Merge of Ethereum Might Not Be Instantly Deflationary

Although the Merge is expected to decrease the supply of ether, making it a deflationary asset, low usage of the network may postpone the anticipated beneficial effect.

The Merge long-awaited technical upgrade, is just a week away, and holders of the blockchain’s native token ether (ETH) may be beginning to feel ecstatic because the upgrade is extensively anticipated to develop ETH as a deflationary cryptocurrency — one with a diminishing supply — and attract more buyers to the market.

According to Singaporean crypto trading firm QCP Capital, the apparently positive shift may remain elusive for some time.

In a newly published study, QCP strategists stated, “The uber-bullish thesis is that ETH 2.0 will immediately usher in a new age of deflationary supply for ETH.” “This is just partially accurate. At present, at least.”

The QCP strategists, led by co-founder and Chief Investment Officer Darius Sit, stated that ether’s metamorphosis into a deflationary coin could be delayed by low network traffic.

QCP strategists stated, “Where the bullish kicker will come from is in the burn rate, which in the midst of [crypto] winter is not looking that bullish.”

The burn rate, which is the quantity of ether tokens taken out of circulation everyday as a result of the protocol’s burning of a portion of transaction fees paid in the cryptocurrency, is directly proportional to the network utilization, which has slowed this year because of the bear market.

Clarification of the Merge and burn rate

The Merge will integrate the existing proof-of-work (PoW) chain of ether with the proof-of-stake (PoS) Beacon Chain, which became live in December 2020.

That will mark the transformation of the world’s largest smart contract blockchain to a PoS consensus mechanism, which needs market participants to retain a minimum number of coins to verify transactions — as opposed to the current PoW system, in which miners solve computing problems to validate transactions in exchange for ETH rewards.

The switch from PoW to PoS will eliminate a substantial quantity of miners.

According to QCP, miners now earn 5 million ETH ($8.1 billion) yearly. After the switch, it is anticipated that the annual awards granted to PoS stakers will decrease to 1 million ETH. (The quantity of rewards paid is contingent on the number of speculators, which is correlated with staking returns.)

While this would greatly reduce supply-side pressures, ETH’s net issuance is unlikely to decrease unless the burn rate increases in tandem with the decrease in rewards provided to validators.

Recently, the average daily burn dropped to a record low of 1,206 ETH per day. That’s less than 9% of the January record daily burn of 13,269 ETH. According to data maintained by blockchain analytics company Glassnode, 13.6 million ETH, or 12 percent of the total quantity of 120 million ETH, are locked in the Beacon Chain.

Ether would continue to be an inflationary currency assuming the burn rate remains low and the number of ether staked doubles after the Merge.

QCP strategists stated, “At the present burn rate and assuming 25% of the ETH 120 million ETH supply is staked, we will have an inflationary supply of 1%/year, compared to a deflationary supply of 2%/year if we just revert to the all-time high burn.”

Will the burning rate increase?

Ethereum’s burn rate is proportional to network usage across multiple industries, such as decentralized finance (DeFi) and non-fungible currencies (NFTs).

January’s record-breaking burn rate was mostly influenced by the escalating activity on the NFT market. OpenSea routinely constituted more than 15% of all ETH destroyed everyday at the beginning of this year.

Consequently, only a significant increase in activity on DeFi platforms and NFT would raise the burn rate.

According to QCP, this is improbable in the near future because DeFi yields are “rock bottom” and NFT profile picture hype is “flattening.”

Information taken from — https://www.coindesk.com