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Top Stories of the Week - 4/14

Weekly Top Stories 041423

This week, we write about Ethereum’s successful Shanghai upgrade, a coming code change for the Bitcoin ordinals project, and a bill advancing through the Texas legislature that would impact Bitcoin miners. Subscribe here and receive Galaxy's Weekly Top Stories, and more, directly to your inbox.

Ethereum Successfully Completes Shanghai Upgrade, Activating Staked ETH Withdrawals

The Ethereum blockchain has successfully completed its 15th hard fork “Shanghai.” Shanghai, which primarily activates staked ETH withdrawals, went live on April 12 at 6:27PM (ET). The network maintained a high participation rate through the upgrade, above 95%, indicating the vast majority of Ethereum node operators were ready for and supportive of the Shanghai upgrade. Immediately following the upgrade, the network began processing withdrawals and withdrawal credential change requests. Ethereum Foundation researcher Danny Ryan noted on an Ethereum developer call that the high number of withdrawal credential change requests, some 40,000, submitted at the time of the upgrade caused high CPU loads on nodes. This in turn contributed to a high number of missed slots, that is, missed block proposals from validators. In addition, a bug in Prysm client software also contributed to some validators missing out on their block proposals. Prysm is the majority client software for the consensus layer (CL) of Ethereum run by close to 40% of Ethereum node operators. For more information about the Prysm bug, read the writeup of this week’s Ethereum developer call here. Other than the issues around missed slots and failed block proposals, the upgrade worked as expected, enabling validators to withdraw their staked ETH. As of April 13, 5:30PM (ET), 203,663 ETH has been withdrawn to the Ethereum balances of over 98,061 validators. 87,118 amount of withdrawal credential changes have been processed and over 17,700 validators have entered into the exit queue to unstake their full principal balance of 32 ETH. Since the upgrade, ETH price has increase 5%, as have the prices of Ethereum liquid staking governance tokens like LDO and RPL. The following is a table summarizing the main impacts of Shanghai in the hours leading up to and shortly following the upgrade:

shanghai metrics to watch table

Our take

As discussed in prior newsletters, the Shanghai upgrade was an important one for Ethereum developers to activate because it completed the Merge upgrade, that is Ethereum’s transition to a proof-of-stake (PoS) consensus protocol. By activating staked ETH withdrawals, developers have finally closed the loop on the Ethereum validator life cycle allowing validators to fully exit and unstake from the Beacon Chain. Contrary to the beliefs of some Ethereum critics, activating withdrawals did not end up becoming a multi-year effort like the Merge, nor did its successful implementation lead to network instability. As highlighted above, network participation rate, that is the number of active validators attesting to the state of Ethereum, has remained strong through the upgrade. Despite the high number of exiting validators, there has also been a high number of new validators depositing funds into the Beacon Chain. For the 203,663 ETH withdrawn over the last 24 hours, which includes Beacon Chain issuance rewards which are automatically withdrawn to validator accounts, there has been 82,384 ETH newly deposited to Ethereum.

Deeper analysis of withdrawal activity on Ethereum since Shanghai indicates that the vast majority of withdrawals processed are partial, representing Beacon Chain issuance rewards, not full, which would conversely represent validators exiting the network and unstaking their principal balance of 32 ETH. Of the full withdrawals process on Ethereum in the first 24 hours after Shanghai, 97% of them have been initiated by cryptocurrency exchange Kraken, which earlier this year was forced to shut down their staking-as-a-service product due to enforcement actions by the SEC. Therefore, contrary to some Ethereum critics’ expectations, it is clear that Ethereum validators have not been ardently waiting for the activation of Shanghai to dump their ETH. Rather, the vast majority of Ethereum validators are continuing to stake, and the ones that are not are predominantly validators operated by a crypto exchange retiring their staking operations. What’s more, as highlighted above, ETH price has increased not decreased in the hours following the Shanghai upgrade.

While the immediate impacts of Shanghai on Ethereum have been bullish in many respects, it will be important to continue monitoring the health of the network as the entry and exit queues continue to get busier over the next few days and weeks. In addition, it will be important to monitor the activation of liquid staking token redemptions in the months upcoming as large staking providers like Lido have yet to open redemptions for their liquid staking token, stETH. More on the impacts of Lido’s unstaking process here. Finally, despite the fact that staking ETH is now significantly de-risked because withdrawals are enabled on-chain, it not clear that there will be an influx of institutions aping into staking on Ethereum post-Shanghai as some of Ethereum's most ardent supporters may think. One of the ongoing headwinds to more institutional investment and involvement in staking post-Shanghai is regulatory uncertainty around staking-as-a-service as evidenced by the enforcement action against Kraken and taxation of staking rewards. Until regulatory clarity is achieved on these matters, as well as other pertinent issues related to Ethereum around DeFi and DAOs, which represent the bulk of decentralized application activity, institutional involvement in Ethereum, staking or otherwise, may continue to be hampered. - CK

Bitcoin Miners may see subsidies removed in Texas

Texas Bill proposes new energy restrictions on bitcoin miners. On April 12, the Texas Senate unanimously approvedSenate Bill 1751 that relates to the regulation and the tax treatment of facilities in the state's power grid, known as Electric Reliability Council of Texas (ERCOT). For the state's Bitcoin miners, SB 1751 proposes revoking certain tax abatements and restricting miners' participation in ERCOT's demand response services. Crucially, though, this bill would not halt the ability of miners to sell any previously purchased power back to the grid during times of stress or high prices—it would only reduce their ability to participate in formal demand response programs administered by ERCOT, which is akin to being paid to be “on call” to turn off your operations, and carrying an obligation to be online unless called to curtail by ERCOT, and therefore forfeiting your option to sell your previously purchased power. Although there are multiple demand response programs in Texas, the ones this bill targets are not well defined.

Texas is one of the largest centers for bitcoin miners thanks to its low electricity costs, extensive renewable energy options, and robust and deregulated liquid trading market. During periods of of high demand on Texas’s grid, such as during extreme weathers events that require lots of heat or air conditioning, large electricity purchasers, like bitcoin miners who are participating in the ERCOT wholesale market by procuring long term fixed rate take-or-pay contracts can halt operations and instead sell their forward-purchased electricity back to the grid, simultaneously making electricity available for the grid operator ensure adequate supply while also earning a profit on the energy trade. Notably, bitcoin miners are uniquely capable of curtailing and selling their forward power instead of using it to mine whenever it is economically reasonable to do so because miners both consume significant amounts of electricity and can halt operations extremely quickly.

Different from selling their already purchased power when spot prices are high, SB 1751 now looks to limit miners' participation in the specific ERCOT demand response program in which miners proactively commit to being on call to curtail by order of the grid operator only unless the energy demand "is less than 10% of the total load required by all loads in the program,” essentially capping the amount of bitcoin miner industry participation in the program. The bill would also revoke tax abatements to mining operators as the bill's sponsors claim there is no need to subsidize further growth of the industry.

After passing in the Senate, SB 1751 now goes to the Texas House for consideration.

Our take

If this bill becomes law, it’s more of bad precedent than directly negative to bitcoin mining economics. Even if SB 1751 passes, miners can still sell their electricity back to the grid through hedging activity in the ERCOT wholesale market, but their participation in a specific—and lucrative—demand response programs that give ERCOT control over their load levels will be limited. That precedent would be a rare negative signal from a state that has been historically uniquely supportive of Bitcoin mining. Singling out bitcoin miners specifically is the main issue—many large purchasers of electricity participates in ancillary services and ERCOT has traditionally encouraged load participation in these services, since they are all competitively bid, and they give ERCOT more visibility and control over the load’s behavior. But as we wrote above, bitcoin miners uniquely capable of doing this—no other large electrical consumer can also turn off at a moment’s notice. We wrote extensively about this dynamic in the Dec. 30, 2022 edition of this newsletter when we described how bitcoin miners in Texas largely turned off during the big winter storm over Christmas.

We expect pushback to the bill in the Texas House, and if it does pass both chambers, it’s also possible that Gov. Greg Abbot (R) will veto the given his long-time support of the bitcoin mining industry. Abbot told the Texas Blockchain Council in November 2022 “I would say we are providing the platform for those who are involved in blockchain, for those who are involved in Bitcoin, to make sure they are going to have a location they can come to.” - AT

1200 Ordinals Get Lost Due to Quirk in Ordinal Software

1200 inscriptions get “lost” due to being submitted incorrectly, leading to calls to upgrade the ORD software. Essentially, the ordinals indexer only counts inscriptions that are created in the first input of a transaction. When creating an ordinal, users inscribe the first sat in the first transaction input. So far, approximately 1,200 inscriptions were not in the first input of the transaction. These invalid inscriptions occurred just before inscription number 420,285 around March 11. While there is consensus on changing ORD to allow inscribing on any in put in a transaction, the community is torn on what to do about the 1200 invalid inscriptions. This upgrade would be the protocol’s first and separately would scale the ordinals ecosystem by allowing multiple ordinals to be inscribed in a single transaction.

Our take

The outcome for 1,200 invalid ordinals will be significant to the ordinal community’s reputation. Although the community has yet to reach consensus on a solution, two viable options are being explored. The first solution is to retroactively change the inscription numbers to include the 1,200 orphan inscriptions, essentially inserting them where they would have been. (Recall that inscriptions receive a unique number that ascends from 0, so there is a certain prestige in which number you have, or how low your inscription number is, etc. Galaxy’s Head of Firmwide Research Alex Thorn, for example, likes to boast that he inscribed his avatar as 10,888.) With this approach, developers would select a block height to upgrade the ord client that will retroactively index the orphan inscriptions. As a result, the number of every inscription between 420,285 and when this upgrade is implemented will be given new inscription numbers. The other proposal is to not include the orphan inscriptions and categorize them as misprints, essentially disregarding the orphan inscriptions. This is seen as a more conservative approach because establishing the precedent that inscription numbers can be renumbered could harm the overall value proposition. If the community retroactively adds the orphan inscriptions, not only will +600k ordinals receive new inscription numbers, but it will prove that the ordinal numbering index scheme is not immutable and shouldn’t be deemed a key value indicator. Others have proposed that an alternative indexing scheme should be explored that doesn’t artifically add sequential inscription numbering, but instead relies on other on-chain metrics, such as block height.

The revelation that the protocol’s first major code fix will require an upgrade did not negatively shock the ordinals market. In fact, the development motivated the ordinals community to coordinate together and find the best course of action. The public can follow and contribute to the upcoming solutions though the official Github repo discussion. Despite what some are calling a “bug,” (although we don’t characterize it that way), ordinals continue to exceed expectations as the cumulative number of inscriptions surpassed 1mn this week. The significant jump in inscriptions coincides with the rapid developments in marketplace and wallet infrastructure. Ordinals have even generated $21mn in marketplace volume in their first three months. Given the recent advancements in key infrastructure for ordinals, digital artifacts on bitcoin are positioned to be a multi-billion-dollar ecosystem in the near term. For more analysis on the potential for ordinals, read our most recent report on it. - GP

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