Ethereum: Post-Merge Looking Forward
Summary:
The London (EIP-1599) and Merge in Ethereum have resulted in net deflationary token issuance, where the rate of token burning exceeds the rate of token creation.
During periods of heightened chain activity, net deflationary issuance accelerates.
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From London With Love
The implementation of the London upgrade EIP-1599 and the subsequent Merge upgrade in Ethereum have brought about significant changes to the network. Prior to these updates, Ethereum operated on a proof-of-work (PoW) consensus mechanism, where new Ether tokens were minted as a reward for miners who validated transactions. However, with EIP-1599 and the Merge, Ethereum has transitioned to a proof-of-stake (PoS) consensus mechanism. Under PoS, new Ether issuance has become deflationary, meaning that the rate of token creation is now slower than the rate of tokens being burned. In fact there are 280,000 less ETH in existence today than at the beginning of the year.
ETH supply since the merge date of 9/15/2022. Source: Ultrasound.money
Mining and Staking
Before the upgrades, Ethereum was mined using a proof-of-work algorithm. The below chart represents pre-merge validator (miner) revenue vs post-merge validator (staker) revenue.
Source: The Block
Next Cycle Problems and Opportunities
The London Upgrade insured that transaction fees would be burned instead of directed to the network’s miners. The below charts depict a rise of transactions and coinciding drop fo net issuance of ETH peaking in late May of this year. This episode provides a glimpse of the potential for a dramatic swing during the next bull market in activity.
Source: The Block
Source: The Block
It is increasingly clear that Ethereum will experience accelerating deflationary net issuance as activity and transaction demand pick up during a bull market move. This will be the first iteration of deflationary issuance coupled with a risk on environment in the nascent history of digital assets.
Given the unique supply and demand aspects of ETH, the current 60%-65% implied volatility of ETH options would seem to discount very little in the way of an anomalous price move. Yet the outliers are often mispriced.
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