The Merge moved Ethereum from proof of work to proof of stake, and the main implication is that the Ethereum blockchain is becoming carbon-neutral. Today was the big day and so far, there have been no hiccups or fatal errors reported. This does not mean that we are out of the woods yet, but it looks pretty good, and chances are high that Ethereum can proceed with the rest of the items on its roadmap. Another factor that comes into play is the supply of Ether, the native currency of the Ethereum blockchain.
Is ETH becoming scarce and how is the supply changing within hours after the Merge commenced?
Scarcity is relative
As many of you might already know, there is no hard cap on the Ethereum supply. Hypothetically, it is possible to have an infinite amount of ETH. This is a major difference between Bitcoin and Ethereum, and its monetary policy is driven by a yearly inflation rate instead.
This inflation rate has been reduced by introducing EIP-1559 before the Merge commenced. Instead of passing on all the fees to miners or the stakers to be precise, a small amount of ETH gets burned per transaction.
With the transition to proof of stake, inflation has been lowered once again, which creates a special situation. If enough people use Ethereum and create a demand for ETH to power their transactions, the emission rate of fresh ETH can fall below the demand. In effect, Ethereum could become a deflationary asset.
A small supply shock has set in
According to the website Ultrasound Money, the burn rate is already higher than the production of ETH. Meaning that the supply of Ether has already shrunk by about 100 ETH after the Merge. It is important to keep in mind that this could change drastically.
A supply shock is possible, but not inevitable. If fewer people use Ethereum or the same amount of market participants make fewer transactions, the burn rate will fall between the emission rate of ETH.
While the Ethereum community is cheering the successful Merge and a first supply shock, it remains to be seen if this can indeed turn Ether into a deflationary asset. There is a technology that could pose a risk to this outcome and interestingly enough, this technology is desperately needed by Ethereum to thrive.
Second-layer networks are important
One thing that didn’t happen with the Merge is that transactions are not cheaper nor are they faster. Ethereum is still waiting for a technology that is called sharding which is meant to solve both problems. In the meantime, second-layer technologies are most important to make transactions instant and cheap.
Most of these technologies achieve that by so-called roll-ups that are finalizing on Ethereum as a consensus layer. They bundle hundreds of transactions into one block, saving a huge amount of time and fees. Fees that would otherwise be burned.
Should the adoption of second-layer protocols continue and on-chain transactions become less important to the broader masses, then this could decrease the burn rate drastically.
It is estimated that we have to wait at least 6 months to get a clearer picture of how this is going to play out in the current market situation. In any case, broader adoption of Ethereum would contribute to a bullish scenario and a reduced user base would be followed by a bearish scenario.