Vitalik Buterin addresses crowd at ETHDenver
Vitalik Buterin addresses crowd at ETHDenverJesse Morgan/ ETHDenver
  • Ethereum will move from proof-of-work to proof-of-stake this summer, Vitalik Buterin has confirmed.
  • The ETH 2.0 'Merge' upgrade promises to cut transaction fees, increase coins 'burned' and improve congestion.
  • That should in turn limit supply and lift activity, giving analysts reason to be bullish in the long term.

Ethereum is finally closing in on its shift to proof-of-stake, and changes to gas fees that should give its cryptocurrency a boost, analysts say — even as rival DeFi blockchains chase at its heels.

After seven years of R&D, proof-of-stake is finally working on ethereum testnets and looking like it's months away from final launch, the network's cofounder Vitalik Buterin said at ETHDenver last month.

As well as using less computing power than "proof-of-work", ethereum 2.0 promises to be faster and more secure. It also is expected to lower transaction costs and supply — and that is bullish for ether, its native token, some analysts believe.

"I expect ethereum's move to proof-of-stake to have a positive impact on price in the long term," GlobalBlock market analyst Marcus Sotiriou told Insider. 

"This is because it should dramatically reduce the cost of transactions on the ethereum network, which is currently ethereum's main drawback."

These costs can soar on the network when it is busy, as users compete for miners to process their transactions. Currently, ethereum is running a surge-pricing model, and transaction fees are highly volatile as a result. 

In August, the London hard fork upgrade brought in the key EIP-1559 protocol to make the costs more predictable. EIP-1559 created a minimum base fee for transactions, calculated by algorithms in response to demand, rather than in an auction.

These gas fees are "burned" — sent to a wallet that can't be accessed — meaning the amount of ether in circulation is reduced.

Amber Ghadder, founder of DeFi start-up AlianceBlock, believes the next stage of ethereum's development — the merge of its mainnet with the Beacon Chain proof-of-stake system — will create more burn. 

"Since EIP-1559 was implemented, we've already seen a few weeks of deflationary supply since November, which didn't have a marked effect on pricing," she told Insider. 

"But the Merge, which will drop the issuance of ETH by 2 ETH per block, added to the burn should put decent downward pressure on supply."

The move to proof-of-stake should also reduce congestion, another reason analysts are bullish.

"Number of transactions is highly correlated to gas prices. If we expect gas prices to fall, we can expect to see a pump in smaller-size transactions, increasing network utility and driving prices higher," Ghadder said.

But in the short term, Ghadder doesn't see any immediate increase in ethereum's capacity from the shift, so its direct effect on gas prices could be muted.

"We can expect the launch of ETH 2.0 to be short-term neutral and long-term bullish," she said.

In the proof-of-work system, high-powered computers compete to solve puzzles to create new coins. With proof-of-stake, people put forward their holdings as a down payment, which enables them to mine coins. 

Up-and-coming rivals to ethereum like solana and avalanche are built on proof-of-stake mechanisms. While solana's sol rose 589% and avalanche's avax gained 202% in the last year, ethereum is up 73%, according to CoinGecko data.

Ethereum is dominant in DeFi, or decentralized finance, which uses the network to build crypto applications for financial services.

But it has lost DeFi market share to competitors rapidly, JPMorgan analysts have said, going from almost 100% at the outset of 2021 to a 70% a year later.

"Ethereum is trying to address scalability and high-cost concerns with this upgrade," Ed Moya, senior market analyst at Oanda, told Insider. 

"It is still winning the race as the top smart contract blockchain, but the competition is growing." 

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