The successful implementation of The Merge update on September 15, 2022, which transitioned Ethereum (ETH) from Proof of Work (PoW) consensus mechanism to Proof of Stake (PoS) consensus mechanism, indicates that the supply of ETH has turned into a deflationary asset with a decreased annualized percentage. Although the price of ETH remained almost unchanged after The Merge update, it can soar with the EIP-4844 update.
Ethereum underwent a significant update called The Merge, which transformed it from a Proof of Work (PoW) consensus mechanism to a Proof of Stake (PoS) consensus mechanism, on September 15, 2022, changing many things fundamentally in the largest smart contract blockchain.
According to the data from the Ethereum analytics platform ultrason.money, since then, 680,455 ETH have been minted and 980,377 ETH have been burned, resulting in a net decrease of 299,922 ETH in the circulating supply. In other words, the supply of ETH decreased by 0.249 percent on an annualized basis. If Ethereum continued to operate as a Proof of Work consensus mechanism, the net supply would have increased by 3.8 million ETH or 3 percent on an annualized basis.
The PoS consensus mechanism requires market participants to hold a minimum amount of ETH in exchange for rewards for validating transactions. In the previous PoW consensus mechanism, miners had to solve computational problems to record transactions on the blockchain in exchange for rewards. The transition to PoS eliminated a significant amount of miner supply from the market. Furthermore, the PoS consensus mechanism also burns a portion of the transaction fees paid by users. Validators receive the base fee or the tip fee added by users to prioritize transactions. Meanwhile, the base fee is burned, causing Ether to be taken out of circulation.
While making Ethereum more environmentally friendly, the update transformed the largest altcoin ETH into a deflationary currency. However, the price of ETH, which is currently $1,630, has remained largely unchanged since The Merge. This indicates that the update has failed to increase Ethereum’s market valuations. On the other hand, Bitcoin has increased by over 30 percent in the past 12 months.
Markus Thielen, the Head of Research and Strategy at Matrixport, described the decrease in gas fees as a catalyst that could boost the price of ETH in a note to clients last week, stating, “In August 2022, the Ethereum Foundation warned users that the upcoming update in Paris would not reduce gas fees. Subsequently, prices dropped and Ethereum has been doomed to underperform Bitcoin. However, this also signaled the next potential catalyst for ETH investors, which is the signal for lower gas (transaction) fees. Reducing transaction fees now appears to be a critical missing building block that the next update, called EIP-4844, is trying to solve.”
The Ethereum Improvement Proposal (EIP)-4844 or “proto-danksharding” is expected to reduce transaction fees and improve transaction efficiency by adding blobs for data. These blobs contain large amounts of data, similar to blocks, but they are not stored forever in the Ethereum virtual machine like blocks. This helps Ethereum’s blockchain process data efficiently and inexpensively.
Thielen said, “Ethereum is definitely not ‘out’ while it is ‘down,’ and ETH investors should slowly follow the positive news surrounding the EIP-4844 update. However, there are many things at risk; if this update is seen as another minimal development, then Ethereum cannot be expected to recover.”
Thielen also added that Ethereum’s monthly transactions have increased from 28 million to 32 million since The Merge.