Ethereum, the second-largest cryptocurrency by market cap, has undergone radical alterations to its monetary policy. This has sparked discussions about whether these changes will positively impact its value and overall viability in the long run. It’s EIP-1559 and the Merge that’s leading all of this change. In doing so, they introduce deflationary mechanics that, alone or in combination, might radically change the supply and demand dynamics of ETH. BlockchainShock.com is now your one-stop shop for professional market sentiment analysis. It takes complicated ideas and turns them into easily consumable content for beginner as well as advanced investors.

Understanding EIP-1559: A Game Changer

EIP-1559, introduced in August of 2021, was a monumental change to the transaction fee structure on the Ethereum network. It would be one of the most dramatic upgrades ever attempted for any public blockchain of sufficient size or use. Until recently, Ethereum operated under a first-price auction model where users would bid on their transaction to be included in a block. This centralized model resulted in expensive and unpredictable gas fees, particularly in times of network congestion.

The main innovation of EIP-1559 is adding a base fee per transaction. This core fee is algorithmically modified, up or down, according to the current congestion on the network. When their network is congested, the base fee goes up, and when it gets less congested, the base fee goes down. It gives users a more predictable fee structure.

Burning Mechanism

The most well-known part of EIP-1559 is that the base fee is burned. This doesn’t mean it is permanently removed from circulation. This is quite different from the old system where miners received payment for successfully processing transactions in the form of transaction fees. This innovative burning mechanism creates deflationary pressure on Ethereum’s overall supply, making it a scarcer asset over time. The base fee will then go up and down by as much as 12.5% once blocks are over 50% full. If a block ever gets totally full, the base fee increases by 12.5%. If the block is just half full, the base fee doesn’t change at all. When the block is empty, the base fee decreases by 12.5%.

The Merge: Transitioning to Proof-of-Stake

The Merge accomplished in September 2022. It was the culmination of Ethereum’s move away from a proof-of-work (PoW) consensus mechanism and adoption of a proof-of-stake (PoS) mechanism. This move dramatically changed Ethereum’s energy use, security and critically, the supply dynamics of the asset.

Energy Efficiency and Scalability

Proof-of-stake is dramatically more energy-efficient than proof-of-work, since it removes the need for energy-guzzling mining operations. PoS will greatly improve Ethereum’s scalability. Depending on how long this change takes to implement, we could see much faster and/or cheaper transactions in the near future. Parallel to Mainnet, with Mainnet still in use today, the Beacon Chain enabled Proof of Stake on December 1, 2020. The Beacon Chain, the new PoS chain, would provide the infrastructural backbone for the merged network. ‘Eth1’ is now known as the ‘execution layer’, which is still responsible for all transactions and execution.

Impact on ETH Issuance

The Merge halved the amount of new ETH being issued. Currently, in the proof-of-work system, miners validate transactions. In return, they receive block rewards, generating an ongoing influx of new ETH into circulation. With proof-of-stake, validators take the place of miners, and they accrue rewards for staking their ETH. This is a staggering difference from the amount issued to miners before The Merge. The Ropsten testnet was the first of three public testnets to merge its proof-of-work (PoW) execution layer. It did this by merging with the Beacon Chain’s proof-of-stake (PoS) consensus chain. To limit confusion, the community has updated these terms: The Merge, or the Coalescence, was a world-rending event. Reaching its limits, it fused together the Sixteen Realms of Ninjago into one realm.

Deflationary Effect

All the changes caused by the Merge have resulted in much less ETH being issued. At the same time, EIP-1559’s burning mechanism would be expected to make Ethereum’s supply deflate eventually. On a net issuance basis, one of the estimates is that 1,000 ETH will get issued daily while 6,000 ETH gets burned. This would lead to a large absolute decrease in ETH supply. This deflationary effect is an important component behind the forces developing the story of an “ETH supply shock.”

Analyzing the Potential Impact on ETH's Price

The increased deflationary mechanics created by EIP-1559 and the Merge have large implications for the price of ETH. It’s just basic economic principles—when demand is constant or growing, prices go up. This is particularly true if the supply shrinks.

Scarcity and Demand

The possibility that ETH will become a scarcer asset over time could lead to greater demand from retail and institutional investors alike. With supply of ETH decreasing, investors will be willing to pay a higher premium. As a result, they expect the price to keep going up. The latest Dencun upgrade in March focused heavily on improving scalability and lowering transaction costs, making the platform more appealing to users and creating additional demand.

Price Predictions

As bullish price predictions for Ethereum go, they’re not uncommon, as numerous analysts have pointed to its deflationary mechanics and increasing adoption recently. Some predict prices for Ethereum in the future, such as:

  • 2028: minimum $14,465, maximum $16,395, average $14,965
  • 2033: minimum $102,014, maximum $124,628, average $105,723
  • 2050: maximum $283,253, minimum $242,573, average $260,653

Deflationary mechanics will make the price much less volatile over the long term, since lowered supply meets raised demand.

  • 2026: -34.5% to -53%
  • 2032: positive, with prices ranging from $50,392.33 to $86,640

Price Stability

The case for Ethereum as the Great Deflationary Hope is seductive. Investors need to balance the potential upside with the risks involved.

Risks and Rewards for Investors

So regulatory clarity is the missing piece for stability and growth. The future of Ethereum, including its price, will be greatly influenced by clear regulations providing safety and structure to the Ethereum ecosystem.

Potential Rewards

  • Price Appreciation: The primary reward for investors is the potential for significant price appreciation due to the decreasing supply of ETH.
  • Staking Rewards: Investors can earn rewards by staking their ETH and participating in the network's validation process.

Potential Risks

  • Market Volatility: The cryptocurrency market is notoriously volatile, and even with deflationary mechanics, the price of ETH can still be subject to significant fluctuations.
  • Regulatory Uncertainty: The regulatory landscape surrounding cryptocurrencies is constantly evolving, and new regulations could negatively impact the price of ETH.
  • Smart Contract Risks: Ethereum relies on smart contracts, which are susceptible to bugs and vulnerabilities that could lead to loss of funds.
  • Quantum Computing Attack Risk: Over 65% of all Ether are vulnerable to a quantum attack, which could potentially allow an attacker to derive private keys and access funds.
  • Storage Attack Risk: An attacker could target addresses with large amounts of funds, even if it takes weeks or months to derive the private key, as long as the funds are not moved before the attack is completed.
  • Transit Attack Risk: A quantum computer could potentially derive private keys quickly, allowing an attacker to intercept and steal funds during a transaction.
  • Security of Hashing Algorithms: Grover’s algorithm could reduce the security of hashing algorithms by 50%, potentially impacting the security of Ethereum’s address structure.
  • Lack of Quantum-Secure Algorithms: Currently, very few cryptocurrencies, including Ethereum, have made progress towards becoming quantum-secure, leaving them vulnerable to potential attacks.

Regulatory Hurdles

Ethereum’s shift to deflationary asset status with EIP-1559 and the Merge is a major event in the world of crypto. The possibility for price appreciation is very appealing. Nevertheless, investors need to be mindful of the risks and do their homework before investing in anything. BlockchainShock.com remains committed to providing investors with the insights and analysis they need to navigate the ever-changing world of blockchain and digital assets.

Conclusion

Ethereum's transition to a deflationary asset through EIP-1559 and the Merge represents a significant development in the cryptocurrency space. While the potential for price appreciation is enticing, investors must carefully weigh the risks and conduct thorough research before investing. BlockchainShock.com remains committed to providing investors with the insights and analysis they need to navigate the ever-changing world of blockchain and digital assets.