You might have heard that the third and final Ethereum testnet, Goerli, went live on August 10. And, okay, maybe the name alone doesn’t inspire excitement — I mean, what in the world is a “Goerli” anyway? — but make no mistake, this is an important milestone for all crypto investors.
Why? Because this event brings us that much closer to the long-awaited transition to Ethereum 2.0—or what crypto folks call “the Merge.” So, what does this mean for you?
What investors need to know about triple halving
Ethereum is on the verge of the Merge, and once the Merge is complete, it will go through a phenomenon called “triple halving.”
For people not familiar with the Merge, the Ethereum network is scheduled to transition from the current proof-of-work consensus mechanism to proof-of-stake mechanism in September 2022.
Proof of stake is used by blockchain networks to achieve distributed consensus whereby a user validates transactions in a block as a function of the number of tokens they stake. It requires users to stake their native crypto tokens to become network validators. Instead of having many miners competing in an energy-intensive fashion to solve the puzzle and create the same block, validators are chosen based on a selection algorithm that takes the size of their stake into account. Once a validator is selected, they have the exclusive right to create a block.
In this context, proof of stake (or “staking”) requires virtually no energy relative to proof of work. In a nutshell, staking will help the Ethereum network become more scalable, safer, and have much lower energy consumption.
Because Ethereum will soon use staking, the issuance of Ether will be significantly reduced. Enter “triple halving.”
How might triple halving affect ETH holders
“Halving” is a concept from the Bitcoin world. Bitcoin halving, an event sometimes known more ominously as "the Halvening," is when block rewards from Bitcoin mining get cut in half. This means that the issuance of new Bitcoin is also cut in half.
It is a feature specifically built into Bitcoin’s software as a means of ensuring monetary soundness over time by periodically reducing the rate of inflation. Historically, Bitcoin halving events have corresponded directly with the start of crypto bull runs.
Ethereum functions in a unique way to Bitcoin, and because of this, ETH issuance operates differently under the current proof-of-work consensus. Instead of “halving,” the Ethereum network reduces the ETH supply by software upgrades agreed upon by the community.
Reduction in ETH Block Rewards Over Time:
- Genesis to 2017: reward block 5 ETH
- 2017 to 2019: reward block 5 ETH to 3 ETH (via EIP-649 update)
- 2019 to now: reward block 3 ETH to 2 ETH (via EIP-1234)
At the current rate, the supply of ETH increases about 4.3% per year. The reason for the high issuance rate is to incentivize miners for securing the blockchain, which is very costly.
But when the Merge takes place, Ethereum will transition from a miner-secured network to a validator-secured one.
When this happens, once a validator is selected, they will have the exclusive right to create a block. In context, this will reduce the high cost for miners by reducing Ethereum’s energy output by ~99.95%.  This will directly influence the “triple halving” phenomenon—the dramatic decrease in issuance.
There are three factors driving down ETH’s supply—two of which will happen after the Merge takes place.
1. Validators consuming less energy post Merge
After the Merge, in the new proof-of-stake mechanism, validators will consume less energy, meaning the network will pay reduced rewards to them. Under the current proof-of-work mechanism, the annual issuance of ETH is around 4.5%. It is estimated that post-Merge under proof of stake, the annual ETH issuance will drop by 10x to about 0.4%.  For example, if there is $100 million worth of ETH being rewarded to miners daily for energy costs for securing the network, after the Merge, it will only be $10 million.
- Why should investors care? The dramatic decrease in issuance is expected to play out as a simple function of supply and demand, with many anticipating it will drive up the price of ETH.
2. EIP-1599 fee burn
Ethereum burning first became a more significant part of Ethereum’s operations last year. On August 5, 2021, the Ethereum network successfully completed the EIP-1599 upgrade, commonly known as “the London hard fork.” In the Ethereum blockchain, for transactions to be confirmed, users must pay a gas fee. Gas fees are payments made by users to compensate for the computing energy required to process and validate transactions on the Ethereum blockchain.
Instead of giving all of transaction fees to validators (whether they’re proof of work miners or proof of stake validators post Merge), the London hard fork took them out of circulating supply, in a way similar to a share buyback.
- Why should investors care? Fee burning means the network may have blocks where supply becomes deflationary. Moreover, if activity is low, the supply is increased. Since the fee burn was introduced in August 2021, the Ethereum network has burned over 2 million ETH (~5 billion), making ETH scarcer. Again, less supply = higher price of ETH.
3. ETH staking
ETH staking on the Beacon Chain refers to the act of providing ETH to a validator to help secure the network after the Merge. As a reward for staking ETH, users are rewarded with block rewards.
- Why should investors care? Staking will prevent validators from withdrawing any of their staked ETH until six months after the Merge. After the initial six-month period, a queue will allow for gradual withdrawal that will effectively reduce the circulating supply temporarily as well.
Investment implications: looking forward
Looking at it from industry perspective, if the Merge is successful, Ethereum 2.0 could cement itself as the sole player in DeFi, Web3, and NFT markets. Under the current proof-of-work consensus, the Ethereum network can only process 30 transactions per second, which leads to long wait times and very high fees.
Although, proof of stake does not directly solve the issue with scalability, its architecture allows for the implementation of a scalable solution through a process called sharding. Sharding implies partitioning of the database into so-called “shards,” where each shard is responsible for processing only part of the data stored in the network, resulting into significantly reduced processing times and low fees.
Not only that, the Merge will bring upon the phenomenon of triple halving, which will significantly reduce supply, potentially driving up demand and affecting ETH’s price.
So, you may ask yourself, “how will the Merge affect me, the investor?”
The demand for ETH seems to be increasing since (1) it was announced that the Merge is expected to take place on September 15 and (2) after the success of the final testnet, Goerli.
With the Merge, Ethereum will slash roughly 99% of its energy consumption. And coupled with the deflationary pressure from triple halving, many speculate that the price of ETH might really hit new heights, which have not been seen in the past. Ethereum could drive a market rally and change the damaging narrative that has been surrounding the crypto world over the last couple of months.
- Gorast Tasevski, Product Analyst, Purpose Investments
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