All eyes in the crypto space are currently on an upcoming watershed moment, the Merge. Ethereum’s adoption of the Proof-of-Stake transaction verification mechanism with the Merge will usher in a new era for the world’s leading smart contract platform and for the broader crypto space.
After this event, nothing will be the same—not even ETH tokenomics. Yes, you read that right. The Merge is going to change how ETH tokens are issued as well as their economics. This is where you find out all about it and learn how it’s going to impact the token and therefore its price.
How ETH works pre-Merge
Pre-Merge, ETH tokens are being issued through an Execution Layer and a Consensus Layer.
1. Execution Layer
The Execution Layer is a Proof-of-Work layer. Miners who successfully add the next block to the blockchain are given a reward—approximately 2.08 ETH for every block mined.
On the rare occasion when two or more miners find a valid block at the same time, or even if a competing miner has simply started to add a block to the blockchain, the miners are rewarded but with a lower fee. In the case of such blocks, the valid but stale block can be added to the non-canonical chain (the shorter of the two chains) as an “ommer” block, and the miner receives a partial block reward—a maximum of 1.75 ETH.
Close to 13,000 ETH tokens are given out as rewards for such blocks every day, in addition to the usual 4.93 million tokens annually to PoW miners. The sum is the number added to the circulating supply. That translates to an inflation rate of 4.13% for ETH.
2. Consensus Layer
The second layer through which ETH tokens are issued is called a Consensus Layer. This layer was created when the Beacon Chain went live in 2020. The chain is secured by Proof-of-Stake validators, who are rewarded with ETH for attesting the state of the chain and proposing the creation of new blocks. A reward of 2.08 ETH is distributed every 6.4 minutes, approximately. That translates to the issuance of ~1,600 ETH per day or annually 5,84,000 ETH tokens.
The fate of ETH post-Merge
Post-Merge, the Execution Layer will no longer be needed; all blocks will be created only through the consensus layer. It means that there will no longer be an annual supply of 4.93 million ETH tokens. Only 5,84,000 ETH tokens will be issued annually. As a result, the ETH issuance rate will come down by a whopping 90%.
The annual inflation rate after the Merge comes down to approximately 0.49%.
How the burn mechanism affects ETH tokenomics
So far we have discussed how tokens are being issued now and how they will be issued in the future. But we haven’t factored in one thing so far—token burning.
Tokens collected as transaction fees from users are periodically burned by the network—which means, they are removed from circulation. The burn rate is not fixed; it depends on the network activity and prevailing gas fees. So how do we factor in the ETH burn mechanism?
Well, we do know that since the implementation of the EIP-1559 upgrade in August 2021, over 2.6 million ETH have been burned by the network.
Combining the post-Merge inflation rate and burn rate of ETH tokens, it is possible to see that ETH token issuance could become deflationary. That means the total ETH circulation will start falling.
Summing it up: How the Merge will impact the price of ETH
To sum it up, after the Merge, with a significant part of the ETH supply locked in staking, the token supply will turn deflationary. ETH will become scarcer with each passing day, and that could result in an appreciation in the price of the ETH tokens.
Thus, if everything goes as per plan, the Merge could become the single biggest catalyst for ETH’s price rise, changing not only Ethereum’s fate but also the dynamics of the entire crypto market.