Merge to Drive up ETH Price, Staking Yield

• Ethereum is on the verge of a major upgrade that could see the supply issuance of ether drop 90%.
• Slated for Q2 2022, ethereum will switch to proof-of-stake from proof-of-work after the upgrade. 
• Vance Spencer explains why there’s so much excitement about ETH price and staking after “The Merge.”

As a self-professed “gigantic ETH bull” who has been involved in the ethereum community since 2015, Vance Spencer could not be more excited about the upcoming ethereum merge. 

The co-founder of Framework Ventures is not the only one who has been keeping his eyes peeled for any news and updates about the major network upgrade. People around the world are curious to find out more as search volumes for “ethereum merge” hit an all-time high last week, according to Google Trends data. 

The growing interest in ethereum has come at a time when ether (ETH) charts a bullish upward trend. The second-largest cryptocurrency has surged 22.6% in the past two weeks to trade at $3,456, compared to bitcoin (BTC)’s 12.8% ascent during the same period, according to CoinGecko data. 

Dubbed “The Merge,” the upgrade will officially see ethereum switch to the proof of stake consensus from the proof of work algorithm that powers bitcoin. Both mechanisms enable a distributed network of participants to verify blockchain transactions, but they differ in how they achieve consensus.

Proof of work requires miners to expend large amounts of computational resources and energy to add new transactions to the blockchain, but it is considered more secure. Proof of stake requires validators to stake cryptocurrency in order to organize transactions and create new blocks in the network. It is considered more energy-efficient and decentralized but may not be as secure as proof of work.

It’s happening for real this time 

Although talks of the merge have circulated since as far back as 2015, the network upgrade has been delayed many times. This time, investor enthusiasm is palpable because there is “credibility” that it is actually going to happen in the second quarter of this year, according to Spencer. 

“The merge was originally supposed to happen in 2016 and 2017, but there were just so many issues that ethereum had to work towards and build around to get to this point,” Spencer told Insider in an interview. “It’s more of a redemption or resurrection moment for ethereum in that it’s really executing on the long-term roadmap that it’s set out once upon a time.”

In August last year, the network successfully executed its London hard fork. Since then, more than two million ether tokens worth over $7 billion have been “burned,” which means that they have been removed from the total supply of ethereum, making the cryptocurrency “net deflationary,” he said. 

More recently, ethereum merged on the Kiln testnet, the last testnet merge before the blockchain network’s long-awaited conversion to proof of stake.

The merge has boosted the demand for ethereum staking, which refers to the act of “locking up” your crypto holdings to help validate transactions on proof-of-stake blockchains in exchange for rewards in the form of tokens. Currently, more than 10 million ether tokens are staked via 320,810 validators, according to Copper Research. 

What’s also breeding optimism for the merge this time is the emergence of the “fee market of ethereum,” in Spencer’s view. 

“This fee market is worth billions a year to the people who are currently mining but will soon be staking to earn this,” he said. “That’s something that really wasn’t happening two or three years ago, there were really no fees on blockchains because we were not really users. But there are so many compelling user applications now that people are willing to pay for this and it’s just going to be a gigantic industry.”

Though to be sure, ethereum gas fees have become prohibitively expensive at times for users to conduct transactions on decentralized finance, non-fungible token, and metaverse platforms built on the blockchain. 

Price action, staking yields, and other benefits 

So what exactly will happen at the time of the merge? The transition has two phases, according to Spencer. 

During the first phase, the network will turn off proof of work and turn on proof of stake. After that, ether holders will transact on the new proof-of-stake blockchain. 

“What exists after that is the stakers are being paid in ethereum instead of the miners, it’s about 90% of a reduction in the supply that’s paid out daily,” he explained. “On the environmental side, it’s about 99% decrease in greenhouse gas emissions and carbon emissions.”

Right after the initial merge, there will be two parts of ethereum too — the staked ethereum that’s locked up in the bridge and the ethereum that is still free-floating. Stakers cannot withdraw the staked ethereum until the old and new chains formally merge in the second phase, which is estimated for sometime in 2023. 

“That’s a massive production supply that just cannot move,” he said. “I think that’s another reason why people are starting to pay attention around not only just the process technologically about building the network, but what it means for the underlying asset.”

As miners transition to holding onto their ether tokens to stake for staking rewards rather than immediately selling newly minted ETH tokens for profits, the supply will decrease substantially. At the same time, demand is likely to grow as institutional investors realize the profit potential in ethereum’s fee market. 

Logically, the supply-and-demand imbalance could drive up both the price of ether and the post-merge staking yield of ethereum. Already, crypto analysts estimate that post-merge staking yields for ethereum could surge to between 7% to 15% from the current yield of below 5%. This is because transaction fees that are currently paid to miners will go towards stakers and validators instead, according to a research note from Genesis Trading.

“If annual percentage yields go up, it’s logical to think that there will be more capital that’s interested in capturing those, so there will be more ETH staked and locked up,” he said. “So you have this interesting potential for a runaway effect. I think that’s why people are excited about the price action.”

Despite the overall positive outlook on the merge, there is the potential risk of another delay — particularly for the second phase of the merge — that derails the bullish investment thesis for ether. 

“The consensus in the industry is that the first part will happen in June, but the formal merge of the two networks is probably the least tied down of the two in terms of exact dates,” he said. “If that moves further out, it just means that there’s more ethereum that are on the other side of the bridge that can’t be pulled back over, so that would exacerbate any potential supply shortage.”