net Worth Businesses”). High Net Worth Businesses include: (i) a corporation which has called-up share capital or net assets of at least £5 million or is a member of a group in which includes a company with called-up share capital or net assets of at least £5 million (but where the corporation has more than 20 shareholders or it is a subsidiary of a company with more than 20 shareholders, the £5 million share capital / net assets requirement is reduced to £500,000); (ii) a partnership or unincorporated association with net assets of at least £5 million and (iii) a trustee of a trust which has had gross assets (i.e. total assets held before deduction of any liabilities) of at least £10 million at any time within the year preceding the promotion. Any financial promotion information is available only to such persons, and persons of any other description in the UK may not rely on the information in it. Most of the protections provided by the UK regulatory system, and compensation under the UK Financial Services Compensation Scheme, will not be available.
© SEBA / Kolinplatz 15, 6300 Zug, Switzerland
Join us as we