- \n
- Final preparations are underway for Ethereum\u2019s transition to the Proof-of-Stake consensus algorithm as The Merge activates.<\/li>\n
- The upgrade will significantly affect the cryptocurrency\u2019s fundamentals, making it deflationary and far more environmentally friendly.<\/li>\n
- The pace of Ether issuance will depend on the number of validators and on-chain activity.<\/li>\n<\/ul>\n<\/div>\n
A Seven-Year Journey<\/h2>\n
The transition from Proof-of-Work (PoW) to Proof-of-Stake<\/a> (PoS) is the most important and complex upgrade in Ethereum\u2019s history. The seven-year-long process has now reached the final stretch.<\/p>\n
In the past upgrades were named Serenity, Casper, Shasper, Ethereum 2.0<\/a> and, finally, \u201cThe Merge.\u201d<\/p>\n
The upgrade will change<\/a> the consensus mechanism that governs how transactions are validated and blocks are produced.<\/p>\n
![\"The](\"https:\/\/u1f987.com\/wp-content\/uploads\/eth_merge_sch-1024x464.png\")
The history of Ethereum hard forks on the path to activation of The Merge. Data: Galaxy Digital Research<\/a>.<\/figcaption><\/figure>\n Since 2014, developers have explored<\/a> the possibilities of PoS as an alternative to PoW systems. Because of its novelty and the limited study of the new algorithm at the time, Ether was launched in 2015 on the basis of the Ethash technology, which relied on Proof-of-Work.<\/p>\n
In the same year, developers presented<\/a> an ambitious roadmap, in which the final development phase was named Serenity. It envisaged a full transition from Ethash to a stable PoS algorithm.<\/p>\n
One of the main motives is to raise energy efficiency. Developers expect that, thanks to The Merge, electricity consumption will fall by more than 99.9%<\/a>. Instead of miners, validators will play the central role in the network, for which 32 ETH are required as collateral.<\/p>\n
According to Galaxy Digital Research, the upcoming upgrade will not alter the protocols for user interaction with dapps<\/span>. No moves of coins will be required from exchange clients, custodial services, or ordinary ETH holders.<\/p>\n
From Inflation to Deflation<\/h2>\n
Currently, most of Ethereum\u2019s new issuance occurs in the traditional PoW blockchain \u2014 execution layer<\/em><\/a>. Miners receive 2 ETH per mined block \u2014 a total of more than 12,000 ETH per day.<\/p>\n
![\"The](\"https:\/\/u1f987.com\/wp-content\/uploads\/Miner-Rewards-1024x262.png\")
Data: IntoTheBlock<\/a>.<\/figcaption><\/figure>\n A small portion of ETH is issued on the Beacon Chain. This PoS-based network is referred to as the consensus layer<\/em>.<\/p>\n
The Beacon Chain launch (the zero phase of Ethereum 2) took place on December 1, 2020<\/a>.<\/p>\n
The amount of ETH issued on the consensus layer varies with the number of validators and the amount of ETH staked. Another factor influencing issuance is the burning of a portion of transaction fees depending on network load. This mechanism (EIP-1559) was activated in the London hard fork<\/a>, since which more than 2.4 million ETH<\/a> has been burned.<\/p>\n
![\"The](\"https:\/\/u1f987.com\/wp-content\/uploads\/ultrasound-money-1024x484.png\")
Inflation data and burned ETH since the activation of EIP-1559. Data from ultrasound.money<\/a> as of 8.06.2022.<\/figcaption><\/figure>\n With about 12.7 million ETH staked (roughly 10% of Ether\u2019s circulating supply) and a daily burn rate of 7,900 ETH, inflation would be 2.1%. In other words, the annual new issuance would be around 5.4 million ETH.<\/p>\n
![\"The](\"https:\/\/u1f987.com\/wp-content\/uploads\/ETH-Supply-Distr-1024x507.jpg\")
ETH supply distribution chart: funds, ETH2 staking, DeFi, exchange reserves. Data: CryptoQuant<\/a>.<\/figcaption><\/figure>\n The next screenshot is a heat map<\/a>. It shows how changes in burn rates and the amount of staked ETH at the consensus layer influence Ethereum\u2019s daily issuance.<\/p>\n
![\"The](\"https:\/\/u1f987.com\/wp-content\/uploads\/Projected-Daily-Iss-of-ETH-Post-Merge.jpg\")
Data: Galaxy Digital Research<\/a>.<\/figcaption><\/figure>\n After activation, the emission mechanism no longer contemplates a fixed reward to miners per block. The amount of ETH paid to validators will be dynamic, with each epoch lasting 6.4 minutes.<\/p>\n
Assuming 11 million ETH are active on the consensus layer, the heat map above shows that, under this parameter, 1,511 ETH would be issued per day.<\/p>\n
If we account for coin burns \u2014 for example, 4,000 ETH per day \u2014 Ethereum would become deflationary. The supply would shrink by 2,489 ETH per day or about 0.77% per year.<\/p>\n
The amount burned directly depends on on-chain activity, which after the DeFi and NFT hype peaked has slowed. The chart below shows that compared with May 2021 peaks, the number of transactions on the Ethereum network has fallen significantly. The daily figure is below 1 million, matching early-2018 levels.<\/p>\n
![\"The](\"https:\/\/u1f987.com\/wp-content\/uploads\/Number-of-trans-1-1024x683.png\")
Data: IntoTheBlock<\/a>.<\/figcaption><\/figure>\n \n
\u00abIf adoption by users of Ethereum grows in the coming months and years after the Merge upgrade, Ether\u2019s supply will shrink even faster\u00bb, said Galaxy Digital Research.<\/p>\n<\/blockquote>\n
Then, they say, the value proposition of the second-largest cryptocurrency will strengthen, especially in the context of a store of value.<\/p>\n
As noted earlier, the security of the PoS network is provided not by energy-intensive miners but by validators who lock in ETH as collateral. The more ETH staked, the harder it is for a potential attacker to seize control of the system and alter transaction history.<\/p>\n
The Ethereum consensus layer is designed so that validator rewards automatically adjust based on the amount of ETH staked.<\/p>\n
![\"The](\"https:\/\/u1f987.com\/wp-content\/uploads\/eth_p1-1024x517.png\")
Annual ETH issuance vs annual validator yield. Data: Galaxy Digital Research<\/figcaption><\/figure>\n When the amount of ETH staked grows and many validators operate, yields fall. Conversely, when there are few validators and little ETH staked, yields rise to incentivise greater participation in the network.<\/p>\n
As of 8.06.2022 there were 399,554 validators.<\/p>\n
![\"The](\"https:\/\/u1f987.com\/wp-content\/uploads\/glassnode-studio_ethereum-total-number-of-validators-2-1024x576.png\")
The trajectory of accounts that deposited 32 ETH into the Ethereum 2.0 deposit contract. Data: Glassnode.<\/figcaption><\/figure>\n The issuance rate, being algorithmically variable, ensures that validators remain sufficiently incentivised to work, regardless of how much ETH is staked.<\/p>\n
\n
\u00abHowever, this dynamic approach poses challenges when forecasting Ethereum\u2019s monetary policy in the long run\u00bb, said Galaxy Digital Research.<\/p>\n<\/blockquote>\n
Beyond the amount of ETH staked and the amount burned, analysts should also consider less obvious indicators: online validators and those subjected to slashing<\/span>.<\/p>\n
![\"The](\"https:\/\/u1f987.com\/wp-content\/uploads\/eth_p2-1024x517.png\")
Data: Galaxy Digital Research, ultrasound.money.<\/figcaption><\/figure>\n The chart above illustrates the projected decline in ETH supply after The Merge. According to Ultra Sound Money, burning 2.9 million ETH per year (or about 8,000 ETH per day, the average since EIP-1559\u2019s activation) will reduce the circulating supply by about 2% per year.<\/p>\n
Other factors will influence the makeup of revenue:<\/p>\n
- \n
- Priority fees that Ethereum miners currently receive will go to active validators after The Merge. According to Coin Metrics, total such \u201ctips\u201d amount to just over 1,000 ETH per day, and roughly the same as daily validator revenue. Consequently, the latter\u2019s income will double.<\/li>\n
- In addition to tips, validators will earn Maximum Extractable Value (MEV)<\/a>. Researcher Flashbots\u2019 Alex Obadia counted that MEV inflows could raise their incomes by about 75%.<\/li>\n<\/ul>\n
Liquid Staking and Centralisation Risks<\/h2>\n
Increasingly, the Beacon Chain\u2019s stake is concentrated among firms operating under the Staking-as-a-Service (SaaS) model. The undisputed leader in this segment is the liquid staking service Lido<\/a>.<\/p>\n
The chart below shows that large exchanges such as Kraken, Binance and Huobi carry significant weight as well.<\/p>\n
![\"The](\"https:\/\/u1f987.com\/wp-content\/uploads\/Top-Depositors-by-Address.png\")
Data: Etherscan<\/a>.<\/figcaption><\/figure>\n Popular SaaS providers simplify staking by allowing delegation. Users do not need to own 32 ETH \u2014 small sums suffice. Moreover, many SaaS providers offer insurance against losses from slashing<\/span>. Liquid staking services also boost capital efficiency \u2014 for example, Lido issues derivative tokens representing funds locked in staking contracts. Such coins can be used in DeFi protocols to earn additional yields.<\/p>\n
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\u00abGiven higher yields on ETH derivatives than ETH itself, tokens like rETH and stETH could at some point become competitors and even surpass Ether in liquidity and acceptance as the baseline for DeFi operations\u00bb, said Galaxy Digital Research.<\/p>\n<\/blockquote>\n
The chart below shows that Lido far outpaces competitors in its segment.<\/p>\n
![\"The](\"https:\/\/u1f987.com\/wp-content\/uploads\/LidoAnalytical-1024x179.png\")
The volume of funds in popular staking protocols over time. Data: Dune Analytics (@LidoAnalytical).<\/figcaption><\/figure>\n Co-founder of Bankless Ryan Sean Adams suggested that, over time, ETH could become something like perpetual internet bonds<\/a>, whose holders are both creditors and owners of the network. In this sense, Ether, as the base asset, will be less and less used in dapps.<\/p>\n
With the range of interesting options from SaaS providers, one can expect further growth in their popularity and, therefore, in the value of assets under management (TVL<\/span>).<\/p>\n
The segment is moving toward greater decentralisation. For example, Lido is implementing<\/a> distributed validator technology. A newer service \u2014 Rocketpool<\/a> \u2014 is gaining momentum as a decentralised staking platform.<\/p>\n
When Will the Merge Be Activated?<\/h2>\n
The Merge testing is in full swing: on June 8, Ethereum developers moved the Ropsten testnet to PoS<\/a>. In the coming weeks, transitions of Goerli and Sepolia are expected.<\/p>\n
In May 2022, one of the leading developers, Preston Van Loon stated<\/a> that the mainnet transition to PoS would occur in August. Vitalik Buterin also said the latter part of summer was most likely, but allowed postponement to September\u2013October if risks emerge.<\/p>\n
According to Messari\u2019s conservative scenarios, The Merge could be activated in November\u2013December.<\/p>\n
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5\/ The fundamental improvements for long-term attractiveness include: <\/p>\n
+Protocol Energy Reduction
+Issuance Reduction
+Net Deflationary
+Bond-Like Yields
+Increased Decentralization
+Slightly Increased Throughput pic.twitter.com\/dhjRT8tJTF<\/a><\/p>\n\u2014 Messari (@MessariCrypto) June 7, 2022<\/a><\/p><\/blockquote>\n