How to Realize Zero-risk Arbitrage after Ethereum Merge

2022-09-16, 14:49

TL;DR

There are four stages in the development of Ethereum: Frontier, Homestead, Metropolis and Serenity. Among them, "Serenity", also known as "Ethereum 2.0", is the final stage of the project, which will be transferred to proof of stake (PoS mechanism), and the Layer-2 scalable solution will be developed.
Forks can also be divided into accidental forks and intentional forks. When two or more miners succeed in mining blocks almost simultaneously, unexpected forks will occur. At this time, the miners will mine on the two forks respectively until one of them is longer than the other - this represents that the miners have reached a consensus on which fork to adopt.
Before ETH 2.0 is formally upgraded and forked, users holding ETH assets on the platform can independently exchange and obtain two futures tokens, ETHS and ETHW, at 1:1 at the entrance of the exchange page.
The fork dispute is essentially a consensus dispute. ETHW's fate is contrary to the current mainstream consensus of PoS.

Ethereum Merge

Ethereum was originally proposed by Vitalik Buterin in 2013. Vitalik used to be a programmer who participated in the Bitcoin community. He once proposed to the core developers of Bitcoin that the Bitcoin platform should have a more perfect programming language to allow more people to participate in program development, but he did not get their consent. Therefore, Vitalik decided to develop a new platform to implement his idea.

Vitalik believes that many programs can achieve further development with the principles similar to Bitcoin. In 2013, he wrote the Ethereum White Paper, explaining the goal of building decentralized programs. Then in 2014, investors used Bitcoin to purchase Ether from the Foundation with the development funds obtained through online public fundraising.

Initially, the Ethereum program was developed by Ethereum Switzerland GmbH, a Swiss company, and then transferred to the Ethereum Foundation, a non-profit organization. At the beginning of the development of the platform, some people praised the technological innovation of Ethereum, but others questioned its security and scalability.

The development project is divided into four stages: Frontier, Homestead, Metropolis and Serenity.

Among them, "Serenity", also known as "Ethereum 2.0", is the final stage of the project, which will be transferred to proof of stake (PoS mechanism), and the Layer-2 scalable solution will be developed. It is upgraded in three stages: Berlin, London, and dual chain merge.

The beacon chain required by PoS will be launched on December 1, 2020, and the collateralization of the proof of stake (PoS) is allowed, but it cannot be withdrawn yet. By November 2021, 8 million Ether has been added to the collateralization of PoS, accounting for approximately 7% of the total issuance. In 2021, Berlin and London forks were deployed, the beacon chain was upgraded to prepare for future conversion to proof of stake (PoS), and the total circulation was controlled through the burning of handling fees and reduction of block awards. Presently, the PoW blockchain was incorporated into the beacon chain on September 15, 2022, converted to PoS, and activated 64 shardings in the same year, completing the upgrade of Ethereum 2.0.

Merge means that the engine of the consensus algorithm has been changed from PoW to PoS. After the Merge, Ethereum has completely stopped the previous PoW and changed to the PoS consensus mechanism. Other subsequent upgrades and scalable shardings of Ethereum 2.0 are possible only based on the PoS mechanism. For the entire public chain, the upgrade is not only a problem of a simple consensus algorithm, but also a test of the ability of a public chain to switch from one consensus mechanism to another. If it can be smoothly migrated, it will be a very big milestone for all public chain upgrades and hard forks.

What Are Forks

In cryptocurrency, forks contain several definitions: for example, one blockchain is divided into two blockchains; It can also be said that a protocol change or two blocks with the same height can be called forks. In order to maintain the past trading records of currencies, cryptocurrencies are generally forked to add new functions or plug bugs.

And forks can be divided into unexpected forks and intentional forks. When two or more miners succeed in digging blocks at almost the same time, unexpected forks will occur. At this time, the miners will mine on the two forks respectively until one of them is longer than the other - this represents that the miners have reached a consensus on which fork to adopt.

As a result, the network of miners would then give up digging other forks. The abandoned blocks are called isolated blocks. Therefore, many cryptocurrency participants require multiple confirmations of transactions in order to prevent unexpected forks from invalidating the block where the transaction is located.

Among them, intentional forks refer to modifying the original blockchain, which can be classified as one of the key points of the article that we will talk about next - hard forks.

Hard Forks

In the hard forks, the blocks generated by the new forks will be considered invalid by the old software. Therefore, all participants, including transaction servers and miners (nodes), must update the software to continue running the new fork. If a node group continues to use the old software while other nodes use the new software, it is possible to split into two currencies.

Soft Forks

Compared with hard forks, the blocks generated by soft forks can be recognized as valid blocks by old software, that is, blocks are downward compatible. However, blocks generated by old software may not be valid under the new rules.

How to Get Candies

As the mainstream "force" in the blockchain world, the deal hunter will not miss the opportunity of forked-coin arbitrage (i.e. candies). Thus, how can we get candies?

1. Get candies on chain
Before forks:
a. Withdraw the ETH stored in your exchange and DeFi protocol to the mainnet of Ethereum
b. Migrate the ETH on other chains back to the Ethereum main network
c. Upgrade playing method: deposit the assets (BTC, stETH, stablecoins, atom, dot, etc.) that can be used as collateral into the DeFi lending protocol before the fork, lend ETH, and transfer them to the Ethereum mainnet.

2. Get candies at Exchanges
Before ETH 2.0 is formally upgraded and forked, users holding ETH assets on the platforms can independently exchange and obtain two futures tokens, ETHS and ETHW, at 1:1 at the entrance of the exchange page. If ETH 2.0 is upgraded and forks eventually occur, ETHS will automatically convert 1:1 to the upgraded ETH token. That is, ETHW is candy coin. Gate.io launched the forked-coin exchange function 10 days before the Merge on September 10.

Ethereum hard fork was completed on September 15, 2022. Gate.io will take ETHW as ETH forked candy, and distribute ETHW (PoW forked coins) to eligible ETH holders at 1:1 according to the snapshot of ETH balance at 14:30 (UTC+8) on September 15. After the distribution of ETHW, the holding users can freely trade in the existing ETHW market. The deposit and withdrawal of tokens on the ETHW chain will be opened after the PoW chain is determined to win.

For the processing of ETHS, Gate.io has delisted the ETHS trading market. ETHS held by users will be converted into ETH at 1:1. ETHS position holders will receive the same amount of ETH.

ETHW Trading Market
https://www.gate.io/trade/ETHW_USDT
https://www.gate.io/trade/ETHW_ETH

ETH Trading Market
https://www.gate.io/trade/ETH_USD
https://www.gate.io/trade/ETH_BTC
https://www.gate.io/trade/ETH_TRY
https://www.gate.io/trade/ETH_USDT

Value of Forked Coin ETHW

The full name of ETHW coin is Ethereum PoW. ETHW is a token launched as part of the Ethereum PoW plan, which aims to retain the proof of work (PoW) version of Ethereum after the "Merge".

The issue date of ETHW coins is September 15, 2022. The exchange rate with ETH is 1:1 snapshot, and the total issue amount is ∞. According to the latest data, Ethereum Merge was completed at 14:42 (HKT) on September 15, 2022, and the height of the merged block was 15537394!

Ethereum PoW (ETHW) is a forked Ethereum based on the Proof of Work consensus mechanism led by developers in the unofficial community. It is the forked coin of Ethereum (ETH).

With the growing ecosystem of Ethereum and the number of users, the computing power of the entire network is also growing. Under the PoW mechanism, miners with low computing power have very little chance to obtain block rewards through mining, Therefore, for small miners, joining the pools (that gather the computing power of large and small miners) is a good choice.

The mining pool gathers a lot of computing power, which greatly increases the probability of digging out blocks, and then distributes the rewards to the miners in a certain way. However, with the continuous expansion of the mining pool, the computing power of Ethereum has shown a centralized trend. A large amount of computing power is concentrated in several pools.

According to the data of Etherscan, the top three mining pools are Ethermine (28.2340%), F2Pool Old (13.2992%) and Hiveon Pool (10.4076%). The excessive concentration of computing power seriously threatens the security of the Ethereum ecosystem, which is the most concerning issue of the Ethereum Foundation.

Now the comprehensive computing power of the top three mining pools has exceeded 51%. If they jointly launch a "51% attack", it can definitely be achieved. From the perspective of Vitalik and the Ethereum Foundation, the rapid growth of the miners group has made the "Miners' Union" a threat to the security of the Ethereum network, which is something that Vitalik and the Ethereum Foundation fear and cannot tolerate.

On the other hand, under the design of the PoW system, even if a person dug up a large number of tokens through simple equipment in the early stage (for example, it is said that Satoshi Nakamoto, the founder of Bitcoin, dug up more than 1 million Bitcoins through personal computers in the early stage), he still could not have full control over the whole blockchain system (accounting right).

However, if Bitcoin suddenly changes from PoW to PoS at this time, it means that Satoshi Nakamoto who has 1 million Bitcoins or those large exchanges that have millions of staked tokens will immediately become the absolute monopoly of the entire mining system, while the latecomers may not be able to surpass this early advantage no matter how hard they try, and the important feature of "decentralization" of the blockchain system will no longer exist. The whole system will even be directly exposed to the "Double Spending" attack.

Similarly, the largest number of token holders in the Ethereum system are also early miners and large exchanges. At this time node, the Ethereum system will be upgraded from PoW to PoS, which also satisfies the interests of early token holders, but is very unfair to the latecomers. The fact that Vitalik Buterin is directly in the PoS camp is in essence one of the features of the insufficient decentralization of Ethereum.

How to Realize Zero-risk Arbitrage?

Since ETHS can be directly converted to ETH in a rigid 1:1 manner after the ETH2.0 upgrade (no matter whether it is forked or not), the potential revenue opportunities are as follows:

Divide the funds into two parts. One part of the funds is used for purchasing ETH and converts it into ETHS and ETHW. ETHW can sell it directly in the secondary market to complete arbitrage; Another part of the funds are used for buying ETH on the exchange, and short contract by one time (the same goes for confirming the snapshot of ETH upgrade);

Monitor the price/exchange rate of ETHS/ETH trading pairs. If the price is less than 1, you can directly purchase ETHS. After upgrading, ETHS will be converted to ETH, and the price difference will be the profitable part; If the price ＞ 1, you can directly sell the held ETHS, and the price difference is the profitable part (low probability);

Monitor the sum of prices of ETHS/ETH and ETHW/ETH trading pairs. Due to the two-way cashing mechanism, there is theoretically a time of 1 ETHS + 1 ETHW ≠ 1 ETH, providing a certain space for merger/split arbitrage. If the sum of the two is ＞ 1, you can directly purchase ETH, convert it into ETHS and ETHW through 1:1 on the exchange page, and sell it to complete arbitrage; If the sum of the two is less than 1, you can purchase the coin with a large price deviation between the two and conduct reverse exchange;

Compared with ETHS, ETHW is the main target of speculation in this market hot spot. Although in the long run, there is no conclusive conclusion on whether there is a fork (according to the existing information, no team has yet provided a technical guide to the fork, which is difficult), in order to attract market heat in the short term, ETHW has the potential to speculate in the secondary market. For some sensitive and mature traders, there are the following potential trading opportunities:

Due to the existence of ETHW, ETHS will deviate from the price of ETH in most periods before the form is unclear (the current exchange rate is 0.95 ETH).

When the big market retreats as a whole, ETH prices fall, and low-risk arbitrage and non long-term ETH coin holders are more likely to rush to sell ETHS, further depressing the price of ETHS.

If the ETH2.0 hard fork fails, some exchanges (such as Gate) require users to provide both ETHS and ETHW 1:1 at the same time to switch back to ETH. If the user sells ETHW in advance, there will be a risk that they will not be able to buy it back, and thus cannot convert ETH (therefore, Poloniex is recommended here, and only ETHS can directly convert ETH if the fork fails).

Arbitrage between trading pairs: presently, the trading pairs of ETHS and ETHW in the market include ETH, USDT and USDD. Arbitrage space is generated when there is a price difference between different trading pairs.

Cashing risk: Since ETHS and ETHW are IOU futures tokens in essence (most exchanges cannot deposit or withdraw Altcoins that only participate in trading on one or two exchanges, such as ALY on GATE), there is a potential cashing risk when ETHS is converted to ETH after the ETH2.0 upgrade. It is worth mentioning that the Poloniex takes the lead in issuing and supporting the charging and withdrawing function of ETHS and ETHW token assets based on the TRON chain in its announcement, and publicizes the token contract and ETH reserve address (the whole network platform may successively support this asset as the ETHS/ETHW before upgrading, connect the liquidity of each platform, and facilitate cross-platform arbitrage).

Conclusion

Forks are essentially a dispute of consensus. After Ethereum forks, there will be two identical versions of the corresponding assets of various protocols and asset issuers. Then the manager of the "vault" must actively choose which version to recognize as true, and the asset value of the unsupported version will be zero directly from the first moment of the forking.

Among the top KOL and institutions in crypto space, 99% of them are against the ETH forked coin ETHW except for Chandler Guo Hongcai and Justin Sun.

However, it may be too early to say that the era of PoW has ended, because PoW is essentially a competition for resources in the entire physical world, such as power resources and chip resources, which are subject to physical restrictions. Therefore, PoW has a capacity limit, which will lead to fewer and fewer new public chains to adopt the PoW mechanism. If there are more new public chains in the future, It is unlikely to adopt the PoW consensus mechanism.

But for old public chains, especially those led by Bitcoin, they have no reason to convert to PoS, because they can obtain better security through PoW consensus. Therefore, for some new public chains, PoS confirms their preference. For husband chains, PoW may be the only choice.

Earlier, Chandler Guo Hongcai, the leader of ETHW, issued a meaningful tweet, "I am just a beef seller, and it is normal if the fork fails. Fork is a highly difficult technical work, 90% of which may fail.”

As of the time of writing, the ETHW/USDT price was $19.05, with a 24-hour drop of 67.58%. Currently, the drop is still expanding, and it is only 24 hours since Ethereum Merge.

The failure of ETHW may be inevitable? Maybe all this is just their elaborate "farce"? Let’s wait and see.

Author: Gate.io Observer: Byron B. Translator: Joy Z.
Disclaimer:
* This article represents only the views of the observers and does not constitute any investment suggestions.
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