Hands up if you’ve said this in the last 12 months!
The upcoming ethereum merge is starting to look interesting. The short version is that at some point in September, ethereum will move from a proof-of-work (PoW) consensus mechanism to proof-of-stake (PoS). The consensus view here is that this is very positive, putting ETH on the path to very high transaction capacity and lower fees and the price might continue responding like it has (up 70% since July).
Under PoS, mining rewards will no longer go to the entity with the most computing power, rather, to the person who stakes the most ETH. That’s a problem for ethereum miners, many of whom have invested billions of dollars in mining equipment for PoW. In 2021, ethereum mining revenue exceeded $1 billion per month.
With their model about to collapse, the PoW miners are not sitting idly by. One of the leading miners has announced he will support a fork of ethereum known as ETHW once the merge happens in September. Essentially, he will take ethereum as it currently is and continue to mine it, ignoring the upgrades planned by the rest of the network.
This introduces a number of issues. Firstly, how much value will shift across to ETHW? That will depend on user and developer adoption, which may well be low to begin with. But if the Merge (the technical upgrade) goes wrong then an existing platform that everyone is familiar with might look more attractive.
Secondly, over $100 billion of other assets sit on the ethereum network, many of them in stablecoins. Is there an argument that it is worth someone spending an enormous amount (say a few billion dollars) to support ETHW with a view to compromising that $100 billion of value on the new PoS chain? For example, might some of the stablecoins lose parity to the $1 if there is chain confusion? Quite trivial in that case to get your $1 billion back by shorting the stablecoins.
If this is an open source, adversarial system then it would be perfectly acceptable to do so, however harsh the outcome might be.
ETH looks a bit vulnerable to this particularly with a market cap of ~$200 billion with $100 billion sat on top of it in other assets. To me, the base layer needs to be significantly more valuable than everything that runs on it.
It’s unlikely to be an issue but exposure to ERC20 tokens looks riskier in the next few months than it has for a while.
For more analysis on the upcoming Merge, see Dan’s article for Livewire.
Tornado hits crypto
Quick explainer: a cryptocurrency mixing service essentially pools cryptocurrency together and redistributes it amongst users to prevent transactions being traced. Generally used for privacy purposes, in some cases, nefariously.
On Monday the US Government banned Americans from using something known as Tornado Cash, an ethereum mixing service, by adding it to the US sanctions list. It’s quite the move because essentially it is software that has been sanctioned, not a person or an entity. It is an interesting question for freedom of speech, effectively we are being told “you cannot write software like that”.
It’s questionable whether a court would actually uphold this course of action but we can also be sure that there aren’t many US citizens willing to test that water.
On the same day, the software repository (GitHub) where users downloaded the software was deleted. The website is also gone (seized by the government). Here’s the website in June thanks to WayBackMachine and now today.
The USG claims Tornado was being used by the North Koreans to launder money. I believe them and so this course of action is not surprising. What might be surprising to people is the ease with which they killed a ‘decentralised protocol’. Anyone who contributed to this project has had their own GitHub accounts deleted. The major ethereum node operators immediately stopped supporting access to Tornado no doubt following knocks on the door from friendly Federal Agents. So over 50% of nodes immediately complied because there is no real decentralisation in ethereum node distribution.
For the avoidance of doubt, that is not to suggest that protocols should support North Korean money laundering. It is to suggest that a decentralised open source protocol simply allows access to everyone at all times whoever they. Bad or good. It is simply agnostic by design.
Suffice to say, the design of digital assets is very important and we might just witness why over the coming months.
Dan further explores the implications in this article for Livewire.
You have enough
“I don’t feel the pain of inflation anymore. I see prices rising but I have enough… I sometimes balk at the price of things, but I don’t find myself in a space where I have to make trade offs because I have enough, and many Americans have enough.”
Unfortunately that was Mary Daley, a Federal Reserve governor. Mary earns US$425,000 annually, pre-grift. It’s a relief to hear she is ok.
It wasn’t a good week for foot-in-mouth bankers. She was followed by serial-buffoon Andrew Bailey of the Bank of England, who helpfully opined:
“Workers should refrain from asking for inflation-matching pay rises …….. there is a risk of inflation becoming embedded”.
Mr Bailey earns £575,538 annually from the Bank, plus he receives CHF 250,000 tax free from his role at the Bank of International Settlements. Don’t get me wrong, I want him to be fabulously well paid, I just don’t want him to be quite so dumb and undeserving. Is it too much to ask?
Bailey went on to explain he expects inflation to peak at 13% later this year. Clearly 13% pay rises seem over the top. The thing is, even if they happened they wouldn’t match inflation. Most people would give up around 35% of that rise in tax. A post tax inflation-matching payrise in the UK would need to be around 18%. Nobody is getting that and Mr Bailey needs to take some responsibility for making everyone in the UK materially poorer at a now record rate.
While she’s away we can have a look at what they have been up to the last few weeks — they haven’t been slack in their bond buying. These purchases were made under the Pandemic Emergency Purchase Plan (PEPP) to solve the problem of spiking Italian bond yields.
It’s pretty straightforward. The ECB gobbles up €15 billion in bonds of the weak countries (Italy and Spain) and sells an equivalent amount of German bonds. Et voila; yields in Italy drop and yields in Germany rise. Job done. Essentially the ECB just monetises the risk premium between the two countries.
The problem of course is that the ECB will at some point run out of German bonds to sell and it will never run out of Italian bonds it has to buy. The policy is only going to work if Germany runs budget deficits greater than Italy, i.e. becomes less prudent than an Italian government. It doesn’t seem likely. So the Euro doom-loop will continue.
In the meantime, Christine has another week off and we should hear from her next week at a guess.