Foreword

September 15, 2022, marked the most significant day for the whole cryptocurrency community. On this day, Beacon Chain, after nearly 2 years, finally merged with the Ethereum Mainnet. After the merge, Ethereum completed its transformation of the consensus mechanism from proof-of-work to proof-of-stake and reduced the network’s energy consumption by about 99%.

While many are celebrating the long-awaited Ethereum 2.0 upgrade, miners feel depressed. These miners have been maintaining the operation of the network over the past seven years, no matter how drastically the ETH price fluctuates. However, The Merge means that the miners’ task finishes. They are no longer needed by Ethereum.

What should miners do when they can no longer mine on Ethereum? The answer to this question relates to a $19 billion affair. Since the inception of Ethereum, its fast-growing ecosystem has boosted the ETH mining industry with a market cap of $19 billion, a majority of which is invested in dedicated computer hardware that is impossible to use for other purposes. This market rose because of Ethereum but faces collapse now due to Ethereum’s upgrade. Miners need to find a way out with their mining rigs.

What is Ethereum Mining?

Different blockchain protocols have adopted different consensus algorithms to ensure that each transaction is correctly recorded by distributed ledgers and will not be tampered with by malicious attackers.

The consensus mechanism allows independent nodes to reach agreements on the transactions that need processing and to effectively block the wrong ones. In this way, the consensus mechanism helps maintain the security and reliability of the blockchain network and achieve stability.

At the initial stage when Ethereum was founded, it used the so-called proof-of-work (PoW) consensus mechanism, just as the Bitcoin network does, to ensure the authenticity and immutability of the blockchain ledger. Before The Merge, nodes in the Ethereum network competed for the right of adding the next block to the blockchain and updating the ledger by solving a complex math problem. The node that successfully solves the problem and updates the ledger can get the newly released Ether (ETH) as a reward for securing the Ethereum network.

The process of solving math problems consumes electricity and computing power. Nodes with higher computing power are more likely to get block rewards. The competition among nodes ensures that every transaction record on the blockchain is endorsed by the largest computing power and that all participants reach a consensus to maintain network security. Since this consensus mechanism is generated out of work that cannot be deceived, it is called proof-of-work.

For every new block created, a new ether is released. Participants working for the right to validate transactions on Ethereum are like gold miners. In crypto mining, nodes are mining rigs. The performance of a mining rig depends on its computing power. The process of solving a complex math problem is mining, and the reward for this process is ether.

Before transitioning to proof-of-stake (PoS) in September 2022, ETH mining developed into a highly capital-intensive industry, just as Bitcoin mining does. Since its inception at the end of 2015, the mining difficulty (by hash rate) of Ethereum Mainnet has risen from less than 100 Gigahash/sec to exceeding 1 Petahash/sec in mid-2022, increasing by a factor of 10,000. The mining rigs have also upgraded from CPUs to GPUs and now to ASIC miners with dedicated functions. It consumes a lot of electricity to mine ether. With the upgrade of Ethereum 2.0, the proof-of-work mining of ETH has been the history and is now replaced by staking that will significantly reduce energy consumption.

Source:2Miners.com

Why did Ethereum migrate to PoS?

Besides proof-of-work (PoW) and proof-of-stake (PoS), two of the most commonly used algorithms, there are many other consensus algorithms existing in the blockchain. Every algorithm has its strengths and weaknesses.

Although Ethereum Mainnet adopted PoW when it was initially launched in 2015, the development team had included the plan to migrate to PoS in the whitepaper as early as 2014 and introduced the difficulty bomb in the frontier thawing in September 2015. When the difficulty bomb is reached, Ethereum miners will not be able to obtain ether through computing power, which prepares Ethereum for a future hard fork to proof-of-stake.

Three key criteria to measure blockchain performance are security, scalability, and decentralization. Two of the properties can only be achieved at the expense of the other one. Therefore, this is called the “impossible triangle” of the blockchain.

Source: Blog of Vitalik Buterin

Proof-of-work is an excellent consensus mechanism that can be used to build highly secure payment networks, with which the transaction records cannot be tampered with unless attackers control more than 51% of the computing power in the blockchain. However, high security is based on huge expenses of hardware and electricity. With the expansion of the network and the increase in the number of nodes, the requirement for mining hardware gets significantly higher, allowing only well-capitalized companies to participate. This, as a result, leads to a centralization crisis and limits the possibility of mass adoption of blockchain.

To solve the energy intensity of blockchains, the upgraded Ethereum adopted proof-of-stake. Participants no longer need to purchase expensive hardware or consume electricity to provide computing power. Instead, they stake ETH in the validator node to obtain the right of adding blocks to the network and get transaction fees as rewards. Proof-of-stake can significantly lower the barrier to participating in the network and reduce unnecessary energy consumption. Common personal computers can run nodes, allowing more people to join to promote the decentralization of the blockchain network and improve security. It opens up a new path for future scaling solutions and development.

How will the Ethereum Merge impact miners

On September 15, 2022, Beacon Chain successfully merged with Mainnet when the Ethereum network’s Total Terminal Difficulty (TTD) hit 58,750,000,000,000,000,000,000. After the transformation of the consensus mechanism, the upgraded Ethereum is maintained by validator nodes that stake ETH instead of miners that provide computing power. For miners, the most direct impact of this transformation is that they cannot use mining rigs to obtain ETH any longer. The newly released ETH will be distributed to validator nodes that stake at least 32 ETH as rewards for creating blocks and validating transactions.

Actually, this is not the first time that miners suffer from such a sharp drop in rewards. In 2017, the Byzantium upgrade reduced the mining rewards per block by 40% from 5 ETH to 3 ETH. Ethereum’s gas fee structure changed after the London upgrade, before which miners took all the transaction fees, but now the base fee is destroyed and miners only get tips. The two upgrades have reduced the rate of return that miners can get and lengthened the period for them to get returns.

However, The Merge has cut the return down to zero. Before The Merge, upgrading the mining hardware and increasing computing power can help make certain returns. But now, this method does not work any longer. Due to the expensive mining hardware and high mining cost, miners are not willing to provide computing power for free. Therefore, they are out of their jobs overnight. They must find alternative approaches to provide computing power to get earnings, otherwise, they can only sell their mining equipment at a discount to reduce losses.

Alternative opportunities for Ethereum miners

Two types of ETH mining equipment are ASIC miners and GPU miners. ASIC, short for application-specific integrated circuit, uses a specifically-designed integrated circuit to optimize the mining algorithm, thereby improving the yield. Exclusively created to mine cryptocurrency, ASIC miners cannot be used for other purposes. Therefore, ASIC miners are most heavily affected by The Merge. According to statistics, ASIC miners provide nearly 30% of the Mainnet computing power.

Generally, miners using GPU have four alternative opportunities:

1.Move to mine other proof-of-work cryptocurrencies

Ethereum is not the only protocol that adopts proof-of-work before The Merge. Many other cryptocurrencies, such as ETC, Ergo, Ravencoin, Dogecoin, and Litecoin, are created by providing computing power. Taking the graphics card RTX 3060 Ti as an example, below is a comparison of the proportion of computing power provided by mining machines using 3060 Ti in each blockchain network before The Merge.

The data was compiled by NiceHash in 08/2022.

2.Join a centralized high-performance computing center

There is a market demand for high-performance GPU computing in many fields, including scientific research, national defense, media entertainment, financial services, machine learning, etc. Though the rewards of ETH mining have significantly shrunk after The Merge, selling computing power to different industrial applications would be an expedient measure in the highly uncertain crypto market. Currently, Hut 8 and Hive Blockchain Technologies, two large Nasdaq-listed crypto mining firms, have announced plans to transform into high-performance GPU computing centers.

3.Provide computing power for Web3 protocols

Many innovative blockchain projects and applications are powered by decentralized computing platforms. Render Network is a platform that meets the demand of art creators and GPU computing power providers, allowing users to render their images easily and quickly. The streaming project Livepeer Protocol uses GPU and network bandwidth resources of computing power providers to enable creators to transcode videos and perform live streaming at a lower cost. Other protocols that use third-party computing to assist with zero-knowledge proofs, such as Starkware, enjoy considerable potential after Ethereum’s upgrade.

4.Stake ETH to operate validator nodes

ETH miners must have earned some amount of ETH even if they have not realized the return. Selling all their ETH at this time may not be able to cover their cost. So it might be a more feasible solution to stake the ETH in a validator node or to run a validator node by staking 32 ETH and selling their ETH when the market rallies. But the problem is that the withdrawal of staked ETH is not enabled at this stage, and the staked ETH generates a much lower yield rate than that of ETH mining. Miners must consider all these factors when making decisions.

Is mining 100% profitable?

What we have discussed above is based on the assumption that Ethereum miners continue mining other cryptos other than ETH to get rewards, or use their mining rigs for other purposes. However, if we look at the future for the longer term, we may see many more alternatives for miners to choose from. Whether miners should continue mining or move to other fields depends on whether the crypto-mining industry still has the potential to grow.

BTC/ETH mining rewards from 08/2021 to 08/2022

According to Coin Metrics, Bitcoin miners created a total of $16 billion in earnings through mining in 2021, while Ethereum miners won $18 billion worth of ETH during the same period. The one-year output produced by ETH miners is approximately the market cap of the entire crypto mining industry, say $19 billion, generating an annualized rate of return of nearly 100%. In the past few years, the prices of Bitcoin and Ethereum have increased by dozens of times from the bottom in the bear market to peak in the bull market, leaving many people with the illusion that “mining is 100% profitable”.

But where do the mining rewards come from? Who pays for the mining rigs and electricity? All cryptocurrency holders do. Funds are not created out of anything. If miners sell their cryptos, there must be some market participants who buy them.

Why do people buy cryptocurrencies? Some of them buy crypto for practical use, many others buy them for speculation. An increase in crypto prices attracts more miners to join and buy. And the increase in mining difficulty drives up the mining cost, which, in turn, boosted the cryptocurrency price. As a result, people rush to buy the crypto until the funds are exhausted and can no longer support the price.

As shown in the diagram above, whether the crypto-mining industry prospers or declines depends on the price of cryptocurrencies. To a certain extent, the mining rigs are similar to an interest-earning asset of a cryptocurrency. The higher the token price, the higher the mining rewards and the more prosperous the mining industry will be. However, when the token price collapses and mining rewards decrease, the mining industry will also suffer a loss. Whether mining can bring miners profits continuously depends on whether people are willing to buy cryptocurrencies.

The mining revenue created for speculative purposes is essentially a Ponzi scheme. Once the bubble bursts, there will no longer be capital inflows to pay for the mining costs. According to Bankless’s statistics in mid-2022, all blockchain networks are currently operating at a net loss. This is because the newly released crypto rewards to miners and validator nodes are the necessary expenditure for securing the blockchain network, while the revenue comes from users’ transaction fees.

Before the Ethereum upgrade, the daily mining rewards generated a selling pressure of $36 million worth of ETH. In contrast, users are only willing to spend $13 million worth of ETH on services provided by the Ethereum network. To keep the blockchain network operating for the long term, there are only two ways: one, increasing the functionality of the blockchain network to scale up user base and revenue; two, reducing block rewards to cut down the cost of operating blockchain networks. Ethereum chose the latter and transitioned the consensus mechanism from capital- and energy-intensive proof-of-work to proof-of-stake that significantly reduced hardware requirement and energy consumption.

Conclusion

The conversion of the consensus mechanism after the Ethereum upgrade came undoubtedly as a terrible blow to miners and the whole mining industry alike. Ethereum mining used to be a cash cow for many people. In the seven years since the inception of Ethereum, it created an average annualized rate of return of 100%, bringing about a group of crypto miners who make profits in both bull and bear markets. However, The Merge has shattered this dream. Now, miners and mining firms can only abandon their mining rigs and move to different fields.

However, even if Ethereum postpones The Merge once again or proceeds with the mining method that consumes extensive energy and requires huge equipment costs, miners will inevitably experience a recession eventually. So far, there is still a long way to go to achieve mass adoption of cryptocurrencies. The fees paid by users for using the blockchain network cannot cover the mining rewards. Except for the efforts of securing the blockchain, miners do not create additional economic benefits and thus cannot motivate the market to pay for their equipment and electricity. Therefore, it is just a matter of time before the mining industry collapses, for which The Merge serves as an accelerator.

In order to find alternate sources of income, many miners have refitted their mining rigs and migrated to mine on other proof-of-work blockchains, or provided computing power sources for different fields, applications, and Web3 projects. In fact, there is no definite answer as to where miners will go after The Merge. The only thing that is certain at present is that executing proof-of-work by simply providing computing power can only be used for securing the blockchain network. If the ecosystem and the number of users do not grow, funds in the market will not continue to pay for such actions that generate no economic value.

Before proceeding with mining other cryptos, it is important to consider whether the crypto has economic value and is worth mining. Who is willing to pay for the mining costs? Only projects with potential and space for growth can become the next cash cow for miners and provide steady income.