The Ethereum blockchain has finally implemented its 5 years expected update. “The Merge” is effective, the Ethereum blockchain has abandoned the Proof-of-Work (“PoW”) consensus for the Proof-of-Stake (“PoS”).

The merge is effective what to expect?

What are the changes of this transition and what to expect now? 

Since April 2022, Ethereum has been experimentally running two parallel chains. One uses the Proof-of-Work module, while the other test chain runs via the Proof-of-Stake module. The two networks have similar origins but they do not share the same operating bases and run in parallel. Only the main blockchain of Ethereum was in charge of processing transactions through the use of a mechanism called Proof-of-Work.

Since yesterday, the Merge has merged the main Ethereum network with the secondary network “The Beacon Chain”. 

The main network has therefore abandoned its PoW mechanism in order to adopt the PoS.

What are the major changes?

  1. Disappearance of the mining activity: to validate transaction blocks, the network now relies on trusted entities called validators to verify transactions and add new blocks. The selection of the validator is random, the prerequisite to be a validator is to hold and stake at least 32 ETH. The difference of the PoS is especially in the choice of selection via the random. With the PoW mechanism, there was a competition between the miners to whom to release the greatest computing power, which consumed much energy. It is estimated that energy consumption will decrease by 99.95% with this new mechanism.
  2. A faster creation of blocks: a new block every 12 seconds against about 14 seconds on the previous version.
  3. The monetary creation of Ethereum has strongly decreased. With the PoW, the inflation was on average of 13,000 ETH per day which went to the miners and which were in large part sold directly. With the POS the inflation will be 1,600 ETH per day from now on. Adding this to the ETH burn in every transaction thanks to the Ethereum update of July 2021 “EIP-1559”, it is enough that the price of gas is on average around 16 gwei, so that 1,600 ETH are burned every day, which effectively brings the net ETH inflation to zero.

What impact for the user? 

Virtually none, a slightly faster transaction validation speed (1-2 seconds less) but equivalent gas fees. The user will have no action to take, everything will be done automatically.

What to expect for the future, what events?

Vitalik Buterin, the creator of Ethereum announced that after the Merge Ethereum will be at 55% of its final form. There are still four major steps before waiting for the final form of Ethereum: “The Surge” (2023), “The Verge” (no date announced yet), “The Purge” and finally “The Splurge”. The final stage is expected around 2025-2026.

Without going into the details of these updates, the goal of The Surge will be to address the problem of scalability in order to accelerate and reduce transaction costs via the integration of Sharding.

A date to remember also, in February 2023, a significant amount of Ethereum (around 13 million ETH, 10% of the supply) will be gradually released after people have locked their ETH to support the transition to The Beacon Chain. A large part of these ETH were locked when the ETH price was around $500, to see the behaviour of these users once their tokens are released.

One last question about the future of the miners of the old version of Ethereum is to see where they will direct their computing power – will they massively move to the fork Ethereum Classic (ETC)?

Market analysis

ETH-USD is close to the lower trend line of the parallel channel drawn since mid June and could rebound strongly towards the 2000. In case of a break of the lower trendline support zone we could see further correction to $1,300 (Figure 1).

Relatively to the BTC, we can notice that the market has well positioned itself since mid July with almost 60% performance on the ETH-BTC pair from 12 July to the 09 September peak at 0.085. The pair is now closed to its 20d moving average and has corrected by 10% at 0.079. We could see further consolidation on ETH to the 38% Fibonacci point at 0.0726 before new acceleration to the Dec 2021 peak at 0.088 (Figure 2). 

Figure 1

ETH/USDT graph trading view

Source: CoinShares France, TradingView – Past performance is not a reliable indicator of future results. Capital is at risk.

Figure 2

ETH/BTC graph trading view

Source: CoinShares France, TradingView – Past performance is not a reliable indicator of future results. Capital is at risk.

On the derivatives market, we can also notice that the ETH future to spot volume ratio has increased sharply since July ahead of the Merge (Figure 3).

Figure 3

ETH volume ratio future to spot Kaiko

Source: Kaiko – Past performance is not a reliable indicator of future results. Capital is at risk.

Funding rates have dipped sharply negative to close out August (Figure 4). This dip negative, coinciding with a buildup in open interest since mid August, leads us to conclude that the majority of the new money piling into futures markets for ETH are short-biased. No such a dip was observed on BTC (Figure 5).

Figure 4

ETH interest & funding rate kaiko

Source: Kaiko – Past performance is not a reliable indicator of future results. Capital is at risk.

Figure 5

BTC vs ETH funding rates kaiko

Source: Kaiko – Past performance is not a reliable indicator of future results. Capital is at risk.

At each recent dip on the ETH funding rates, ETH prices have rebounded strongly and funding rates moved closer to positive territory (Figure 6).

Figure 6

ETH funding rates kaiko

Source: Kaiko – Past performance is not a reliable indicator of future results. Capital is at risk.

One would expect short futures positions to be unwinded and funding to move back towards positive territory after the Merge which can be a good catalyst for a further rise of the ETH price.