The most important development in crypto has not happened. We are talking about the launch of phase1 of Ethereum 2.0(Eth 2.0) This major redesign of the Ethereum network will lead to many important innovations in the crypto world. Each new change will impact the price of Ether and possibly ending in a major rally around this asset. In this article, we will explore all of the coming changes and their possible effects on the price of ETH.
A summary of Eth 2.0
Ethereum 2.0 (Eth 2.0) is the name of the project which aims to move the Ethereum blockchain from Proof of Work (PoW) to Proof of Stake (PoS). In the future, there will no longer be miners competing to generate blocks using the resources of hardware, mainly GPUs. In PoS the network rely on validators that randomly select nodes that stake a minimum number of Ether in the network.
The expected move from miners to validators will result in a more decentralized network. As the expensive hardware requirements and electricity costs to successfully run a node are gone. Now only Ether locked in a wallet will be a validator and profit from the network's usage.
Additionally, the change will allow 1000 transactions per second (TPS) to go through the network. This will greatly increase the capacity of the Ethereum Blockchain, which now only can handle 15 TPS.
For more information about Eth 2.0, check out what you need to know about Ethereum 2.0.
Eth 2.0: Validators replacing miners
As mentioned before, the big change in going from miners to validators. The basic requirement for becoming a validator is to hold at least 32 Ether and locked in the staking smart contract. The length of time a person can do this is 3, 6, 9, or 12 months. The return rate increases from 4% to 10% depending on the time the funds are withheld by the network.
This move will severely constrain the circulating supply of Ether. As all validators receive an incentivize to stake their coins for longer periods to receive bigger gains. This is especially attractive for institutional funds. Typically these types of investors want to have financial returns between 3 to 5% in a year. On the longer periods of 6 to 12 months of staking, Ethereum can give returns of 6 to 10%. So, the big players have all the incentives to buy large quantities of Ether and lock it for long times.
The success of this model is already showing in the numbers.
source: research.arcane.no
As the number of Ethereum wallets with the necessary 32 ETH to stake has grown rapidly since the announcement of the new mechanics. Right now, there are 120 thousand wallets with the necessary amount, which means all of that Ether will dissapear from the market and circulation will shrink.
The new fee structure
The way fees operate right now is by incentivizing inflationary prices of Gas. In order to process a transaction, or execute a smart contract, a user has to par a Gas fee to the node. The node picks up the request, including it in the block being mined at the moment. If a user wants his transaction to go faster, this person can increase the Gas fee and essentially pay a small bribe to the miner. Miners obviously prioritize requests that pay more gas.
So, the final result of this mechanism is that at times of high network congestion gas prices go through the roof. All users of Ethereum essentially compete with each other to pay higher gas to the nodes. In turn, these nodes accumulate more Ether in the form of gas and rewards given to miners. At some point, all this ETH is either dissolve in the market, or it will contribute to speculation.
Many effects are a direct result of this mechanism. To address this shortcoming, there is a proposal for a new fee structure by the Ethereum community, named Ethereum Improvement Proposal 1559. EIP 1559 proposes that the base fee (a set amount of gas determined by network usage) will be disappear with each transaction.
This means that every time someone uses the Ethereum network, part of the gas in the network will be destroyed. The remaining amount will be received by the node, but it will no longer be the full amount of gas used in the request. As a result, Ether would be taken out with every single use of the network.
This mechanism would further limit the circulating supply of Ether available in the market. As with anything scarce, price should rise in relation to other assets and the dollar.
Final outlook
Ethereum 2.0 is a very big update. It is further complicated because the complete transition will take years, since it will be delivered in stages, each changing a huge part of the system. Yet, staking and EIP 1559 both work together to bolster the price of Ether.
Each in its own way will reduce the circulating supply of ETH. As available Ether becomes scarce, prices will go up. Finally, Ethereum 2.0 will also increase transactions per second to at least 1000 at the start. Right now the network is only able to do 15, so this major change will do a lot to relieve congestion and increase throughput. As a result, even more, people will use the Ethereum blockchain. More gas will be destroyed when used to pay transactions, more people will stake to become validators, and the price will move up with demand.
It seems all of the ingredients for a major market rally in Ether are in place. The one uncertainty is the timing, right now Ethereum 2.0 is still on track for a release at the end of 2020. But when will EIP 1559 be implemented is not completely clear. In the end, we may not see this rally happen until the end of 2021.
