Ethereum Block Reward Suppression Part 1
How the proposed block reward reduction may make it impossible to achieve ROI on mining equipment
Last friday I listened to a stream of the Ethereum Foundation meeting in which core developers and ETH pool members discussed whether or not and to what extent the Ethereum block rewards should be mitigated. The decision ultimately reached by the Ethereum Foundation will have a huge impact on not only Ethereum and its stakeholders, but also a large segment of the crypto Yflecosystem. This is of particular concern for Whalesburg as we are directly in the business of maximising miners’ profit by delivering a cutting edge mining pool.
Why Reduce the Block Reward
At its current price of around $280/ETH, it can be said that Ethereum’s daily security fee approaches $6 million. Remember, every 14 seconds an average of 3 ETH (in some cases as much as 8.5 ETH) are produced and distributed to the miners who dedicate their hashpower to Ethereum’s proof of work algorithm. This adds up to over 20,000 ETH per day (18,200 ETH from block rewards + 2,600 ETH from uncle blocks) or the equivalent of $5,800,000 at today’s market price.
All of that ETH goes straight to miners, who must decide how to manage it. A significant portion of the ETH is sold into fiat currency because miners have to pay electricity bills, maintain and replace equipment, and cover other expenses like building rental, loan repayment, and salaries. Leftover ETH earned by miners may remain in their coffers, or it may be converted to other coins, currencies, or assets perceived as superior investments. The daily selling of ETH into fiat represents a significant downward pressure on the market price of ETH.
In an attempt to cut the costs of securing the network and reduce the associated downward pressure on the price of ETH, the Ethereum Foundation is proposing a significant reduction in the block reward. The theory is that if less ETH is distributed to miners, the reduced downward pressure will result in an increase in the price of ETH. However, the actual result of reducing the mining reward is unpredictable: too large of a reduction in the block reward may have unintended negative consequences for Ethereum at least and likely for the wider crypto ecosystem.
Miners have made huge investments into the Ethereum network, mainly by buying, setting up and running mining rigs. Between September 2017 and March 2018, 147 TH/s was added to the Ethereum network total hashrate. This represents an increase of 280% in just six months. Put another way, the miners who joined in those six months now make up about 65% of the total Ethereum hashrate.
The price of a typical mining rig fluctuated between $12 — $30 per MH/s during this time. Assuming the lowest rate of $12 per MH/s we can conservatively estimate that miners invested at least $1.7 billion into securing the Ethereum network in just the six months between September 2017 and March 2018. Most of these miners got into the business expecting a return on their investment.
How long would it take for the miners who joined ETH in the six months between September and March to recover their costs?
We can use the following base calculation:
Total invested by Sept-Mar miners — Amount already recovered ÷ (The entire daily ETH block reward — The percentage of hashrate contributed by non Sept-Mar miners)
Total invested by Sept-Mar Miners = $1.7 billion
Amount already recovered = $500 million (assumes a generous 30% already recovered)
The percentage of hashrate contributed by non Sept-Mar miners = 35.7%
At the current block reward and without considering electricity costs and other operational expenses:
$1.2 billion / ($5,800,000–35.7%) = 322 days to return investment
Operational costs typically run at near 15% of overall profits and the electricity cost to generate 147 TH/s can be estimated at $800,000.
At the current block reward and taking into account electricity costs and other operational expenses:
Total invested by Sept-Mar miners / (The entire daily ETH block reward — The percentage of hashrate contributed by non Sept-Mar miners — Operational costs — Electricity costs )
If the block reward were lowered to 2 ETH:
$1.2 billion / ($5,800,000 * 2/3–35.7% — 15% — $800,000) = 913 days or 2.5 years to return investment
If the block reward were lowered to 1 ETH:
$1.2 billion / ($5,800,000 * 1/3–35.7% — 15% — $800,000) = 4675 days or 12.8 years to return investment
The dramatic increase in time required to recoup mining equipment investment is largely a result of the fact that operational costs remain basically fixed. So as the block reward decreases, operational costs constitute a greater and greater proportion of total expenses.
Considering that the typical lifespan of a GPU is just 2–3 years, the only scenario that currently makes sense from a miner’s perspective is if the block reward remains at least in the region of 2 ETH.
Let’s take the example of a typical miner who has 1 GH/s to play with. Such a miner will have an investment of approximately $12,000. At the current block reward and taking into account operational and electricity costs, this miner would need about 717 days to recoup their investment.
If the block reward were reduced to 2 ETH, the miner would instead need 1,294 days to cover their costs.
If the block reward were reduced to 1 ETH, the miner would need 6,623 days. In this scenario the miner would be better off selling their GPU or focusing its resources on another coin.
What about ASIC miners?
Currently more than 90% of mining on Ethereum is done by GPUs and although the amount of ASICs being added to the network is increasing, thanks to Ethereum’s ASIC resistant algorithm, the difference in efficiency between GPUs and ASICs isn’t nearly as pronounced for Ethereum as it is for other PoW coins, particularly Bitcoin. This means that even a large scale addition of ASIC miners to the Ethereum network isn’t likely to make a big impact on the above numbers, at least in the short term.
A component of the block reward not considered in the above calculations is the transaction fee. Ethereum network users currently spend nearly 1200 ETH per day on transactions. This is the equivalent of about 5% of the total daily block reward.
However, if the Ethereum Foundation decides to lower the block reward, a likely consequence will be an increase in transaction costs as miners struggle to remain profitable. Adding to the pressure is the fact that the Ethereum Foundation funds itself using a portion of the transaction fees. Combining these two factors, it’s highly likely that the gas price will rise as high as 90 gwei almost immediately after the block reward is reduced. This would translate to a single transaction cost of $1 or more, obliviating the business model of a large portion of the projects built on the Ethereum network and putting into jeopardy the feasibility of development on Ethereum.
A Middle Path?
Clearly something must be done to ensure the continued utility of Ethereum while balancing the needs of miners, the Foundation, developers, and end users.
In next parts of this essay I’m going to provide you with a couple of scenarios and calculations of miners profits if they switch to another coin or algorithm.
In the meantime I’d love to hear your thoughts on this important issue so please don’t hesitate to leave a comment below. You can also express your opinions and discuss in our Telegram group.
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