First, it was the third quarter. Then it was sometime in September. Now, we know that The Merge, the most sweeping upgrade in Ethereum’s history, will likely take place on Sep. 15.
On Monday, Marius van der Wijden, an Ethereum developer, tweeted that he had run some code to pinpoint the exact moment Ethereum’s Proof-of-Stake Beacon chain will merge with its mainnet and usher in a new era for the No. 1 smart contract network worldwide.
The key, van der Wijden said, was measuring when Ethereum’s Total Terminal Difficulty (TTD) will be triggered. TTD, also known as the “difficulty bomb,” is the total difficulty of the final block mined under Proof-of-Work. The subsequent block will be produced under Proof-of-Stake.
It should be noted that the exact timing of the Merge is subject to change based on the hashrate and mining luck of the network. Indeed, according to a website dedicated to tracking the Merge, the transition is expected to take place roughly seven hours later than van der Wijden’s original estimate.
The Merge will kick energy-intensive miners off the network in favor of Proof-of-Stake validators, ushering in a near-total reduction in the network’s energy consumption.
In a recent appearance on The Defiant Podcast, Justin Drake, a researcher at the Ethereum Foundation, described The Merge as precipitating as scaling down Ethereum’s electricity utilization by roughly 10,000 times. “Right now, Ethereum uses between 0.1% and 0.3% of all the electricity produced in the world,” he said. “After the move to Proof of Stake, that’s essentially going to almost zero.”
The Merge will also trigger a dramatic reduction in new Ether issuance, with analysts estimating ETH emissions may drop by 90%. With the network destroying base transaction fees since the introduction of the burn mechanism alongside EIP-1559 in August 2021, many analysts are predicting that ETH will become deflationary after The Merge — meaning that more Ether would be removed from supply than is issued as rewards.
The Merge may dispel the fears inflation and rising interest rates are sinking crypto and equities into a prolonged bear market, Darren Langley, the general manager of staking provider, Rocket Pool, told The Defiant.
Lift the Cloud
“There is a giant macro cloud hanging over crypto,” he said. “The Merge has the potential to lift the cloud and kick off a new cycle.”
But there’s a catch.
The current burn rate isn’t on track for Ethereum to become deflationary after it has transitioned to Proof of Stake.
Vitalik Buterin, Ethereum’s co-founder and chief scientist, said during a July 21 conference appearance that after The Merge, annual Ether issuance will be equal to 166 times the square root of the number of staked ETH.
This means that new Ether issuance will increase at a progressively decreasing rate as more stakers join the network. If 1M ETH is staked, 166,000 new Ether will enter into circulation each year. But if 100M ETH is staked, issuance will only be increased to 1.66M Ether.
Under Proof of Work, the consensus mechanism that has been used to maintain Ethereum’s blockchain since its introduction in 2015, about 13,500 ETH are currently created each day and distributed to miners. With 12.93M Ether currently staked, 1,631 ETH are set to enter supply daily under Proof of Stake consensus — an 88% reduction in issuance.
But Ethereum’s burn rate is falling shorty of projected post-merge issuance, with an average of 1,571 ETH being destroyed daily over the past seven days, according to Ultra Sound Money.
The burn rate is still below the expected post-merge issuance despite increasing 48% since transaction fees tagged a two-year low last week, with just 1,063 ETH being removed from supply daily as of Aug. 8.
The drop in on-chain activity can be attributed to the gas-intensive NFT bubble ending in addition to a general decline in network participants amid the bear trend. The increasing migration of DeFi protocols and users onto Layer 2 may also be a factor contributing to the falling demand for block space.
Leading rollup solutions Arbitrum and Optimism are now ranked among the six-largest smart contract networks by total value locked, with each boasting a rich DeFi ecosystem. Rollups reduce fees by bundling together transactions executed on a Layer 2 network to be submitted in batches for validation on Ethereum’s base layer.
Langley argued that the increasing adoption of L2s is actually placing pressure on Ethereum’s fee market.
“Layer 2 rollups still need to store transaction information on Ethereum mainnet, just in a compressed form,” Langley said. “As adoption for L2s increases, this will translate into increased burn rate for Ethereum. Competition between Layer 2 protocols is extremely high and this will drive significant demand for mainnet block space.”
Cam Crossley, an analyst at web3 venture studio NotCentralised, told The Defiant that Layer 2s will continue to drive up demand for block space for the foreseeable future. He expects the fee pressure created by increasing L2 adoption to subside with the implementation of proto-danksharding through Ethereum’s future EIP-4844 upgrade. Drake estimates that EIP-4844 won’t be live until one or two years after The Merge.
“Optimism is the second-highest gas spending entity behind only Binance over the past seven days, driven in part by the $OP liquidity incentives,” Citing said, citing data from Nansen.
Crossley also predicts that demand for block space on Ethereum’s L1 mainnet will continue to outpace its L2 ecosystem until gas fees reach an unacceptably high level.
“Whether that level facilitates persistent deflationary ETH is still unclear,” he continued. “Over enough time, hopefully we continue to battle-test DeFi protocols and ship shiny new use cases to entice more adoption (and ultimately increase the burn). Until the masses return, I doubt we’ll see too much ETH supply deflation.”
If Ethereum fails to become deflationary after The Merge, that could interrupt momentum for Ethereum.
Still, traders are converging on Ethereum in anticipation for The Merge, with the combined volume of Ether derivatives surpassing Bitcoin earlier this month.
The two assets are now neck-and-neck after the latest market pull-back, with Bitcoin perpetuals and futures representing $33.21B in 24-hour volume combined compared to Ethereum with $33.14B, according to CoinGlass. However, open interest in Bitcoin has pulled ahead at 13.8B compared to $9B for Ethereum.