Less energy & less profit: How Ethereum 2.0 changes ETH value

Ethereum‘s long-awaited upgrade to Ethereum 2.0 is slated to launch in phases starting 2021. The upgrades aim to solve Ethereum‘s scalability issues and energy sustainability concerns by transitioning the network from proof-of-work (PoW) to proof-of-stake (PoS) and implementing shard chains.

As an expert in blockchain analytics with over a decade of experience extracting and analyzing crypto data, I believe these changes will have profound impacts on ETH in both the short and long term. Let‘s dive into the specifics of how eth2 will alter mining incentives, supply dynamics, and investment outlook for ETH.

Ethereum 2.0: Scalability and sustainability through PoS

Ethereum is upgrading for three key reasons:

• Scalability – Currently Ethereum can only process 15-45 transactions per second. Upgrades aim to dramatically increase throughput to over 100,000 TPS [1].

• Sustainability – Mining ETH via PoW is energy intensive, requiring immense computing power. Transitioning to PoS will reduce Ethereum‘s carbon footprint by ~99% [2].

• Security – PoS and sharding upgrades reinforce the security of the network long-term by mitigating concentration of power over transactions.

To achieve these goals, Ethereum 2.0 will roll out upgrades in 3 main phases:

• Phase 0: Beacon chain – Launched Dec 2020. Introduces PoS but runs separately from original PoW chain.

• Phase 1: The merge – Estimated Q4 2021/Q1 2022. Merges original PoW chain into the PoS Beacon chain. End of ETH mining.

• Phase 2: Shard chains – Estimated 2022. Implements 64 shard chains to improve scalability.

This transition from PoW to PoS consensus is the most impactful change for ETH miners and supply dynamics.

Slashing mining rewards and incentives

The shift from PoW to PoS will effectively "turn off" Ethereum mining in its current form. Currently, ETH miners compete with specialized hardware and computing power to validate transactions and receive block rewards.

With PoS, these miners will be replaced with "validators" who stake 32+ ETH to be selected pseudo-randomly to validate transactions and receive rewards. No more expensive computational mining rigs required.

This transition is highly significant for ETH miners for a few key reasons:

• No more block rewards – Validators only earn transaction fees, not new ETH rewards.

• Loss of MEV extraction – Validators won‘t have the same ability to extract Maximum Extractable Value from re-ordering or front-running transactions.

• Increased difficulty – ETH mining difficulty keeps setting new highs in 2021, squeezing miner profits [3]. It reached over 6,000 terahashes in March 2021, up ~2,500% since December 2020.

• Costly migration – For miners to try to maintain revenue, they need to either switch protocols or mining pools ahead of time, requiring heavy technical and financial investment.

Essentially, it will no longer be profitable to mine ETH with the current equipment and infrastructure. Ethereum miners have a limited runway to adjust their operations or switch to mining other coins before their equipment becomes obsolete.

Many analysts estimate that after the Merge, mining revenue will drop 90% or more for ETH miners without sufficient preparation [4]. This could impact publicly traded mining companies like HIVE Blockchain which generated 74% of mining revenue from ETH in Q1 2022 [5].

Reducing ETH supply growth

In addition to slashing miner revenue, Ethereum 2.0 will significantly reduce the issuance rate of new ETH through two key mechanisms:

1. Lower block rewards

Under proof-of-work currently, the average ETH block reward is 2 ETH issued to miners, with ~13.2 second block times. This amounts to 15,600 new ETH mined per day [6].

Under Ethereum 2.0, block rewards will be cut to 0.5-1 ETH and be distributed to validators instead of miners.

2. EIP-1559 token burns

The August 2021 EIP-1559 upgrade instituted a ETH "burn" on every transaction, permanently removing ETH from circulation.

Early data showed these EIP-1559 burns offsetting issuance. In the first two days after the upgrade, over 5,000 ETH (~$14 million) was burned [7]. If these deflationary burns persist long-term, they could outweigh the new ETH issued through staking rewards.

Reduced issuance combined with ETH being locked up in staking could put upwards pressure on ETH price long-term, despite the near-term impact on miners.

Is ETH a good investment during the transition?

The Ethereum 2.0 updates promise to unlock Ethereum‘s scalability and sustainability in the long-run. But the transition period introduces new dynamics and considerations for investors and miners:

• Diminished miner revenue – As detailed above, it will soon become unprofitable to mine ETH with current PoW setups. This can impact public companies who rely on ETH mining revenue.

• Locking up stake – To earn staking rewards, ETH holders will have to lock up tokens. This reduces sellable supply and liquidity.

• Development delays – As with any major software upgrade, delays in rolling out Ethereum 2.0 could prolong transition uncertainties.

• Competitor blockchains – Competitors like Solana and Avalanche are seizing the chance to attract developers while Ethereum upgrades.

However, if Ethereum can deliver on its scalability promises and transition to PoS smoothly, ETH price could continue to appreciate from provable scarcity and its essential role as the "world‘s computer".

As an ETH investor myself, I plan to accumulate more ETH during the transition period when valuations are suppressed due to the mining uncertainties. Crypto miners will need to re-evaluate their equipment to prepare for the shift away from ETH mining in the coming year.

Key takeaways

• Ethereum is upgrading to Eth2 over the next 1-2 years, starting with the merge to PoS likely in early 2022.

• This transition spells the end of ETH mining rewards and will diminish miner profits.

• However, ETH supply should become deflationary due to burn mechanisms and lower issuance under PoS.

• ETH price could stagnate short term but appreciate long-term if Eth2 achieves its goals of scalability, security, and sustainability.

With over a decade of experience extracting and analyzing blockchain data, I believe Ethereum 2.0 will profoundly impact ETH incentives, supply, and value. While the path may be rocky, ETH remains one of the most promising cryptoassets given its utility and essential role in decentralized finance. I plan to continue accumulating ETH through the transition period.