Ethereum (ETH) has plunged around 22 percent from its recent zenith of $2,021 recorded on the 13th of August, precipitated by moderation in erstwhile animal spirits that had taken hold of much of the risky asset universe amid expectations of an imminent dovish pivot by the US Federal Reserve. Hammered by the budding risk-off sentiment as the meme stock mania 2.0 has apparently run out of fuel, coupled with an absolutely atrocious German PPI print which again hammered home the likelihood of elevated structural inflation for the foreseeable future, Ethereum is experiencing a price correction right now, one which sets the stage for an even more outlandish rip in the post-merge phase. Investors and crypto-dabblers generally assume that Ethereum’s merge event will dramatically reduce the network’s energy consumption and that any price upside would result from the ensuing ESG-related inflows. However, in reality, the merge event will introduce two major sources of intrinsic tailwinds that are likely to result in rip-roaring gains for the world’s second-largest cryptocurrency by market capitalization.
Ethereum’s Merge Event Will Introduce Intrinsic Tailwinds for the Cryptocurrency’s Price Dynamics
Currently, Ethereum is operating under a Proof-of-Work (PoW) regime where miners authenticate and then incorporate transactions into the Ethereum blockchain, winning ETH-denominated rewards as compensation. The merge will transition Ethereum to a Proof-of-Stake regime where validators lock up a specific amount of Ethereum in dedicated nodes in order to compete with each other to authenticate transactions and introduce new blocks into the chain. Here, validators would no longer be required to run energy-intensive cryptographic calculations, as was the case under the PoW regime. This factor introduces the first major tailwind for Ethereum. A PoS dispensation is much more efficient, entailing energy cost reduction of around 99 percent relative to current levels. Before going further, let’s discuss how Ethereum’s validator rewards will be computed in the post-merge phase. The snippet above mentions variables that together determine how much reward each validator will receive for ensuring that the network continues to operate smoothly. After the London Fork, a base fee is determined for a given level of network activity. This base fee is then burnt. Consequently, the validators’ reward in the post-merge phase will predominantly consist of two variables: the tip fee, which is the cost incurred by a user to prioritize the processing of a particular transaction, and the block subsidy, which is fixed at 2 ETH per block and will be divided equally among all of the validators. Given the increased efficiency of the network in the post-merge phase, transaction processing rewards are slated to fall precipitously, which means a lower rate of new supply addition. Nonetheless, Ethereum validators are still likely to experience an increase in staking yield. Also, at the prevailing price level, Ethereum miners are liquidating a large proportion of their mining rewards in order to cover the costs associated with running expensive mining rigs. This equates to around $18 million in selling pressure every day. The merge will reduce these energy costs by a whopping 99 percent. This means that validators would no longer be required to dump their Ethereum winnings in the market just to cover costs. Moreover, staked Ethereum is locked until the entire Ethereum 2.0 transition is completed. Even then, given attractive staking rewards, it is likely that outflows under this head will remain muted. As per one estimate, the daily selling pressure from miners/validators would fall from 10,800 ETH to just 200 ETH. This brings us to the crux of the matter. The combined effect of these two factors is expected to be truly deflationary for Ethereum. In fact, Ethereum’s annual token issuance is expected to decline by a whopping 90 percent in the post-merge era – falling from 5.5 million ETH per year to just 0.6 million ETH annually. For context, this reduction is equivalent to over 3 halving events for Bitcoin in a single go! The snippets above summarize these supply dynamics. As you can see, in the pre-merge phase, Ethereum is experiencing a supply growth of 2.5 percent per year, which is inflationary. However, in the post-merge phase, Ethereum will witness a deflationary reduction in total supply of -1.6 percent per year. This creates powerful intrinsic tailwinds for the cryptocurrency. Consequently, given these supply imbalances, the lower Ethereum goes right now, the more powerful will be the post-merge phase price pump.
