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On September 15, 2022, Ethereum, the largest smart contract blockchain, transitioned from a proof-of-work (PoW) to a proof-of-stake (PoS) consensus mechanism. The transition has not only made Ethereum more environmentally friendly but has also had a notable impact on its supply dynamics.
According to data from the analytics dashboard ultrasound.money, Ethereum has seen a net reduction in supply since the Merge upgrade. Approximately 889,990 ETH have been minted, while a staggering 1,205,101 Ether have been burned.
This has resulted in a net supply decrease of 315,110 ETH, equivalent to a reduction of 0.210% in annualized percentage terms. The net supply would have increased by almost 6 million tokens or 3%, had Ethereum operated as a proof-of-work blockchain.
The PoS mechanism requires market participants to hold a minimum amount of Ether to validate transactions and earn rewards. In contrast, the previous PoW setup involved miners solving computational problems in exchange for rewards.
The transition to PoS has removed a significant portion of the miner supply from the market. Additionally, the PoS mechanism burns a portion of transaction fees, specifically the base fee, which reduces the circulating supply of Ether.
Has Ethereum Become Deflationary After Merge?
Following the Merge upgrade, Ethereum exhibited deflationary behavior, with the supply reaching its peak of nearly 120.534 million ETH three weeks later. The burn rate accelerated in early 2023, decreasing by approximately 276,500 ETH between February 1 and June 8.
While the burn rate slowed down in the third quarter, the supply of ETH continued to decrease, reaching a post-merge low of around 120.2 million ETH on August 31. This effectively offsets inflation by 307,370 ETH.
In September and October, the supply of Ether turned inflationary for the first time in 2023, with approximately 53,700 coins added to the supply. Despite this temporary shift, Ethereum experienced a resurgence in on-chain activity in November, driven by bullish market conditions, leading to a significant acceleration in the burn rate.
Overall, the Merge upgrade has made Ethereum deflationary, with a decreasing supply of ETH due to the PoS mechanism and the burning of transaction fees. However, there is currently no guarantee that Ethereum will remain deflationary, as a drop in network activity could slow down the burn rate and make the token inflationary again.
The Merge Did Not Lower Gas Fees
While the Merge upgrade made Ethereum more environmentally friendly, it did not lower gas fees directly. Instead, the update created the technical environment necessary for future gas optimizations.
Specifically, activating PoS was the first step toward enabling sharding. This upgrade will allow the network to be split into “shard chains” that share the load of Ethereum, theoretically reducing congestion and increasing transaction throughput.
Furthermore, there are hopes that the upcoming Ethereum Improvement Proposal (EIP)-4844, also known as “proto-danksharding,” will address the network’s high gas fees.
EIP-4844 aims to reduce gas fees and increase transaction throughput by introducing data blobs, which efficiently process and store large amounts of data without burdening the Ethereum virtual machine.
The Bottom Line
With the EIP-4844 upgrade expected to go live later this year, gas transactions on Ethereum are poised to become cheaper, which is going to be a win for users across the board.
These developments, coupled with Ethereum’s deflationary supply dynamics, provide an intriguing outlook for the future of the Ethereum network.
