Interpreting "Minimum Viable Issuance" (MVI): Seeking a balance between security and inflation in ETH.

Source: Anders Elowsson, Ethereum researcher

Translation: Deep Tide TechFlow

Introduction

I believe that implementing "Minimum Viable Issuance" (MVI) is very important, which is an important commitment to ordinary Ethereum users. Staking should be able to ensure the security of Ethereum, rather than becoming an inflation tax, while reducing utility and liquidity, and creating oligopoly risks.

Ethereum is constantly evolving and may drive the global financial system in the future. We must assume that the "average user's" understanding of the internal workings of Ethereum will be similar to that of the average person's understanding of the current financial system.

Of course, we cannot assume that ordinary users will be driven by any ideology, just as the initial creation of Ethereum was motivated. Our job is to ensure that the correct incentive mechanism is in place so that Ethereum can develop unimpeded.

One important design principle that existed from the beginning of Ethereum's birth is "Minimum Viable Issuance" (MVI), which means that the amount of ETH issued by the protocol should not exceed the amount required for security purposes. This principle is reasonable whether it is under Proof of Work (PoW) or Proof of Stake (PoS).

Under PoW, the role of MVI is to prevent miners from charging ordinary users too much inflation tax. Therefore, the block reward was reduced from 5 ETH to 3 ETH, and finally to 2 ETH.

Under PoS, the MVI principle should also be adhered to, and ordinary users should not be charged excessive inflation taxes. Ordinary users should not need to worry about the details of staking in order to avoid their savings being eroded or supporting a verification node set that may be subject to censorship, and so on.

Therefore, MVI is actually able to maintain the collateralization ratio (the proportion of ETH used for staking) at a sufficiently high level, but not higher. In this article, I will try to explain why issuing beyond the "minimum viable amount" will reduce the utility of Ethereum.

MVI Empowers Users with Benefits

For individuals, there are various opportunity costs associated with participating in staking. It requires resources, focus, and technical knowledge, or the need to trust a third party, while also reducing liquidity. Liquidity staking tokens (LST) are not as reliable as native tokens and are not suitable as currency or collateral.

Therefore, individuals hope to obtain returns through pledging. They define their minimum expected rate of return as the minimum rate of return they are willing to pledge (using their best pledge method). Therefore, the (reverse) supply curve of Ethereum originates from the minimum expected rate of return of future Ethereum holders.

The reserved yield of the holder can be described as the "indifference point", at which point the utility they receive from staking is equivalent to not staking. This means that reducing the issuance can actually increase the utility for everyone, including stakers, as long as Ethereum remains reliable and secure.

Considering the assumption supply curve (in blue) with an elasticity of 2 for the supply yield. In this example, I set it to reach a yield of 2% when the collateral amount D reaches 25 million ETH, meaning that when 25 million ETH is collateralized, the minimum expected yield for marginal pledgers is 2%.

The supply curve in reality is a rather complex phenomenon, and we have not yet reached the equilibrium point where it can be anchored. However, we will start from this simple and quite realistic scenario. We will also ignore the complexity of compounding.

The combustion rate b is set to 0.008. This is the proportion of burned ETH represented as an annualized rate since the merger, compared to the total supply. However, this is not the key point, as we are concerned with the shift in supply and demand between the mid-term equilibrium points (circles), rather than the drift of the total supply of ETH.

The extracted value (REV) (slightly higher than 300,000 ETH per year) has been added to the protocol issuance to form the black demand curve (current policy) and the green demand curve (by reducing the base reward factor F from 64 to 32, halving the issuance).

The halving of the issuance reduces the yield y (red arrow). This reduces the issuance yield yi=y-yv (where yv is the yield from REV), thereby reducing the issuance i=yid and the inflation rate of the circulating supply s=i-b (orange arrow).

Within one year, the proportion of circulating ETH holdings that a person can obtain, denoted as P, depends on s and the yield rate y of each holder, according to the formula: P=1+y/1+s-1.

The ratio between the current issuance policy P1 and the halved issuance policy P2 is: P=1+P2/1+P1-1.

The utility change related to definition is u=P, but when calculating P2, for those who stop staking, their respective minimum expected yield rates are used. When the yield is lower than that rate, they would not have staked in the first place, so as the yield further decreases, they will not suffer additional utility loss.

According to this definition, everyone will receive higher utility at the new equilibrium point. Although the stakers see a decrease in profits, the decrease in the inflation rate of the supply allows them to obtain a larger proportion of ETH.

Of course, non-stakers would obviously be better off, because the only change for them is a decrease in the ETH issued to stakers. Those who stop staking are the only participants who experience a decrease in the proportion of circulating ETH at the new equilibrium point.

Despite the friction, their situation still implicitly improves due to the improvement of utility. For example, marginal pledgers who didn't care about pledging at the old equilibrium point can now stop pledging and receive the full supply quantity, which improves utility due to currency contraction.

When the person who stops staking finds themselves in between, they still benefit from the decreasing inflation but suffer some losses in earnings until they become indifferent to staking and unstaking. We have explained that, from a utility perspective, the issuance policy is not a zero-sum game.

In addition, any increase in utility obtained by any group will also generally benefit all token holders.

As long as you have underlying ETH, everyone can benefit from MVI. This does not include CEX and other staking service providers (SSP) that profit from staking fees. They will not benefit from the reduction in supply inflation and hope to maintain high yields to keep high reduction.

However, the issuance above MVI forces unwilling stakers to bear a decrease in utility when staking, or a decrease in economic consequences when not staking. Under the realistic supply curve, even willing stakers would face a worse situation. Please note that this example does not even consider the impact of taxes.

A PoS cryptocurrency with a yield of 5%, where everyone participates in staking and the average tax rate on staking yield is 20%. 1% of its market value is used for taxes annually. This is higher than the amount that Bitcoin will be distributed to miners after the next halving.

The debate does not necessarily depend on users' views on tax levels or how to interpret pledge returns. We can still conclude that by implementing MVI, Ethereum maintains a more neutral stance on differences in tax policies between nation-states.

It can be said that Proof of Stake requires lower rewards to achieve the same level of security as Proof of Work, and it is important to fully utilize this to maximize user utility. For example, with a yield of 2% and a total reward of Y=0.022500=500,000 ETH for staking 25 million ETH.

The "return rate" that maintains this stable and secure state is approximately r=Y/S=0.4%, which is surprisingly low. We fully utilize this point to provide maximum utility for users. The potential balance of the current issuance policy is represented by the black circle.

The yield is about 3%, with a pledge of 50 million ETH, which is Y=1.5 million ETH per year. The annual reward difference of 1 million ETH (calculated at over 1 billion US dollars based on the current token price) can be rewarded to Ethereum users without diluting token holders.

For MVI, the average extraction of 15% of the staking fee will provide approximately $250 million in excess profits to CEX and SSP each year. Some of it will be passed on to company shareholders, while some may be used for lobbying to keep the yield always above MVI.

From a macro perspective, the benefits of MVI

I often think that the penetration of Ether into the ecosystem is desirable. As for L2, bridging Ether binds L1 and L2 together, and provides external funding for users on L2, thereby improving their financial security.

If in the system you create, users must rely on some stubborn ETH derivatives as funds to avoid inflation tax, the entire ecosystem is more vulnerable to disruption.

For example, consider the following scenario: users who are unable to pledge their ETH provide it to organizations (SSPs) that run validators for them. These organizations can issue LST as collateral and use it on Ethereum.

If this protocol does not run under MVI, but operates at a higher deposit rate, one or more LSTs may replace the currency in the Ethereum ecosystem and embed it into every layer and application. What impact will this have?

Firstly, the positive network externality brought by the currency function may keep LST in a dominant position, while its SSP provides services that are worse than competitors (for example, charging higher fees or only providing inferior risk-adjusted rewards).

Secondly, and most importantly, LST holders as well as any applications or users who need to preserve the value of LST will share a common fate with LST and the ultimate LST issuing organization (SSP).

This requires a large part of Ethereum to destroy itself. Affected users may be more willing to reinterpret errors or improper behavior as completely different things. Once you become a currency of Ethereum, you become a social layer to some extent. We are no longer only concerned with the ratio of LST pledged ETH, but the ratio of total ETH under LST. Corrupt institutions are also located one level above the consensus mechanism.

From The DAO, it is evident that if the proportion of the total circulating supply affected by the outcome becomes large enough, the "social layer" may shake its commitment to the potential consensus process.

If the community is unable to effectively intervene in events such as 51% attack, then risk mitigation in the form of the warning system discussed by Buterin may not be effective.

In this case, the consensus mechanism has become so large and interconnected through derivatives that its ultimate arbiter - the social consensus mechanism - is overloaded.

Now let's consider the different scenarios under MVI. Firstly, each LST will face tougher competition from non-staked ETH. Therefore, the ability to monopolize currency functions and charge high fees or offer higher-risk products will be weakened.

Secondly, the social layer will continue to be bound to Ethereum and ETH natively, rather than being bound to external organizations and their ETH derivatives. By keeping the collateralization ratio low enough through MVI, the risk calculation for participants is changed.

Under MVI, when the collateralization ratio is low enough to prevent the development of moral hazard, delegating the pledge to the agent problem (PAP) that dominates LST can be more accurately priced. Without LST, it will not grow to the point of being "too big to fail" in the eyes of the Ethereum social layer.

This pricing will reflect the fact that the larger the pledged shares controlled by the agent (or any party able to intervene in the relationship) acting on behalf of the principal, the better the opportunity it has to degrade consensus for its own profit.

The entrusted pledger must always consider what security guarantees it has (such as the value risk of the pledging agent or the intervening party itself), and know that if the worst case happens, it may lose everything.

Cancel the direct dominant position of Ethereum currency and assume that under MVI, the deposit ratio has increased to the scale of utility maximization. Larger SSPs are likely to find non-monopoly strategies more profitable (i.e. cost increase).

This is just a comment related to the present. But what's important is that it reflects a fact: for every "cartel layer" we can eliminate, the value proposition of secure and consistent SSP increases relatively.

One important step towards MVI is MEV burning, which may also have the potential to eliminate the "cartel layer" that is more important than monetary functions. MEV burning helps to reduce the reward variance of independent stakers, and if the issuance yield is reduced, this variance will increase.

It also brings higher precision for targeting MVI, as it eliminates a potential source of gains that may change unpredictably over time.

It is worth noting that various methods may be adopted in the future to address certain aspects of the delegation-agent problem (i.e. one-time signature) in the delegation of pledge. However, the fundamental issues of establishing trust, monopolistic incentives, and review capabilities may be difficult to avoid.

Another benefit of MVI is that it improves the conditions for (independent) staking, which is directly related to the size of the collateral, the number of validators, and the size of the validators. If the size of the collateral changes, the size or number of validators (network load) will also change.

This effect will spread throughout the entire protocol design space and will affect any targets that may be replaced to achieve higher or lower network loads, such as parameters related to variable validator balances.

This is a basic attribute of the current consensus mechanism. If the issuance policy leads to d=0.6 at the mid-term equilibrium point instead of d=0.2, independent staking will require three times the amount of ETH to maintain the same network load, with other conditions remaining unchanged.

Returning to the essence, I believe the most important benefit of MVI is its ability to provide utility for ordinary users. Ethereum is in a unique position to make native cryptocurrencies a global currency, which I believe is an opportunity worth pursuing.

When a country implements price inflation by increasing the monetary base, they control the time choices of ordinary people and believe that this control is still feasible in a digital and globalized world.

Ethereum should not control ordinary people, nor should it force them to save liquid energy. We should allow them to use Ethereum currency as conveniently as possible and derive utility from it. The "risk-free interest rate" in Ethereum is simply holding (and trading) ETH.

解决 MVI 的潜在问题

translates to

Solving Potential Issues with MVI

in English.

After explaining the potential benefits of MVI, the second part will address some of the suggested drawbacks. These include reduced economic security and the notion that if we lower profits, delegated staking will replace all independent staking.

When it comes to the first point, this is indeed correct, as a higher deposit rate will indeed force attackers to spend more resources, such as recovering finality. This is not something that can be taken lightly.

Our goal is not "minimum issuance". We must always ensure that it is "feasible". Buterin provided some intuitive explanations on how expensive a 51% attack on Ethereum would be.

We can also consider the nearly 14 million ETH that are being merged to ensure the security of Ethereum as the "preference" of the ecosystem for a collateral scale that is deemed safe enough under the current consensus mechanism (in terms of resisting the 51% attack, not just the super committee accountability system).

At the same time, having a considerable margin is indeed good. The current mortgage rate (d0.2) may also bring a significant improvement in resisting false accounts compared to the mortgage rate (d0.1) at the time of consolidation.

The slope of the reward curve cannot be too steep, which is why we may want to operate at a certain distance from the preference point and ultimately determine d from the probability analysis of staking supply and demand.

Some people may think that delegating staking makes resource allocation easier in some way, but this is only "superficial" security. However, by making all staking face punishment and eliminating moral hazard (through MVI), the delegator must be very careful when delegating staking, as mentioned above.

Under this setup, the market determines the appropriate capitalization ratio for the staking operator and prices the risk of staking. In contrast, Ethereum is responsible for punishing improper behavior and maintaining the value of ETH relative to the value it secures.

By ensuring that ETH tokens penetrate the real economy and that all consensus participants have a real stake, we have set a price that is more difficult to evade through financial engineering attacks.

I mention this because there are indeed some interesting alternative solutions being discussed, among which Ethereum intervenes in the delegation process, and the delegator has no risk. So for delegators who contribute to the deterioration of consensus, the risk will be much lower.

Or at least it looks like it. When Ethereum forks and/or requires social intervention to save it, risk-free delegates may be surprised at how the social layer evaluates their delegation and the harm they are deemed to have caused if the worst happens.

Here I return to Buterin's request again, not to overload consensus. My point and one of the themes of this article is that when a high proportion of ETH is involved in the consensus process, everyone will be involved and it may not be possible to achieve a "neutral" result.

The conclusion to the first question is that the value of d under MVI must be kept large enough to ensure security. Delegation does reduce security to some extent, but as long as their staking is at risk, all parties will try to evaluate the risks and delegate wisely.

Reserving independent pledgers is indeed a complex problem. Economies of scale are difficult to design away, and we do not have enough attention to liquidity in pledging. However, there are some subtle differences in the current argument that are more favorable to MVI, and I hope to bring them up.

Ethereum's independent home stakers incur certain costs when staking. They prepay a large portion of the fees, including knowledge acquisition. They also incur variable costs such as bandwidth, troubleshooting time, and interruption risks.

Many SSPs in the Ethereum industry have incurred significant costs in designing their services and also bear other types of operational costs that independent validators do not have to worry about. However, they rely on economies of scale to lower the average cost of operating validators.

We must assume that SSP seeks to maximize profits and may consider what their costs might be at different equilibria. What are the differences in economies of scale between d=0.2 and d=0.6? It seems reasonable to assume that SSP's average costs are much lower at d=0.6.

Do you remember that at d=0.2, individual stakers may be able to run validators that are up to three times smaller than before at d=0.6? As for the proportion of individual stakers we can attract, there may be differences in the minimum number of validators between 32 ETH and 96 ETH (or 11 ETH - 32 ETH).

Therefore, not only will a higher d force independent stakers to hold more ETH under the same network load, they will also have to compete with SSPs that are able to charge lower fees. While fees will be set based on market strategies, the average cost should ultimately be important.

If we reduce our profits, SSP hopes to increase fees to appropriately offset and amortize costs. The cost of entrusting pledgers is variable, including PAP and fees. They can easily get rid of the added costs.

The argument that reducing rewards will cause independent stakers to leave (before delegated stakers) should be taken seriously. However, due to the current fixed costs of household stakers, their current personal income supply elasticity may not be high.

However, if we reduce the profits to a level where independent collateralization for households becomes unfeasible (including for new entrants), their short-term lower elasticity will be of no avail. If we want to maintain independent collateralization, there is a minimum total collateralization revenue threshold that we cannot fall below.

Assuming the total cost (in ETH) of pledging by independent households is C, and considering other factors such as the annual risk R of funds when pledging. Then, the return must be higher than y>C/32+R, even if pledging brings liquidity, reasonable margins are required.

Here, I also hope to discuss the impact of DeFi yield. All pledgers will receive intrinsic yield y from pledging, which comes from issuance, MEV, and priority fees. Some people may also receive extrinsic yield yc outside the consensus mechanism.

It is not possible to simply sum up y+yc for LST holders and draw a conclusion: no matter how much y decreases, LST holders always profit relative to independent stakers. It can be expected that ETH tokens will bring higher utility compared to LST (without considering its intrinsic returns).

The entrusted pledger must weigh y(1-f), where f is the percentage fee, against the risk/cost including the inherent disadvantage of PAP and LST relative to native ETH, and only when y(1-f) (not y+yc) exceeds these costs, the decision to pledge is made.

When y=0, the agent will not delegate the pledge. They can obtain better liquidity or higher yc through native ETH, and they will face serious adverse choices by delegating the pledge to the operating loss SSP. Independent pledgers may also not pledge.

For anyone who wants to hold ETH no matter what, the decision may not depend on whether yc is 1% or 5%. At 5%, it can be expected that ETH will provide +5%. Of course, that 5% comes with risks and is not free money (our returns shouldn't be either, hence MVI).

With the rise of y, potential independent pledgers and delegated pledgers will gradually discover that pledging is worthwhile, starting with the most ambitious/adventurous individuals. Here we are forming a supply schedule, where each agent makes decisions based on their specific situation.

The distribution of the minimum expected yield between potential independent pledgers and delegated pledgers is not yet clear. At the mid-term equilibrium point of d=0.2, the proportion of independent pledgers may be lower than d=0.6, but another option is also possible.

Higher d may allow for more diversity in SSP, but the cartel of monetary function puts pressure on it. The proportion of individuals with enough ETH for independent staking is also limited, setting a soft upper limit on the total number of independent stakers.

This is indeed a topic worth further research. The key is that the opportunity cost of pledging must always be fully taken into account, and economies of scale and monopolies will affect basic equilibrium analysis in a fairly complex way.

Finally, re-pledging has the potential to make independent pledgers more competitive. It allows them to "re-pledge" their collateral when desired (however, they may also encounter principal-agent problems if they want to provide economic security themselves).

Another benefit of additional collateral is that if Active Verification Service (AVS) can quantify decentralization, it can also give economic surplus value to decentralization. This is something that Ethereum as an open protocol cannot achieve.

The previous argument also applies to the re-staking of EigenLayer functionality outside of the protocol. Under very low yield conditions, it is best for users to directly use non-staked ETH (free staking). For many use cases, it seems reasonable for AVS to choose a token that will not easily evaporate.

Also note that if PEPC expands its scope beyond "block production use cases", the resulting benefits may become more endogenous, depending on the remaining utility provided.

Looking to the Future

The discussion about the advantages and disadvantages of MVI ends here. Although there are some concerns about individual staking, MVI is a fundamentally reasonable design policy that gives Ethereum a real chance to provide users with the best digital currency ever.

Each argument has its subtle differences, and some discussions cannot be succinctly expressed in tweets. However, I believe that considering all factors comprehensively, it should be possible to accept that MVI is also a favorable design principle under PoS.

We must always prioritize the "ordinary users", which requires research based on microfoundations and evaluating how we can maximize utility for ordinary people when Ethereum (hopefully) becomes their new financial system.

So the question is how do we implement MVI, which is a problem I have been researching deeply. Dietrichs mentioned the importance of communicating current release policy research in a recent developer call, and my process started with this tweet.

Changing the issuance policy is a sensitive issue. What we desire is an issuance policy that can maximize utility without further intervention from developers, so that it can always allocate MVI with maximum utility proportionally.

However, the current reward curve does not allow the protocol to affect the collateralization ratio (security), but rather the collateral size. In the medium term, the results are closely related to both, but in the long-term equilibrium, there may be significant divergences as the circulating supply drifts.

This is my article on Ethresearch and my presentation topic at Devconnect in 2021: Defining the circulation supply S and how to drift towards balance (i=b), so that we can improve the reward curve and achieve the minimum viable issuance under proof of stake.

Due to the current reward curve, the issuance i can be expressed as i=cFd/S, which will change with the change of circulating supply (the collateral rate d provides some adjustment space). The figure shows the issuance rate diagonal of Ethereum and the average b since self-merging.

 The combustion rate b is not dependent on the flow supply - the demand for block space will not change due to a change in the currency pricing unit. If i>b, S will rise and pull i down until it equals b. If i<b, S will decrease and pull i up until it equals b.

In 2021, since the pledger does not have REV yet, I directly used the minimum expected yield rate y- to obtain the security of Ethereum, which is d=b/y.

Today, we simply add the "REV rate" v to the equation to obtain d=(b+v)/y. This means that we cannot control the mortgage rate and security in the long term unless we are prepared to change F from time to time.

We can reduce F as a temporary solution to avoid paying too much security fees (which will be discussed in the next tweet). However, Ethereum will eventually return to the same long-term equilibrium collateral ratio under lower circulation supply (other conditions remaining the same).

This is why we ultimately hope to change the reward curve to be related to d instead of D. Simply replacing D with S0d (where S0 is the current circulating supply) looks tempting. This takes us one step closer to a policy of autonomous issuance, but still does not guarantee its implementation.

Assuming there is MEV burning, the protocol can fully adapt to changes in revenue, but still cannot adapt to the permanent shift in expected yield or supply curve. This can be addressed by allowing the entire reward curve (demand curve) to slowly drift.

The ultimate goal is a dynamic balance, where the circulation supply can change at a constant rate without external influence. Whether it is inflation or deflation depends on how the supply curve and the value of block space are reflected in the ETH market value.

Therefore, we have achieved the "constant" security referred to as Polynya, which I believe aptly describes our ultimate goal - to ultimately seize control of issuance from developers and enable Ethereum to achieve autonomy under MVI.

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