In The Network - Zcash
Miner Economics and Shielded Activity
This instalment of Formal Verification is free for everyone. If you don’t want to miss out on the latest crypto research and content, then hit that subscribe button today.
Zcash is a privacy coin, born from a fork of Bitcoin’s code and has advanced privacy technology with zk-SNARKs privacy technology baked in at the base layer. The network itself can be thought of as two systems - one that is transparent and one that is private (shielded) meaning the network has both transparent and shielded addresses.
As of 12th May, Zcash has a circulating supply market cap of $373 million which marks a $1.88 billion reduction in market value since its peak on 7th January 2018. Beyond the simple price action however, Zcash was the centre of conversation on several fronts in late 2019 including developer funding and regulation. But as a cryptocurrency that has some of the most advanced privacy features, what is the current state of the network? More importantly, how much is the network being used for its intended use case?
We can look at cumulative miner revenue (“thermocap”) which is the summation of block rewards (i.e. newly issued ZEC) and transaction fees. Thermocap can be used an exotic but proxy measure for net inflows to a PoW network which assumes miners expenditure roughly equals miner revenue. In Zcash, 80% of the block reward is given to miners so it is important to account for this in the calculation (see further information on the block reward distribution here). Note, fees are consistently less than 0.03% of total miner rewards.
In October 2019, Zcash’s thermocap breached the $1 billion milestone but the most interesting discovery is that the accumulated economic expenditure (i.e. net inflows) has been lower than the total circulating market cap of the network since August 2018. Thus, based on thermocap, ZEC is trading below the aggregate mining resources spent securing the network.
Despite prolonged negative price action, there has been continued investment from Equihash-based miners who have looked to deploy on the Zcash network. On two occasions since 2018, we can see hashrate climbed significantly at the times when Bitmain released the Antminer Z9 Mini in Q2 2018 and Z11 in Q1 2019 signifying more efficient mining hardware coming online to secure the network.
The continued rise in hashrate despite the overall decline in ZEC price signifies strong miner support - this provides evidence that Zcash miners have doubled down on efficiency in order to maximise their profitability. It is also possible that miners believe ZEC continues to be trading at a discount such that they expect their mining rewards (and holdings) to increase in USD terms over time.
One of the most overlooked aspects of crypto networks is that they represent open-source economic structures. A suitable measure to determine how these new economic structures are being used is to look at the economic throughput (i.e. financial bandwidth per unit of time). While one might be quick to point out that transaction count has plummeted sharply from 225k to 18k per day today we can measure the economic throughput of the network instead by taking the mean transaction size and multiply by the number of transactions (this of course only considers the transaction values where transparent Zcash addresses are used). 14d MA were used for the analysis to reduce noise.
While transactions count plateaued throughout 2019 and 2020, economic throughput has started to grow to similar levels seen during the 2017 bull run. In other words, Zcash is becoming an economically dense network that is indicative of a settlement network than of a payments network. Note, it is relatively unknown how much of this network activity was driven by regulatory crackdown late 2019.
We can also analyse the use of privacy on the network to some degree. Since there are 3 address types, there are 3 value pools in which ZEC can be placed in. Since ZEC must be (currently) mined to a transparent address before a shielded one, the ZEC value entering a shielded pool is visible. We can therefore measure how much ZEC is being used privately.
Since inception, the number of shielded ZEC has been rising at a consistent rate of ~100k ZEC annually. Today, there is 441k shielded ZEC in the sprout and sapling private pools. However, this only marks 5% of all circulating supply of ZEC. The astute reader may also see that despite a continuous rise in shielded ZEC on the network, the % of total circulating ZEC supply has been decreasing since October 2018. This means that rising popularity of shielded ZEC balances has not been increasing at a high enough rate to offset new (and non-shielded) supply ZEC from block issuance.
One of the limitations of the Zcash codebase is that all coinbase transactions sent to miners have to contain transparent outputs. This is partly because shielded transactions required significant memory and CPU resources to create at the time when Zcash made its modifications from the Bitcoin Core codebase. However ZIP-213 defines modifications that will give miners and mining pools the option to mine directly to a shielded coinbase. We would expect that ZIP-213 would drive up the % of shielded ZEC to total circulating ZEC over time.
While the value and memo field for transactions between shielded addresses on Zcash is encrypted, the transactions themselves (and fees paid) are not. The number of fully shielded transactions per day (shielded address to another shielded address) is incredibly small with ~400 transactions per day, although there are early signs this might be climbing since January 2020. Relative to the total number of transactions on the network, we can actually see that fully shielded transactions are accounting for more of the economic bandwidth in the last 5 months. Now 2.2% and is recently at its highest percentage since July 2017. Note, for this analysis, the time series starts at April 2017 and a 14d MA in order to remove noise.
It should be pointed out that this steady rise in shielded activity in recent months comes at a time when the Zcash Foundation and Electric Coin Company are leading two key efforts: the rollout of Flyclient which allows light clients to verify transactions (less reliance on centralised backend servers) and SDKs for iOS and Android devices that will ease development of mobile wallets with shielded transactions.
But how does this relate to ZEC price action? As a more exotic metric, we can create a composite that takes the % of Zcash transactions that are fully shielded and divides it by the ZEC spot price. What this particular ratio can show is the change of shielded activity relative to change in market price. Firstly, the ratio spiked during the summer local bottom before ZEC began climbing back above $100. Secondly, the ratio saw its highest level recently in March (and nearly again in April) as shielded transactions climbed higher and ZEC price was at its all-time low. Subsequently, the ratio has seen a steep decline as ZEC moves back above $40.
Lastly, we can compare shielded activity on Zcash to other privacy-centric coins, such as Monero which provides privacy by default (there is no option to use transparent addresses). This is in contrast to Zcash which will move into a fully private network (see work on compliance viewing key support here). Putting them side by side, Zcash only has ~2% ‘market share’ with Monero which has 39x more shielded transactional activity. It seems likely that Zcash’s sustained low market share is due to the optionality of privacy on the network.
It is critical to analyse how a network is being use for its intended use case as well as the miners who secure it. It has been nearly 4 years since Zcash launched and while the network still feels like it’s in constant R&D phase, the return will start being reflected through the growth of Zcash’s anonymity set. Some of this growth is starting to moderately show.
This is where the research on increased accessibility to shielded addresses like shielded mobile wallets, interoperability efforts with other networks to share out its privacy layer, and scalability (i.e. Halo) - all of which will be covered in future Formal Verification deep dives - will become key in driving this growth.
Subscribe to Formal Verification
Formal Verification offers both key and concise crypto research so you can be attuned to the latest decentralised network developments both on and off the chain.
Formal Verification will be free for everyone until June 8th. If you subscribe before June 8th, you’ll receive Formal Verification at a 20% discount forever as a special thank you for your early support. Get it locked in.
Formal Verification research is not investment advice and is strictly for informational purposes only. Please conduct your own research.