The most significant impact of the Ethereum blockchain’s transition to proof-of-stake (PoS), a process known as the Merge, was the change in net issuance of ether (ETH), which fell close to zero, Citi (C) said in a research report Monday.
Before the Merge, issuance was stable at 2 ETH a block, resulting in annual inflation of supply of around 4.2%, the report said. Following the Merge, proof-of-work (PoW) issuance stopped, leaving only staking yield issuance, which is partly offset by burning – or removing from circulation – the fees.
The Merge was the first of five upgrades planned for the blockchain and involved the shift from PoW to a more energy-efficient PoS consensus mechanism.
“Ether looks like it could be moving towards a deflationary future as it exhibits periods of deflation amidst low network activity,” analysts led by Joseph Ayoub wrote. As activity rises it could maintain a deflationary supply having “already shown deflationary tendencies post-Merge in a low-burn environment.”
Citi says the switch to PoS has removed about 564,000 ETH from circulation in the six weeks since the Merge, compared with if PoW issuance was still occurring. In U.S. dollar terms this represents about $870 million. Annualized, it equates to a reduction of about $7.7 billion in active ETH supply following the transition to PoS.
Recent moves in the price of ether look to be driven by derivatives markets. Open interest has risen to the highest levels since April, when the cryptocurrency was trading at around $3,000, the note said. “This marks one of the largest divergences between price and open interest over the last [three] years,” and indicates further volatility is likely, according to the note.
The bank says this indicates a high amount of leverage in the derivatives market, “which may be the tail wagging the ‘spot-price’ dog.” Ether 30-day historical volatility reached record lows following the success of the Merge upgrade, but is rising following the cryptocurrency’s breakout from its recent trading range, the bank added.
Open interest reflects the total number of derivative contracts held by investors in active positions.
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