One Year Anniversary of Ethereum Merge: ETH Enters Deflation, Layer 2 Narrative Continues

Author: Terry, Baihua Blockchain

Unknowingly, it has been almost a year since Ethereum's The Merge was completed, and Ethereum has successfully operated under the Proof of Stake (PoS) mechanism for a year, proving the reliability of its network.

In this year, in addition to the changes in the ETH supply side leading Ethereum into a deflationary era, the Layer 2 sector has also welcomed new changes, while traditional financial institutions and tech giants are actively laying out strategies, contributing many noteworthy new and old narratives to Ethereum.

1. Ethereum Enters the "Deflationary" Era

Firstly, in the year following The Merge, the new Ethereum has only been produced from PoS staking.

According to current data estimates, after the upgrade to PoS mechanism, Ethereum theoretically adds about 660,000 new ETH annually.

According to data from ultrasound.money, the circulating supply of Ethereum has decreased by over 300,000 since the merge, which is valued at approximately $500 million at current prices. Additionally, the total amount of Ethereum destroyed has surpassed 3.58 million.

Source: ultrasound.money

It is particularly noteworthy that Ethereum has actually entered a deflationary era, with an annualized deflation rate of about -0.26%, while Bitcoin's rate during the same period is 1.716%.

If we calculate based on the issuance data of Ethereum under the PoW mechanism, Ethereum would still be in an inflationary state, with an annualized inflation rate nearly double that of Bitcoin, reaching 3.162%.

This clearly demonstrates the significant impact of transitioning to PoS on Ethereum's output, causing Ethereum to shift from inflation to deflation, continuously destroying ETH from a supply and demand perspective to support the value of ETH.

Moreover, this data is still in the context of a recent decline in Ethereum's on-chain activity and a sluggish ETH destruction rate—currently, the quiet market environment has led to on-chain activities reaching a low point, with daily ETH destruction hovering between 1,000 and 2,000.

Once the market warms up or on-chain activity increases, reaching historical highs (4,000 to 5,000), the data will undoubtedly become more objective.

Additionally, the amount of ETH staked has been steadily increasing, with the staking amount surpassing 24 million ETH at the time of writing, valued at approximately $39.6 billion at Ethereum's current price, close to 20% of the total ETH supply, a significant increase from about 13% a year ago. This further enhances the scarcity of ETH from a supply-demand perspective.

However, compared to the staking ratios of many other major public chains, Ethereum's staking rate is relatively low. Many public chains have staking ratios mostly distributed around 60%-80%, indicating that there is still considerable room for improvement in Ethereum's staking rate.

2. Layer 2 Overwhelms Competing Public Chains

In addition, Layer 2 has now become the largest established variable in the entire Ethereum ecosystem's innovation landscape. From the data alone, the total TVL of the Layer 2 sector has returned to historical high levels, approaching $10 billion.

Source: L2BEAT

Among them, the OP Stack, representing modular development services for Rollup, is gaining momentum, with Arbitrum Orbit, ZK Stack, and others continuously making strides, combining Ethereum and EVM's first-mover advantages, making the narrative of competing public chains' high performance seem less attractive.

Previously, application developers faced a relatively simple choice when deciding which chain to deploy their applications on: Ethereum, Solana, Cosmos, or other Layer 1 blockchains. At that time, Rollup had not yet launched its mainnet, and few had heard of the term "modular stack." The differences between L1 chains (throughput, fees, etc.) were very obvious and relatively easy to understand.

Now, with the maturation of the Layer 2 sector, developers are faced with a richer array of choices, even beginning to squeeze the narrative space of competing public chains like Cosmos.

Especially with the Cancun upgrade approaching, the overall transaction costs of Layer 2 are expected to achieve further significant reductions, which means more extensible imaginative space and greater realization of derivative functionalities.

"In the past two years, Ethereum gas fees have reached $1-20, which means someone has to spend hours of hourly wages for a single Ethereum operation. In other words, it's hard to call Ethereum a usable network in practice."

It should be noted that previously, due to the performance limitations of Ethereum's main chain and inter-chain gas fees, more complex applications faced performance issues and significantly increased operational costs based on frequent contract calls, causing the threshold and cost for ordinary users to participate in derivatives and other DApps to skyrocket, becoming an "unbearable burden" for them.

The Cancun upgrade's support for Layer 2 means that the currently relatively monotonous ecosystem of Layer 2 networks will gradually become richer, enabling and unlocking new use cases.

In fact, the rise of Mirror previously indicated a relative advantage of high-performance public chains in the synthetic asset sector, and with the help of cheaper Layer 2 networks, applications like derivatives are also experiencing a timely development opportunity.

3. Some New Variables for Ethereum

Another long-term narrative that has been overlooked after the initial hype is PayPal's launch of the dollar stablecoin PYUSD based on Ethereum, which has made waves both within and outside the industry.

As a well-known traditional payment giant, PayPal's every move in the stablecoin sector not only brings a new variable to the originally fixed stablecoin market but also undoubtedly carries a significant traffic effect, while also drawing regulatory attention once again, much like Facebook's failed Libra project.

Overall, as the largest third-party payment institution in the U.S., PYUSD is destined to bring long-term benefits to the crypto market, especially since its issuance is based on Ethereum, further advancing Ethereum's vision as a global settlement layer.

As of the time of writing, PYUSD has been launched on mainstream platforms like Coinbase and Kraken, but the current issuance is only 44.37 million, with only 452 holding addresses. Whether it can challenge USDT's dominance and carve out its own market share in the stablecoin space remains to be seen.

Additionally, regarding regulation and traditional financial institutions, Bloomberg reported, citing informed sources, that the U.S. Securities and Exchange Commission (SEC) is preparing to approve Ethereum futures ETFs and is unlikely to block them. Nearly a dozen companies, including Volatility Shares, Bitwise, Roundhill, and ProShares, have applied to launch Ethereum futures ETFs.

Futures ETFs taking precedence over spot ETFs also means that Ethereum is beginning to be more widely accepted by traditional financial markets. For example, while U.S. regulators have not yet approved applications for spot Bitcoin ETFs, they have been quite open to futures-based Bitcoin ETFs—such as ProShares and Valkyrie, which have been listed on the U.S. capital markets.

Vitalik Buterin once stated that the next decade is crucial for blockchain technology, and blockchain applications need to prove their practicality rather than just promise they will be useful in the next ten years.

"Due to today's scalability issues, many applications are theoretically promising but currently seem unfeasible. If scalability is not an issue after Ethereum's merge and the improvement of Layer 2, and they still cannot operate, it indicates that using blockchain from the start was meaningless."

Now that Ethereum's The Merge has successfully run for a year, and the development of Layer 2 continues to advance, attracting more and more traditional financial institutions and tech giants to participate in the layout, Ethereum seems to be at the best historical moment.