Why the Ethereum Merge Could Be Pivotal for DeFi and Crypto

Why the Ethereum Merge Could Be Pivotal for DeFi and Crypto

September 26th 2022 new story

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The Ethereum Merge is a significant event in blockchain history that has been heavily hyped by many individuals and investors, including financial experts. After years of development, the gigantic Ethereum upgrade known as the Merge has finally happened, switching the digital machinery at the core of the second-largest cryptocurrency by market value to a considerably more energy-efficient system.

Ideally, the Ethereum Merge is the process of merging the original Ethereum mainnet, which depends on the proof-of-work mechanism, to a different blockchain known as the Beacon Chain, which utilizes the proof-of-stake mechanism, and once accomplished, they now exist as one chain. Basically, it is an upgrade from the original proof-of-work system to a proof-of-stake mechanism that effectively removes the reliance on Ethereum miners and their significant carbon emissions.

The upgrade has been projected since 2014, but there have been numerous delays along the line of development. However, on September 15, this historic event was successfully concluded, transitioning the network from a proof-of-work to a proof-of-stake consensus mechanism.

The Merge has numerous advantages, including an eco-friendly environment, reducing high energy consumption by 99%, increasing blockchain security, and paving the way for the network’s improved scalability.

How will the Merge impact DeFi Protocols moving forward?

Following the Merge, the Ethereum blockchain will use the PoS (proof-of-stake) mechanism, while the PoW (proof-of-work) mechanism will become obsolete. Miners who validate transactions using the PoW mechanism will cease mining on the Ethereum blockchain, effectively ending their mining rewards. The Ethereum blockchain will no longer be run by miners, but rather by validators. Also, transactions on Ethereum will no longer be processed by miners, but rather by validators who lock up (stake) their ETH and earn rewards in exchange.

Validators deposit not less than 32 ETH to activate their validator software and are responsible for validating transactions and adding new blocks to the blockchain, depending on the amount of ETH they are willing to stake. This process, on the other hand, helps to keep the Ethereum blockchain network functional and secure while you earn newly created ETH as a reward.

Staking ETH will positively affect the entire decentralized finance sector. This new protocol creates a medium for investors to earn yields while holding ETH, which is an added benefit for those looking to generate returns from their holdings.

On the flip-side, As more ETH gets locked up in the Ethereum staking contract to secure the network, we could negatively witness a liquidity shrink across DeFi protocols like Aave, Maker, and other leading protocols as they might have to reasonably raise interest for lenders above that of the Ethereum staking rewards in order to stay competitive and retain liquidity providers.

How It Affects the general Crypto Sector

Putting the entire cryptocurrency industry in context, this event will likely alter many people's perceptions of cryptocurrency, particularly those who do not support cryptocurrency and view it as a risk to the environment. This, however, highlights to central authorities and anti-crypto activists that the crypto industry can exist on its own without endangering the planet through mining.

Beyond the staking mechanism, many institutional investors and corporations will likely begin to speed up their adoption of ETH and other cryptocurrencies as the recently concluded Merge will bring the crypto ecosystem closer to the mainstream sector.

In addition, given that the entire crypto market has been in a bear market for a long time, this event has the potential to recapture investors' and individuals' interest in the crypto ecosystem. In other words, the Merge and other series of upgrades lined up in the Ethereum ecosystem moving into 2023 and beyond could be a catalyst for the next bull market.

Market Sentiment around the Merge

The crypto market has been in turmoil since the Merge took place, with traders interpreting the event as a trigger to see an uptick in the price of ETH regardless of the broader crypto market's slump. However, it is unlikely to accurately predict what will happen after the Merge is completed or how the post-Merge event will impact the market.

One significant thing to note is that the shift of Ethereum to a proof-of-stake consensus mechanism is likely to decrease the rate of new token issuance, particularly in the months immediately after the Merge.

According to ultrasound money, the total amount of ETH burnt since the introduction of the EIP-1559 is roughly 2,629,057.37 ETH as of the time of writing.

On the other hand, Ethereum’s switch to PoS will reduce fresh ETH issuance by 90%, which is roughly comparable to more than three Bitcoin halving events. This means that the amount of ether generated each day will drop from 13,000 to around 1,600.

As the rate of token issuance decreases, the blockchain's token-burning mechanism will continue to remove ether from circulation at the same rate it did before the Merge. This might reduce the entire market supply of Ether over time, especially during the high network usage period experienced during the bull market. We could begin to witness a shrink in the total ETH supply over time.

This could result in a massive pivotal point for the Ethereum ecosystem, ultimately making ETH a deflationary cryptocurrency. As always, supply shrink will have a massive positive impact on the price of ETH in the long term.

What the Future holds for Ethereum

The journey to a mature system for the Ethereum blockchain has only just begun, as the Merge is only the first step in what the foundation has in store for the network's and the entire crypto ecosystem's growth.

Vitalik Buterin, co-creator of Ethereum, a set of next steps for the network a month ago when he spoke about how to start now to build towards something that would be an Ethereum protocol that we want to see in the long term. He also talked about the updated roadmap with five different categories that will happen on the Ethereum protocol which include the Merge, the Surge, the Verge, Purge, and the Splurge.

Additionally, there have been misconceptions about the Merge's ability to solve the problem of high gas fees. However, the merge is not an event to reduce the gas fees but rather a change or an upgrade in the blockchain consensus mechanism (transactions validation) to make the network more secure, create a way to increase its scalability, and also initiate an energy-efficient Ethereum blockchain. Ideally, the Merge has set the stone rolling in Ethereum’s journey towards becoming a scalable, efficient, and reliable blockchain.

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