Ethereum in full deflation mode as Eth2’s merger approaches

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The Ethereum community has worked hard over the past few years, laying the foundation for moving away from their current Proof-of-Work (PoW) algorithm, which remains the backbone of blockchain operations to this day.

The move from Ethereum to its proof-of-stake (PoS) powered Ethereum 2.0 chain is getting closer to reality, with recent updates to its blockchain causing the issuance of Ether (ETH) to become deflationary.

The recent upgrades have resulted in a deflationary spending of ETH, with burning off some of the transaction fees outpacing the issuance of new ETH by mining. Some in the industry didn’t expect this before the network was upgraded to Ethereum 2 (Eth2). It is an important factor that should drive the value of the underlying cryptocurrency up in the months and years to come.

The impact of this earlier than expected shift towards deflationary issuance from ETH cannot be underestimated in terms of the impact on ETH’s value. Additionally, industry participants believe that once the network fully migrates to Eth2, that deflation will increase, more than ten times the current output of 2 ETH per block mined.

Recent developments

The foundation for the transition to Eth2 was laid late last year when the proof-of-stake beacon chain went live so users can use Ethereum to become validators. This would essentially replace the role of current miners who use physical hardware to validate transactions, add new blocks, and generally maintain the network.

As of November 17, 2021 there are over 260,000 validators who have used at least 32 ETH to become a validator in the chain. At the time of writing, the current amount of Ethereum tokens in use is 8,327,638 ETH – valued at around $ 34.1 billion.

Ethereum’s value is on a steady upward trend in 2021 and has hit new highs this year, driven by a variety of factors, including the skyrocketing popularity of the decentralized finance (DeFi) space, much of which is based on Ethereum -Blockchain operates.

The most anticipated upgrade of 2021 was the London hard fork, which introduced a handful of Ethereum Improvement Proposals (EIPs). One particular proposal, EIP-1559, has been a point of contention due to the change in fee structures that are earned by miners and paid by users.

A sore point was the built-in ETH burning mechanism, which destroys part of the ether that is used to pay a transaction fee. This angered the Ethereum miners before the upgrade, as transaction fees are a driving factor that encourages miners to keep the network going.

Related: Bitcoin Taproot Upgrade improves the network as the impact on BTC price can be limited

A key benefit of the London hard fork, which took place in July 2021, was the deflationary action of the ETH burn mechanism. Each transaction now destroys a percentage of ETH, which gradually results in more ETH being removed from the ecosystem, which should add to the scarcity and value of ETH as an asset.

London has also been touted for reducing the fees paid by users of the Ethereum network. That possibility did not fully materialize as high fees in November 2021 were still a cause for concern. This has led some investors to try to leverage decentralized multichain financial networks to mitigate the high transaction fees that still occur on the Ethereum mainnet.

The most recent upgrade of the Ethereum network to London was coined as Altair. As Beiko told Cointelegraph, Altair served as the first update to the Beacon Chain since its launch in December 2020. In his opinion, the upgrade served as a test for the merger and also served the purpose of providing incentives for validators:

“The upgrade brought the penalties validators receive for suggesting invalid blocks or being offline to their ‘true’ level. When the Beacon Chain was introduced, these penalties were lowered to be milder towards stakers in the early days. Now that we know things are working reliably, it was time to bring the penalties up to their true level. “

Ben Edgington, Lead Product Owner of Teku, a ConsenSys Eth2 client, also commented on the intricacies of the Altair upgrade: “We had never done it before and wanted to make sure everything worked before we did the big upgrade we’re moving to proof-of-stake. “He added,” It went very smoothly and we are confident that we can coordinate future upgrades. “

Edgington highlighted some of the major changes to Altair, but acknowledged that most of these upgrades are general improvements that Staker may not have seen.

Sync committees were introduced as an enhancement that will allow light clients to confidently sync with the state of the beacon chain, according to Edgington, making it “possible in the future to have things like an in-browser wallet, which does not depend on any “. trustworthy third party. “

The internal calculation of the block bonuses has also been refined. Offering blocks will now receive a higher reward along with some other technical changes, while staking rewards will remain unchanged.

Finally, an important change has been made to the penalties, which were set to a lower threshold when the Beacon Chain went live last year. Slashing is used to prevent validators from malfunctioning in the network. Examples of this would be that they are offline and therefore cannot sign transactions. As Edgington explains, there was now enough time to assess the effectiveness of the mechanism:

“Slashing penalties were reduced at the beginning of the beacon chain to increase staker trust. Now that we’re all much more comfortable with staking, the penalties are gradually being raised to their ‘crypto-economically correct’ levels. “

A number of representatives from Ethereum customer teams attended a workshop called Amphora in October. The group worked together to run a series of development milestones to mimic the Eth2 merge on a test net – effectively as a rehearsal for the real thing over the next year. Edginton unpacked the results of the workshop and gave a best estimate for the transition to Eth2, which will happen sometime in the second quarter of 2022.

“We’re now working on a public merge testnet called Kintsugi, which should go live in early December next month. Kintsugi is scheduled to implement a release candidate design for The Merge, which means that the technical implementation work is as good as complete. After that, all that remains is a test, risk management and governance process before The Merge can take place. “

Now concentrate directly on “The Merge”

The roadmap towards Eth2 provides for another smaller upgrade for 2021. Arrow Glacier consists of the lonely EIP-4345, which changes the parameters of the so-called Ice Age Difficulty Bomb of Ethereum.

The Difficulty Bomb is the name for the planned increasing level of difficulty for miners in the current PoW Ethereum Mainnet. If the bomb goes live, the mining difficulty of the Ethereum network will increase exponentially above a certain threshold and will serve as one of the driving factors to motivate the entire Ethereum network to participate in the merger to Eth2.

Beiko said the main focus for the broader Ethereum development community is now solely on “The Merge,” which signals the beginning of the final chapter in the evolution of blockchain towards PoS consensus.

What to expect when Eth2 becomes a reality

While the exact date of “The Merge” is not yet set in stone, both Beiko and Edgington emphasized the fact that the Ethereum developers are now exclusively focusing on the final steps towards Eth2.

Even so, many cryptocurrency users and enthusiasts are asking the same question. What can happen if Eth2 becomes a reality? Edgington provided some insight into how the network works in conjunction with various Layer 2 solutions that improve scalability:

“Switching to proof-of-stake will not bring significant additional throughput to the Ethereum chain immediately, so I don’t expect any measurable effects on gas prices. The scalability strategy in Ethereum now revolves around Layer 2 solutions like the various rollups that are currently in use. As soon as The Merge is complete, we will focus on providing data shards within the Ethereum protocol that enable roll-ups to be massively scaled. “

Edginton also noted that after the merger, ether output will decrease by 2 ETH per block as a result of the removal of the mining block reward, while EIP-1559 will continue to burn ether as it does today: “As a result, it is very likely that the total supply of ethers will shrink for the foreseeable future. “

Viktor Bunin, protocol specialist at Coinbase, highlighted the importance of the London hard fork and its much-discussed EIP-1559 earlier this year. The mechanisms set in motion by the upgrade give an idea of ​​how the value of ETH will change as the deflationary mechanism gains momentum, says Cointelegraph:

“Since inception, EIP-1559 has reduced the net Ethereum spending by 66%. If the merger were live today, the net ETH issue would actually be negative, which would make the network deflationary. The key to EIP-1559 and running validators make ETH, the asset, more useful. While ETH previously only indirectly captured the uptrend generated by Ethereum, direct measurable metrics will be useful in helping industry participants understand the value and benefits of holding and using ETH.

These views were confirmed by Coinbase software engineer Yuga Cohen, who looked at the numbers to provide a data-driven overview of the impact of EIP-1559 to date and how it will continue when The Merge finally takes place: “Total Miner Revenues in Dollars Despite this burn, the conditions have actually increased by 33%. As validators replace miners and more ETH is used – and therefore at least temporarily blocked – to secure the network, the greater scarcity of ETH will be part of its value proposition. “