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Many friends will ask what happened to Ethereum? Will it go back to all-time highs or even higher? What will happen to the price after ETH2.0 is completed? In this issue I will try to discuss these issues with you. I will also express some of my thoughts on the development direction of ETH. Arguably the most important upgrade to Ethereum since its inception is the move to Ethereum 2.0. This will peak this year as we move into the next phase of the upgrade, which is the proof-of-stake merger. I think it’s worth discussing what exactly ETH 2.0 has upgraded so that we can stay on the same page. The ETH 2.0 upgrade officially kicked off in December 2020, when developers launched the so-called Beacon Chain. This is a separate Ethereum network that will serve as the final proof-of-stake blockchain. The next phase of the ETH 2.0 roadmap is the Proof of Stake merger. This was originally planned last year but has been postponed to this year. In simple terms the merge is when the current Ethereum proof-of-work chain merges with the beacon chain. This will mark the end of the proof-of-work consensus mechanism. Instead you will have network validators who will stake ETH to propagate blocks. Of course this brings many benefits. One of them is that maintaining the Ethereum network will be more environmentally friendly. The energy consumption problem brought by the proof-of-work blockchain has always been a hot topic. A rough estimate of the energy required to drive an Ethereum transaction is 238 kWh. Moving to proof-of-stake will make Ethereum more environmentally friendly. But the bottom line is that the proof-of-stake merger won’t immediately lead to a massive shift. That’s because it’s still a blockchain that must process transactions in a sequential manner. The massive scaling component of ETH2.0 comes with the introduction of sharding. This is a concept that has been used for database scaling for years and is now being implemented in blockchain technology. These separate shards will be their own separate blockchains, also known as shard chains, due to their association with Ethereum. A chain of 64 shards will spread the load on the Ethereum network and allow different transactions to be processed simultaneously. As for when ETH 2.0? While steady progress is being made, progress is indeed slow. The first is about the beacon chain, which has been around for over a year, and where the amount of ETH staked continues to climb. There are currently over 9 million ETH locked inside. On Beacon Chain’s first birthday last year, Vitalik released an updated roadmap for ETH 2.0. Basically it shows what we can expect to build on ETH 2.0 after the merger. Ethereum developers launched the Kintsugi testnet about two weeks after Vitalik made this announcement. This is a self-proclaimed longer-lived testnet that will allow developers to experiment with Ethereum in the exact way the network will function after the transition. For example, these developers can test certain DeFi applications and tools. It’s just that on Chinese social media, there are rumors that ETH 2.0 will be delayed for another year. It may happen now in the second quarter of this year, and if the second quarter is not completed, we can only look forward to the end of the year. The question is what exactly will it mean for the price of ETH when done? Sentiment and speculation aside for now, it’s important to look at the economics of the merger and what it will do to ETH demand and supply. The first question is what will it do to all the locked ETH once the merge happens. Can people who have been locked up for years finally get out? So to sell it because of that, obviously that’s not a good idea. That’s because there will be a limit to the exit rate of validators. This is done to ensure that validators do not change too quickly in a short period of time. So this means that at most four validators will unlock their ETH per epoch, i.e. every 6.4 minutes. It is entirely possible that the amount of ETH locked and pledged exceeds the amount withdrawn. There was a recent report from the Coinbase agency earlier. It’s basically an introduction to how ETH 2.0 will impact Ethereum and other layer 1s in the ecosystem. The Coinbase report said the merger could increase efficiency, as more ether will end up being staked than created. Also this shows that miners are forced sellers. They have to sell a portion of the ether to pay for the mining equipment and electricity. Running validators is much cheaper, however, and replacing miners with fewer validators can reduce ETH issuance by up to 90%. It is estimated that this will result in a 30% to 50% drop in the amount of ETH flowing into exchanges. Yet one of the best solutions for users to adopt Ethereum during this period and beyond is of course those Layer 2 protocols. Ethereum Layer 2 is evolving so fast that it is sometimes hard to keep track. Optimism and Arbitrum and Polygon and Starkware etc all these solutions use zk Roll ups or Optimistic rollups. Nearly all dapps are now deploying Layer 2 solutions, and the total TVL value locked in these protocols is reaching record levels. Some of these layer 2 solutions provide a great user experience in terms of fees and speed, even challenging the status of large centralized exchanges. For example, at the peak of DEX trading last year, dYdX’s Layer 2 protocol’s 24-hour record surpassed Coinbase’s. To be clear, there is also a common misconception that these Layer 2s may become obsolete when the ETH 2.0 upgrade is complete. Instead, sharding of the Ethereum main chain will enhance their scalability. It will allow rollup solutions to take advantage of more Ethereum block space. To quote the researchers, this is critical in the long run to allow the network to potentially scale to billions of users and process tens of thousands of transactions. These layer 2 solutions are at the heart of the future of Ethereum. Everything looks fine, but why does this affect the price of ETH? In order to get into these aggregated solutions you have to lock up Ethereum. This is Ethereum that has been pulled from the market. And the larger the total value locked TVL, the less ether will enter the exchange. In addition to this, now that there are more dApps and users on layer 2 platforms, the more likely it is that the ETH main chain will eventually be used when the full scale is released. For example, porting a dApp built on Arbitrum to Ethereum is much easier than porting from Solana or Avalanche. Unlike proof-of-work mining, once Ethereum transitions to proof-of-stake in a merger, it will be seen as a greener option. This may be even more attractive to institutional investors eager to enter the cryptocurrency space, especially those concerned about the impact of investing in proof-of-work virtual currencies. Of course we can also glean a lot of information from on-chain statistics. One of the most important of these is what other holders are doing and what they are holding. Starting with one of my favorites is the Ethereum balance in an exchange wallet. You don’t have to look to know that it’s near an all-time low. It’s just bullish in reverse thinking. Because it shows that people who are currently selling ETH are a smaller and smaller percentage of the overall market. According to some data from Santiment, the top 10 non-exchange addresses now hold more than 25 million ETH. Since the launch of EIP1559, the net amount of ETH flowing into small wallets is mostly positive. If you look at the previous eight months, inflows and outflows were roughly flat. Of course less ETH on the market statistically means less ETH available for sale. Finally I do want to share some of my personal thoughts. Let me start by saying that I am disappointed with Ethereum’s performance so far this year. This is not just an ETH problem. The entire cryptocurrency market was dragged into the quagmire along with other financial markets. But being able to separate fundamental value from price is important. Many friends are getting impatient with the progress of Ethereum. In addition, a large number of Layer 2 scaling solutions are being built on the Ethereum network during this period. The shard may grow exponentially as it completes. Ordinary retail investors as well as whales and miners are hoarding, which could fuel an influx of capital once ETH transitions to a clearer proof-of-stake consensus. The merger is the biggest upgrade Ethereum has experienced. Of course we can’t ignore the threat of Avalanche and Solana, another very powerful Layer1 blockchain, and Fantom and Terra. They are all vying for ETH market share.