Ethereum’s Merge will create demand for ETH — here's why

Ethereum is inching closer towards The Merge, and here's our analysis on what could happen when these events unfold.

Ethereum’s Merge will create demand for ETH — here's why

Ethereum is inching closer towards its most significant event ever, the merger of the current Ethereum mainnet with its beacon chain proof-of-stake system (PoS), an event known as The Merge.

The Merge is significant because:

  • It marks the end of Ethereum as a proof-of-work system and transitions it towards a more eco-friendly proof-of-stake system, cutting electricity use by ~99%
  • It will cut ETH issuance rate by almost 75%-90% — from 5.4M to 0.5M ETH annually, the equivalent of 3 Bitcoin halving events

Since the price of ETH is determined by demand and supply factors, let us analyse what could happen when these events unfold.

More institutions can get involved in ETH staking

Institutions are extremely concerned about the heavy use of electricity when it comes to cryptocurrency mining. Many have put off heavy investments in cryptocurrencies as they go against ESG policies.

However, if Ethereum moves towards Proof-of-Stake, where the validation of the blockchain is done without expensive mining equipment, it may kickstart an era of institutional investment towards ETH.

ETH could be staked in a validator node to participate in validating transactions, earning a return (in ETH) for providing this service. The yields for staking can range from 10% to 15% depending on how much ETH is staked across the network.

These yields provide not only an investment opportunity on ETH, but also a sustainable source of yield in a yield starved environment.

ETH is also be seen an internet bond, allowing anyone in the world to invest, participate, and profit off an open-sourced, decentralized digital economy.

ETH “triple halving event”

It is said that the 90% reduction in ETH issuance is equivalent to three Bitcoin halving events.

A Bitcoin halving event is usually an event that drives cryptocurrency markets as each event reduces new supply inflows to the secondary markets. Historically, Bitcoin halving events have led to a bull market for cryptocurrencies.

Since each Bitcoin halving event takes 4 years to play out, this issuance reduction may see ETH cutting 12 years equivalent amount of BTC supply in just one year.

Besides a supply issuance reduction, new ETH issuance which previously went to miners will now go to validators. When miners were mining ETH, they had to sell ETH to cover costs of mining equipment and electricity. However, validators must now stake their ETH to participate in blockchain validation, and stakers usually are long-term holders.

Long-term holders tend not to sell their tokens, and this creates further supply reduction in the market.

A dashboard tracking ETH burn statistics since EIP-1559 was introduced puts ETH issuance offset at 6X post-merge. A total of 2.1M ETH has been burned, a rate of 5.85 ETH per minute, or 3M ETH per year.

ETH burn statistics

If 3.1M ETH is burned annually, and 0.5 ETH is issued annually (as staking rewards), then we can expect each year the supply of ETH is -2%, i.e. net deflationary.

Increased staking yields

Currently, there are 354,000 validators staking ~10.9 million ETH, and staking pays out around 4% per year from staking rewards.

Validator growth

When The Merge happens, ETH that goes to miners from unburnt fee revenues (see EIP-1559) will also go to stakers, increasing staking yields to possibly 10% to 15%.

Staking yields offer almost a risk-free yield on ETH, since they do not incur impermanent loss, and do not have huge smart contract or hacking risks from DeFi protocols, increasing the demand to stake ETH for yield.

If more ETH from the market ends up being staked, then ETH circulating supply in the market falls, increasing its price, ceteris paribus.

Overall thoughts

Ethereum’s merge will see huge positive catalysts for ETH’s price in the long term.

Assuming Ethereum remains a neutral, decentralized and open-source software fundamental in the new blockchain-driven economy, the continued use of the network will see more ETH being burned each transaction and less of it in the open market.

No wonder they call it ultra-sound money.

Buy ETH on Binance or FTX and get discounts on trading fees.