Ethereum will change its operation in the next few days, between September 14 and 15. The change seeks to reduce the power consumption used by proof of work to secure the network for proof of stake, an event that also promises to reduce the number of ethers on the network and among its participants.
Unlike the network Bitcoin, in which there is a limited supply of 21 million bitcoins to mine, in ethereum, that limit does not exist, so, as more ether is created as the blocks of the chain are mined, the cryptocurrency experiences an annual inflation of around 4.6% for the entire network. But for Lex Sokolin, chief economist at Consensys, The Merge could substantially reduce ether inflation to 0.5% and even turn it negative, which would make it a deflationary asset, that is, its supply could be reduced.
In interview with The EconomistSokolin talks about how The Merge will change the way ether is issued and how this change will affect Web 3 and technological projects, such as the NFT and decentralized finance.
─ How does the current ether supply work with proofs of work?
—Ethereum’s current mining mechanism, which is proof-of-work, is similar to Bitcoin’s mining mechanism. Every block has rewards on it and the rewards are essentially determined by the competition to mine the block. blockchain and then there is some probability by which the mining activity gets the rewards to be distributed to different miners. So there is a luck factor in terms of where the rewards go. I think today, on average, it’s something like 4.6% inflation for the network as a whole, in terms of rewards that are minted through the different blocks and then distributed to the different miners.
When we move to proof of stake, we’ll actually be massively changing the mechanism by which validation occurs, so you’re also changing the nature of its cost. Proof of work is based on the hardware and burning electricity and basically solving math problems to earn the reward while proof of stake does not require the hardware. Instead, what you’re doing is committing capital, so you have to incentivize people less, because it’s not that hard to participate in network security. It’s easier to be a validator than it is to be a miner.
Whereas in the case of mining you need that fixed cost for the hardware, in the case of proof of stake, the economic stake and committing that economic stake to the blockchain is all you need. So the inflation in the network is going to go down to something like 0.5%, something that is also going to be moderated by the burning of ether that is used for the payment of transactions and commissions, so part of the commission will go for the validator and part of it will be burned and removed from the offer; so that’s going to have kind of a side effect of getting inflation down.
─ There is a belief that bitcoin is sound money because there is a limited supply of 21 million bitcoins. Why is ether ultra-sound money in your opinion?
—These are great stories to tell, but I think the world is much more complicated than the particular label of sound money or ultra-sound money. Is the euro sound money against the dollar? Is the pound sound money against the dollar? They all have volatility and they are all suitable for their purpose, which is to mediate trade within their particular economy.
I think the conception that bitcoin is sound money is motivated by fixing the supply in an algorithm and that can be satisfying: there is only so much of this stuff and of course that’s where the analogy with gold comes from. What people miss when they create that framework is that there is supply and demand in the price equation and therefore there may be a lot of commodities that have a fixed supply, but that doesn’t mean there is demand for them. If there is no demand, then its use in the world will be low for payments, for commerce, for storage of value and then that will impact the price, so it is not enough to have a fixed supply, you also need the I use and I think bitcoin has a lot of use in terms of store of value.
I think for ether, the ultra-sound money narrative has to do with the fact that not only will inflation be reduced, but it can be negative. So there could be deflation in the network, there could be fewer tokens year after year. Now, that depends on network activity. If people use the network a lot, then more supply of ether will be burned because it is going to be part of the fees to do transactions. In that case, you don’t have a supply that slowly increases and then stays flat, you can have a supply that decreases, so the more applications are used on the network, the more ether it burns and therefore becomes more valuable, because there is less of it. That is a mechanism that Bitcoin does not have.
─ What will be the effects of The Merge on decentralized finance (DeFi) and other technologies such as NFTs?
—I think it will be very positive to have native proof of stake within Ethereum available to many people. Defi usage today is, I wouldn’t say it’s niche, but it’s still a small portion of Web 3 users that are heavy Defi users, you know, 5%, 10%, something like that. And getting involved to protect the network is going to make it much more visible and much more accessible for regular people to have a financial stake in protecting the network itself. If you look at other proof-of-stake networks, something like 75% or 80% of the people participate in the network, in the chain. So you’re introducing a lot of people who might not otherwise commit financially and expect interest.
The second thing is that whatever interest rate the stakers get is going to be the benchmark for any other DeFi protocol. So if you’re a DeFi protocol that offers a lower return than Ethereum’s staking return, you’re going to have to justify why that lower return is lower risk, because there’s going to be a natural benchmark for the equivalent of holding your crypto. on Web 3 once this is released.
─ What do you recommend that exchanges, other institutions and users do before and during The Merge?
Well, it depends which part of these institutions, but I think education is really important and educating your users in particular is really key. It’s important to set realistic expectations that you have the opportunity to earn this return, but you could also experience capital gains or losses. So you may get the percentage return in terms of your rewards, but then the price denominated in some other currency may go up or it may go down. So it is important that consumers understand this.
I think the story about the impact of energy and the fact that this is like a green blockchain is also very important, because it’s a big transition for the community, you know, if we can remove the carbon footprint from Web 3 to through this transition and reduce it so significantly, then it’s going to allow artists who were concerned about the environment to create NFTs on Ethereum without having that objection. It’s going to remove a lot of skepticism from some institutional investors, and you know, I think it’s going to be a very positive thing.
rodrigo.riquelme@eleconomista.mx
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