Shift Happens… | The Ethereum Merge Demystified | Part 2

Introduction

A major shift in central bank monetary policy is coming. It’s called the Ethereum Merge, and its implications are going to be big, with huge opportunities for investors, builders, and everyone else in the web3 space.

To get to the bottom of all this, we created a 3-part mini-series to get you up to speed and set you up for success.

In this series, we’ll address:

• Consensus algorithms, what are they, and why do they matter?
• The Merge, what is it?
• And beyond: What’s next in Web3?

Now that we discussed the benefits of PoS and why ETH will switch over, we’ll also dig into the other meaningful changes that will happen along with the merge including monetary policy, finality, and constant block times. 

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Monetary Policy

The biggest change from The Merge is removing rewards that go to miners. Currently mining rewards are approx 13,000 ETH per day, and staking rewards are approx 1,600 ETH per day. The Merge essentially reduces ETH issuance by 90%, setting the stage for it to become a fixed quantity asset, similar to gold or Bitcoin.

This is quite meaningful as it is often touted as one of the biggest selling points of Bitcoin, the fact that it will have a capped supply for 21 million. Post Merge, Ethereum will have an inflation rate of ~0.5%. However, some amount of ETH is burned as each block is created as part of a proposal called EIP-1559. This is to allow users that need urgent processing to pay more to squeeze their transactions into the next block. If usage increases, the amount burned might exceed the issuance rate, causing ETH to become deflationary. This has already happened for brief periods of heavy usage in 2021, and may happen again as more users onboard into the Ethereum ecosystem due to its more eco-friendly consensus algorithm.

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Constant Block Times

Switching to PoS will also make blocktimes more stable since it is known in advance who needs to validate which block, whereas in PoW the blocktimes were only statistically likely to occur in a certain time period. This will give rise to a lot of new market microstructure as participants can now expect a lot more stable block production times, but also create new arbitrage and timing opportunities for those that want to send their transactions at the very last second prior to a block being committed. 

It remains to be seen how this will impact the ecosystem, and whether more stable block times may give fruit to novel applications that rely on accurate timekeeping.

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Finality

Another detail we haven’t touched on in the previous section, is that in PoW the ledger is never “final” since a rival miner could expend resources to create the longest block with the most accumulated difficulty. The fact that it doesn’t happen is a matter of economics, but makes the system more unstable in rare occasions where a significant portion of the network goes down, or shortly after hard forks when nodes need to switch to a new set of operating parameters.

In Contrast, PoS introduces finality, meaning that beyond a certain point, we know for sure that blocks of transactions are “settled”, making the network more secure.