Can Ethereum miners influence the market? An analysis from the perspectives of supply and miner flow

This article was published on Crypto Valley Live, author: Karim Helmy, translated by: Li Hanbo.

The relationship between the Ethereum community and miners has always been somewhat tense. The network's proof-of-work algorithm, Ethash, was explicitly designed to be ASIC-resistant, thereby resisting the professionalization of mining. Since then, the network has begun its transition to PoS, with the ultimate goal of completely eliminating the role of miners in the network.

Before the transition to Ethereum 2.0, the network will continue to be supported by proof-of-work. However, even before this transition, the economic structure of mining on the network will change. One major impact is that the block rewards received by miners will decrease.

This is also reflected in the increasing compensation miners receive from miner extractable value (MEV), which is the extractable rent from ordering transactions. As the profits from on-chain arbitrage and liquidation transactions become higher, successful MEV executions are starting to play a more important role in miner economics.

In addition to Ethereum's currently volatile monetary policy and the increasing importance of MEV, upgrades to Ethereum may also change miners' profitability. One proposal, called EIP-1559, burns a portion of the fees instead of sending them to miners. Another proposal under discussion, EIP-969, modifies Ethash to reduce the utility of ASICs on the platform, while a third proposal, EIP-1557, suggests a complete overhaul of the proof-of-work algorithm. EIP-1559 is planned to be included in the upcoming London upgrade, while EIP-969 and EIP-1557 seem less likely to be adopted.

At this critical juncture in the network's development, understanding the role of miners in the Ethereum ecosystem is more crucial than ever. In this article, based on the first and second parts of the "Following Flows" series, we analyze the activities of Ethereum miners using data from Network Data Pro version 4.9. We found that the activities of Ethereum miners increased significantly last year, likely due to the rise in MEV extraction, and that miners primarily sell on Binance and Huobi.

Supply

The metric works by categorizing mining activities into two types. 0-hop activity corresponds to mining pools, while 1-hop activity corresponds to miners. Addresses that receive block rewards are classified as 0-hop addresses, while addresses that receive payments from 0-hop addresses are classified as 1-hop addresses. This reflects the typical flow of funds in mining, where pool operators receive block rewards and miners receive payments from operators.

Applying the same method to Ethereum, we see that miners are controlling an increasing amount of Ethereum (ETH), while the supply held by mining pools is relatively small. In particular, in 2020, the amount of Ethereum held by miners increased significantly.

Due to the premise of Ethereum, most of the native token supply is not generated by miners. Therefore, miners have always held a low proportion of the total ETH supply. As their original value has increased, the proportion of miners' holdings in the total supply of the network has generally grown over time.

This is in stark contrast to Bitcoin, where proof-of-work has always been the primary method of issuing tokens, and as the network matures, miners' share of the native token supply has generally declined.

Pool Flow

In addition to observing miner holdings, we can also analyze the flow of funds into and out of pool addresses. While these flows are largely insignificant, they provide useful context for the broader miner flows discussed in the next section. Like Bitcoin, the transaction volume processed by Ethereum pool addresses is relatively small, with inflows and outflows generally occurring in sync.

0-hop outflows are more volatile than inflows, primarily consisting of block rewards. Due to the network's volatile monetary policy, fee fluctuations are significant, and the income miners receive from block rewards has a certain level of unpredictability.

While pool expenditures are far from historical highs when measured in native units, they have been soaring when measured in USD. This reflects the rapid appreciation of ETH prices.

Miner Flow

Mining pools account for a relatively small proportion of total miner activity. Like Bitcoin, Ethereum miners play a broad role in the ecosystem, and this role cannot be fully captured by 0-hop flows alone. 1-hop flows are an order of magnitude larger than their 0-hop counterparts and have surged dramatically over the past year.

The rapid increase in inflows and outflows seems to be part of a broader trend over the past three years, with the proportion of miner activity in the total value transferred across the network increasing. The flow from pools remains relatively insignificant, further highlighting the importance of taking a broader view when assessing miner activity.

Several reasons can explain the broader growth, including the maturation of the network. However, the recent surge may be related to MEV: entities associated with pools may engage in on-chain arbitrage and liquidation to earn money beyond the block rewards specified by the protocol. If these addresses have received at least one payment from a pool, they will be heuristically marked as 1-hop addresses, and their inflows and outflows will be classified as miner activity. Because the scope is broad, it is likely that this activity is actually conducted by traders and arbitrage bots that are not directly affiliated with miners.

Like total value, the net flow of 1-hop addresses has seen significant growth over the past year. This may also represent the increasing role of MEV extraction in miner economics.

ETHASH and Exchanges

In "FOLLOWING FLOWS II: WHERE DO MINERS SELL?", the Coin Metrics team announced the release of flow metrics that measure the interactions between miners and exchanges. These metrics are an iteration on our standard miner flows, providing a more nuanced view of miner activity.

Deposits by miners on exchanges can be used to gauge miners' sales volume and location. Like Bitcoin miners, Ethereum miners generally tend to deposit coins into Binance and Huobi. These large Asian markets have good connections with miners, and both exchanges also operate mining pools.

Compared to their overall network share inflows, Huobi and Poloniex hold a disproportionately large market share among miners, while Binance's share is nearly the sum of the two.

The share of miner withdrawals on exchanges is similar to the share of miner deposits but is more volatile. For some reason, a lot of Huobi's miner withdrawal share has recently been overtaken by Kraken: the reason is unclear, and the result is likely anomalous rather than indicative of a real market change.

The total flow between miners and exchanges is also a valuable source of information. As expected, miners are generally net depositors: this is intuitive because they can obtain coins through mining outside of exchanges.

Because they are natural sellers, miners are often blamed for market volatility. In Ethereum, as in Bitcoin, these accusations are unfounded, as miners typically account for only a small single-digit percentage of exchange inflows. While a significant amount of miner selling occurs in over-the-counter (OTC) transactions and therefore does not immediately reach exchanges, the changes in miner activity are rarely large enough to attract attention.

Correlation analysis seems to support the lack of a substantive relationship between changes in miner selling and market volatility.

Over a one-year span, Ethereum prices have a moderately low negative correlation of -0.42 with exchange pool deposits and a moderately low positive correlation of 0.40 with overall pool outflows. The positive correlations of price with miner deposits and overall miner outflows are also low, at 0.20 and 0.31, respectively.

If miners were to be held responsible for price declines, we would expect a consistent moderate or strong negative correlation between expenditures and prices. Currently, there is almost no evidence that miners have caused market corrections.

Conclusion

Ethereum mining is at a critical moment, with the community considering several proposals that will fundamentally change the mining economics of the network, with MEV playing an increasingly significant role in miners' profitability. More importantly, these changes occur against the backdrop of a broader plan to transition the network to PoS, complicating the situation further.