Investors Bullish Over Ethereum Merge Disinflation Narrative

A successful Merge could greatly reduce ETH inflation, and investors are buying options and staking ether in anticipation

article-image

Blockworks exclusive art by Axel Rangel

share

key takeaways

  • “The network is effectively buying back shares [of ETH] and is destroying them,” a crypto trader told Blockworks
  • Ethereum open interest has exceeded bitcoin interest for the first time ever

After many delays Ethereum Merge to Proof-of-Stake (PoS) remains at least a month and a testnet trial away, but investors are already sending ether on a bull run. The price of ether gained 59% in July, more than tripling bitcoin’s 17% increase, according to crypto exchange Kraken.

Investors are betting a successful Merge will greatly reduce ether’s inflation rate — and possibly even turn the token deflationary. Derivatives traders are snapping up options contracts to profit from a potential upward push on ether’s price. 

Under the current Proof-of-Work system, miners are rewarded with two ETH for being first to solve a computational puzzle and create an Ethereum block.

Read more: The Investor’s Guide to The Ethereum Merge

Ethereum counters its token issuance to miners by removing from circulation, or burning, a gas fee paid by buyers that varies based on network demand. Currently, more ether is created for miners than is removed through gas fees, causing inflation. But the network was briefly deflationary in the month following the launch of EIP-1559 — the improvement that started burning ether. Since then, some 2.57 million ETH have been burned to date, according to tracking site WatchTheBurn.

Proof-of-Stake instead has validators lock up, or stake, their ether in exchange for a yield on their tokens. Ethereum pays 90% less for the network’s security by rewarding stakers as compared to miners because of the difference in required computer power, according to research from Runa Digital Assets.

If the gas fee exceeds the yield paid to stakers, more ether will be burned than created, leading to deflation and upward price pressure on ETH.

The PoS system “feels like a share buyback to equity investors,” Max Williams, assistant portfolio manager at Runa, told Blockworks. “The network is effectively buying back shares [of ETH] and is destroying them.”

How much will ether inflation decline?

The more ether is staked and the higher demand is for Ethereum blocks, the more deflationary the Merge will be.

Based on current block demand, Blockworks research estimates the Merge will not be deflationary, but greatly reduced inflation can still create investor optimism. 

“Even if it’s not deflationary, it would just be a much lower rate of inflation,” Williams said, citing 90% disinflation as a realistic outcome of the Ethereum Merge.

Investors are betting on ether by buying options and staking ether. 

Options allow investors to make low-risk bets on an asset’s price movement within a fixed time frame. Digital asset broker BitOoda reported the current record volume of ETH option interest exceeds BTC interest for the first time ever. Crypto trading firm QCP Capital noted in a Telegram announcement that hedge funds have been major options buyers.

The Merge “is so well telegraphed that it hypothetically makes trading options a little easier because the biggest thing with trading options is just getting the timing right,” said Williams. “Traders feel like they have an advantage in terms of timing.”

Williams also thinks options are an attractive play amid worsening macroeconomic conditions. 

“People want pure exposure to this event, and they don’t want to have exposure elsewhere, so they’re putting this exposure on through options markets,” Williams said.

Staking ether has also been popular of late. The 13 million ETH staked as of this week are an all-time high, according to Kraken. Over 10% of ether’s circulating supply is currently staked, compared to 7% in February, per CryptoQuant.

Blockworks researcher Sam Martin pegged post-Merge staking yields at 5.89% based on data from August 4.

All speculation about positive Ethereum price movement depends on the Merge — one of the most ambitious software upgrades in crypto’s history — coming off without a hitch. Therefore, investors will be closely watching Ethereum’s final practice merge with the Goerli testnet expected on or around August 10. If it succeeds, the mainnet Merge is scheduled to follow in mid-September.


Start your day with top crypto insights from David Canellis and Katherine Ross. Subscribe to the Empire newsletter.

The Lightspeed newsletter is all things Solana, in your inbox, every day. Subscribe to daily Solana news from Jack Kubinec and Jeff Albus.

Tags

Upcoming Events

Salt Lake City, UT

WED - FRI, OCTOBER 9 - 11, 2024

Pack your bags, anon — we’re heading west! Join us in the beautiful Salt Lake City for the third installment of Permissionless. Come for the alpha, stay for the fresh air. Permissionless III promises unforgettable panels, killer networking opportunities, and mountains […]

recent research

Screenshot 2024-05-23 091855.png

Research

Bitcoin L2s aim to boost scalability while preserving decentralization and security, unlocking a better user experience, and new avenues for Bitcoin-powered innovations. However, no existing Bitcoin L2 leverages the full security of Bitcoin.

article-image

I believe that the innovation happening on Bitcoin right now is what will ultimately lead to a better Bitcoin for everyone

article-image

The payments firm is exploring PYUSD’s payments use cases

article-image

Planned funds would not stake their holdings, which some say will hurt the ETFs’ appeal for certain investors

article-image

Solana validators voted in favor of a proposal that would send 100% of priority fees to validators

article-image

In November, an iteration of the survey found that 34% of respondents were paying attention to crypto, but that figure has since jumped to 41%

article-image

The sentencing of former FTX exec Ryan Salame is the first among those who pleaded guilty to crimes related to the exchange’s collapse