This will be the economic model of Ethereum 2.0 after the merger

Deflationary Ethereum chart.

Key facts:
  • The economy of ETH will be based on two factors, the emission and the commissions.

  • The more ETH that is staked, the less cryptocurrency will be issued.

Beyond the changes that Ethereum 2.0 will bring to the current network, it also raises expectations to know what will happen to ether (ETH), the Ethereum cryptocurrency, after the merger or The Merge. This is how it is known at the time of the transition to the new version of the network that, as expected, would occur in the second half of this year.

To explain in detail what is going to happen, Twitter user DeFi Surfer (@808_Investor) posted a thread on social network in which he details the future of ether in the coming months.

According to what this developer details, who in turn was based on publications by renowned Ethereum developers such as Justin Drake, Ryan Berckmans, North Rock Digital and 0xHamZ, the economy of the network will move from two factors. These are the issuance of ETH to reward validators and commissions to be paid online.

Regarding the issuance of new units of the cryptocurrency, which will now remain in the hands of the validators and not the miners, this will be based on a compensation scheme that depends on the number of validatorsas described in Roadmap of Ethereum 2.0 and as seen in the image below.

What this graph indicates is that ETH issuance will be diluted as more ETH is staked (i.e., deposited as collateral) on the network. Based on this formula, with a total stake of 15 million ETH (currently there are 12.7 million, according to beaconcha.in) it can be calculated that validators will earn approximately 700,000 ETH per year for their contribution to the network.

On the other hand, in terms of commissions, it must be taken into account that 70% of these are burned from the implementation of EIP-1559, an improvement proposal that modified the rewards and fees mechanism of Ethereum. The other 30%, meanwhile, is used to reward validators.

What you need to know in this regard is that, the more activity on Ethereum, the higher the amount of fees that will be paid. In turn, if fees rise, more units of the cryptocurrency are taken out of circulation. Thus, in the future, the use of Ethereum will contribute to reducing the currency of its cryptocurrency.

So far in 2022, Ethereum gas consumption (i.e. fees) ranged from 248,444 ETH in March to 301,166 ETH in January, according to data from Glassnode. Following this average, the network would consume 3.2 million ETH per year by the end of 2022, of which only 978,400 ETH would remain in circulation.

Ethereum will become deflationary in the long run

It is expected that in version 2.0 of the network, Ethereum will become deflationary. That is the issuance of your ether cryptocurrency is less than the amount burned.

For practical purposes, DeFi Surfer calculates the monetary landscape of Ethereum 2.0 considering a staking of 15 million ETH and total fees of 2.2 million ETH per year.

What these two points imply that Ethereum would become 0.7% deflationary. That is, of the 2.2 million commissions, 70% (1.5 million) would be burned. The other 700,000 ETH would go to validators following the scheme presented above.

Deflationary Ethereum chart.
The deflation of Ethereum 2.0, according to the commissions in ETH (Y axis) and the % of the total circulating ETH in staking (X axis). Font: Twitter @808_Investor.

When the merger is completed, it is likely that ETH staking will increase because there will be more certainty about the operation of the network and because the period of blocking funds to be a validator will be shorter than the current one (in which the coins are blocked indefinitely , at least until the merger occurs).

You could also raise the return for validatorsso that it matches that of other networks that work with proof of participation (PoS).

With this, it could go from a staking of the current 11% of the circulating 120,000 million ETH to a potential 28% after the merger, indicate the theoretical calculations of the developer. This translates, as said, into a lower emission of ETH.

But ether deflation can be achieved, according to DeFi Surfer, even with low onchain activity. In case lower than average commissions are paid, the issue will be much lower than the current one, so it will not be necessary to burn as much ETH to achieve a balance in favor of burning.

To this is added that, if the activity in the network is greater, the fires will be even greater. Therefore, the negative balance would increase even more, and with it Ethereum would become deflationary even faster.

Nowadays, Ethereum has a mostly positive balance in terms of daily issuance of ETHas can be seen in the graph below.

Ethereum net issuance.
Except on some specific days, Ethereum is an inflationary network in its current version. Font: watchtheburn.com.

The merger to Ethereum 2.0, a key milestone for the network

The current Ethereum network will move to its new model, called Ethereum 2.0 or consensus layer, thus changing its consensus algorithm. New blocks will no longer be created via proof of work (Proof of Work or PoW), but with proof of participation or staking (Proof of Stake or PoS).

As this newspaper has reported, the developers are betting on achieving the expected transition in the second half of the year. However, it should be noted that the difficulty bomb has already been postponed several times, which will end mining as we know it. In the meantime, the entire process continues to be tested and refined on testnets.

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