How will the merger affect Ethereum's inflation rate, gas fees, and energy consumption?

After nearly eight years in the making, Ethereum will finally switch from proof-of-work (PoW) to proof-of-stake (POS) around 2pm today.

The transition from PoW to PoS will have a big impact on Ethereum, including:

- ETH issuance decreases (meaning ETH becomes deflationary)

-Gas price will not drop

- 99% reduction in energy consumption

Let's break it down in detail.

In a PoW chain, miners use computing power to solve mathematical puzzles, and the first person to complete is rewarded and creates a new block. According to the Ethereum Foundation, the mining reward on the PoW chain is about 16,000 ETH/day. This means that every day 16,000 new ETH are minted and paid to miners. After the merger, ETH issuance will be reduced by 90%, about 1600 ETH/day. These ETH are paid out to validators (i.e. people who have staked their ETH) to help secure the network. But minting 1600 ETH per day after the merger still makes ETH an inflationary asset, so where does the "deflation" come from?

Remember EIP-1559? This is a proposal to change the way gas fees work, and it went live on August 5, 2021. EIP-1559 introduces a fee burning mechanism, where part of the gas fees originally paid to miners will be destroyed. A total of 2,622,781 ETH has been burned since the introduction of EIP-1559. On average, about 6400 ETH are burned every day. So while ETH issuance did decrease after the introduction of EIP-1559, it still cannot offset the daily minting of 16,000 ETH. This situation will change after PoS is officially launched.

At an average gas price of 16 gwei, 1600 ETH would be burned, which would at least bring ETH inflation down to zero. As the gas price increases, so does the amount of ETH burned, making ETH a deflationary asset. A misconception emerged in the summer of 2021 that gas costs will improve with EIP-1559. I've also heard that the combined gas price will be the same. Unfortunately, gas prices will still depend on network usage. Remember, gas price is a function of supply and demand. Supply refers to block space, and demand refers to the number of pending transactions on the network. Suppose each bus is a block and each character in South Park is a transaction. There is limited space on the bus, but you can pay extra (gas fee) if you want to jump in line and get on the first bus. This is the basic premise of Ethereum gas fees. This is why people think "NFTs are dead" when gas fees are low, because low gas fees = low network load. This means, the transaction volume on Ethereum is low.

So, why doesn't the merger lower gas costs? (And what is that reduction?) Transitioning from PoW to PoS does not increase block size or block issuance rate. The buses leaving the station are still the same size (carrying the same number of passengers) and still leave every 12 seconds or so (Ethereum mints new blocks every 12 seconds or so). If PoW is buses with diesel engines, PoS is the new fleet of electric buses. Both have the same passenger capacity, but one is a gas guzzler and the other is more environmentally friendly. PoS will thus reduce ETH's energy consumption by 99%, as there will no longer be armies of computers all over the world solving mathematical puzzles to earn miner rewards and mint blocks. This will be done by those who stake their ETH to run validators.

So, when will the gas fee be lowered?

Or to ask a better question: When will the Ethereum network improve scalability?

While the original plan was to introduce shard chains, things have changed recently with more focus on Layer 2 technologies such as Rollup and Danksharding. The combination of Danksharding and Layer 2 Rollup technology reduces the amount of data that needs to be processed on the Ethereum main chain. This should allow Ethereum to scale to about 100,000 transactions per second (currently about 24 transactions/second)

This is all expected to begin sometime in 2023, making this the next major milestone for ethereum core developers following the merger. Today will be a historic moment and an exciting one in the crypto space.