Status check: Ethereum in full deflation mode as Eth2 merge gets closer

Over the last few years, the Ethereum community has been working hard to lay the foundation for the shift away from the current proof-of work (PoW), which has been the backbone of blockchain’s operation until now.

The switch to Ethereum’s proof-of-stake (PoS) powered Ethereum 2.0 chain has been moving closer to becoming a reality. Recent updates to Ethereum’s blockchain have resulted in the issuance Ether (ETH).

Recent upgrades have led to deflationary issuances of ETH. This is where transaction fees are burned and new ETH is issued through mining. This was unexpected by some in the industry prior to the network upgrades to Ethereum 2(Eth2). This is an important factor that will drive the underlying cryptocurrency’s value up in the coming months and years.

The influence of this earlier-than-expected shift to the deflationary issuance of ETH cannot be understated in terms of its effects on the value of ETH. Industry participants also believe that this deflation will increase once Eth2 is fully implemented, which will be more than 10 times less than the current issuance of 2 ETH per block.

Recent developments

The foundation for Eth2’s transition was laid when the proof-of stake Beacon Chain went online in late 2013. This allowed users to stake Ethereum to become validators. This would effectively replace the current role of miners who use physical hardware to verify transactions, add blocks, and otherwise maintain the network.

Over 260,000 validators have staked 32 ETH to become validators on the Ethereum chain as of November 17, 2021. The current Ethereum token staked totals 8,327 638 ETH, which is approximately $34.1 billion.

In 2021, Ethereum’s value has been in a steady upward trend. It has reached new heights due to a number of factors this year.

The London hard fork, which introduced a few Ethereum Improvement Proposals (EIPs), was the most anticipated upgrade in 2021. EIP-1559 was one of the most controversial due to the changes in fee structures that miners earn and users pay.

The built-in ETH burning mechanism, which destroys a portion Ether that was used to pay a transaction fees, was a major problem. This was a problem for Ethereum miners prior to the upgrade. Transaction fees are a motivator that encourages miners maintain the network.

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The deflationary action by the ETH burning mechanism was an important advantage of the London hardfork that took place in July 2021. Each transaction sees a portion of ETH being destroyed. This will gradually lead to more ETH being taken from the ecosystem, which should increase the value and scarcity of ETH.

London was also expected to see a decrease in fees for users of Ethereum. However, this was not to be. In November 2021, high fees remained a concern. Some investors have begun to look at multichain decentralized finance networks to reduce transaction fees on Ethereum mainnet.

Altair was the name given to the most recent upgrade of Ethereum’s network after London. Altair was the first update of the Beacon Chain’s Beacon Chain since December 2020, according to Beiko. He said that the upgrade was a test of the merger and also served the purpose to align incentives for validators.

“The upgrade increased the penalties validators get if they propose invalid blocks and are offline at their ‘true” levels. These penalties were lower to be more friendly towards stakers when the Beacon Chain was launched. We now know that these things work reliably so it was time for us to raise the penalties.

Ben Edgington is the lead product owner at Teku, an Eth2 client that ConsenSys created. He also commented on the details of the Altair upgrade.

While Edgington highlighted some material changes to Altair, he also acknowledged that many of these improvements are not immediately obvious to stakers.

Edgington stated that Sync committees are an enhancement that will allow light clients trustlessly sync with the state of Beacon Chain. This, Edgington says, makes it “possible” to have an in-browser wallet without relying on any third-party.

The internal calculation of block rewards was also refined. While the stake rewards for blocks that are proposed have been increased, they remain the same.

A significant change was made to the penalties. They were previously set at a lower threshold when Beacon Chain went online last year. This is done to discourage invalidators from engaging in misbehavior on the network. Examples of this include being offline and being unable to sign transactions. Edgington says that there has been plenty of time to evaluate the effectiveness of the mechanism.

To increase stakers’ trust, penalties were lowered at the beginning of the Beacon Chain. We are now all more comfortable with staketaking and penalties are being gradually increased to their ‘cryptoeconomically correct’ value.

In October, a number of representatives from Ethereum client groups participated in an Amphora workshop. They worked together to create a series of milestones that would mimic the Eth2 merger on a test network. This was effectively a rehearsal for the real deal, which will take place next year. Edginton outlined the results of the workshop and provided a best estimate for Eth2’s transition in Q2 2022.

“We are currently working towards a public Merge Testnet called Kintsugi, which is expected to go live in December. Kintsugi will implement a release candidate design of The Merge. This means that all technical implementation work has been completed. The Merge will then be possible only after that. This is where testing, governance, and risk management are required.

Now, focus on “The Merge”

One more minor upgrade is planned for Eth2 in 2021. Arrow Glacier is made up of one EIP-4345. This modifies the parameters of Ethereum’s Ice Age Complexity Bomb.

The Difficulty bomb is the name of the plan to increase the difficulty level for miners on the PoW Ethereum mainnet. The Bomb will make it exponentially harder to mine Ethereum networks. This will be one of the motivators to encourage the entire Ethereum network to join the merger to Eth2.

Beiko stated that the Ethereum development community’s main focus is now on ‘The Merge’. This signals the end of the last chapter in the blockchain’s evolution to PoS consensus.

What can you expect from Eth2 when it becomes a reality

Although the date for “The Merge” is still unknown, both Edgington and Beiko highlighted the fact that Ethereum developers now only care about the final steps towards Eth2.

Many cryptocurrency enthusiasts and users are still asking the same question. What will happen when Eth2 becomes reality? Edgington shared some insight into the network’s operation in combination with layer-two solutions that will improve scalability.

“The transition to proof-ofstake won’t immediately provide any significant additional throughput to Ethereum chain. Therefore, I don’t expect it will have a measurable impact on gas prices. Layer-two solutions, such as the roll-ups currently in use, are now Ethereum’s scalability strategy. After The Merge is completed, we will be focusing on data shards within Ethereum that will allow rollups to scale massively.

Edginton noted that Ether issuance will fall by 2 Ethereum per block after the removal of the mining reward. EIP-1559 will still continue to burn Ether today. “It is very likely that the total supply will shrink for theforeseeable future,” he said.

Coinbase protocol specialist Viktor Bunin highlighted the importance and debate surrounding the London hard fork and EIP-1559 earlier in the year. Cointelegraph was told that the upgrade has set up some mechanisms that will affect the value of ETH as the deflationary mechanism gains momentum.

EIP-1559, which was launched in 2016, has resulted in net Ethereum issuance being reduced by 66%. Net ETH emission today would be negative if the merger were to take place, which would make the network deflationary. EIP-1559 is the key element. Running validators make ETH, an asset, more valuable. ETH used to only indirectly capture the Ethereum upside, but now it can provide industry participants with direct metrics that will help them understand the utility and value of holding and using ETH.

Yuga Cohen, a Coinbase software engineer, echoed these sentiments. She looked into the numbers and gave a data-driven overview on the impact of EIP-1559 so far. “Total miner revenues have actually increased 33% in dollars despite this burn. The network will become more valuable as validators replace miners, and more ETH will be staked (or at least temporarily locked up) to protect it.

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