The Merge and NFT – The Cryptonomist

Ethereum’s Merge was a key step in the evolution of its infrastructure: will it impact the NFT sector as well?

Indeed, it replaced Proof-of-Work (PoW) with Proof-of-Stake (PoS). 

PoW had some limitations, including high power consumption. This meant that validating transactions on the Ethereum blockchain required large apparatuses with significantly large costs. 

These limitations also applied to NFT transactions

Instead, PoS simply provides for validator nodes to be able to validate transactions, with greatly reduced effort and cost. 

Merge: failure to reduce fees, NFT suffer

In theory, this could also have generated a reduction in transaction fees, but this did not happen. 

Indeed, miner fees have been cut completely, so much so that the miners have disappeared. As of 15 September 2022, ETH is no longer being mined. Transaction fees, on the other hand, have not been reduced and are now collected by validator nodes. 

The fact is that the number of transactions that can be validated has remained the same, including the rate at which they are validated. So what has always varied the fees is the market demand from those who want to register a transaction on the Ethereum network. 

Taking the daily median of fees as a reference, in the first 15 days of September, it was around $1. Between 16 September and 7 October it had dropped below $0.8, but starting 8 October it rose to around $1.4. 

So currently median fees on individual Ethereum transactions are higher than they were in the weeks before the Merge. 

The explanation for the fact that the exact opposite of what was expected has happened may be due to the partial burn of the same fees. 

In fact, precisely since 15 September, the supply of ETH has almost stopped growing, thanks to the fact that more or less the same number of ETH are burned with each block as are created. 

Whereas from 1 August until 15 September the supply of ETH had grown by 0.6 million units, from 15 September onward it has remained essentially stable. 

The ETH that is being burned comes from fees paid by users, and is not collected by validator nodes, so it is more than fair that fees have increased. 

NFT and the possible impact of the Ethereum Merge

The problem of high fees affects NFTs in particular. 

For to pay $1.5, or sometimes even $2, for a single transaction is to place a big limitation especially on the circulation of NFTs that have low or very low market value. 

So for now, the Merge has had a negative impact on low-cost NFT transactions on the Ethereum blockchain. 

It is no coincidence that, for example, on OpenSea in October the trading volume of NFTs on Polygon grew by 77 %, while that on Ethereum fell by 20%. 

Before the Merge it was hoped that fees would decrease, allowing more NFT trading volume on Ethereum, and instead burn volume increased causing fees to rise, and reducing NFT trading volume. 

Polygon allows NFT exchanges at lower fees, but for example Solana allows them at almost negligible fees. 

Ethereum’s future for NFT

At this time it appears that this problem cannot be solved. 

Therefore, in the near future, NFT trading volumes on the Ethereum blockchain may decline further, waiting for other layer 2 solutions such as Polygon to make the fees on NFT trading on Ethereum become negligible as well. 

It is worth noting that, on the other hand, in terms of trading volumes on the Ethereum blockchain this decline does not seem to have occurred. 

Prior to the Merge about $3 billion was being moved daily, and after a brief decline from 17 September to 23 October, it has been more or less back to that figure for the past few days. 

The average value of individual transactions in ETH has also experienced a similar dynamic, so the fee increase has affected almost only NFT trades. 

Should this trend continue for a long time, it is possible that other platforms will take over as far as NFT trades are concerned, especially those with low market value. 

Energy consumption reduced by the Merge: NFT on Ethereum become greener

There are, however, those who focus attention on cutting energy consumption. 

With the move to PoS, the Ethereum network now consumes only a small fraction of the power it used to consume with PoW. 

This has almost completely removed the objections that were being made in this regard to those using NFTs on Ethereum. 

It is an argument that was brought to light by SuperRare co-founders Jonathan Perkins and John Crain. 

The problem mainly concerned artists, and especially those involved with environmentalist issues. 

Now such objections have simply been erased since the Merge, and in theory, they could also encourage the spread of NFTs in the art world. 

However, even before the Merge there were actually environmentally friendly solutions for exchanging NFTs, thanks to alternative blockchains to Ethereum already based on PoS. 

In fact, not only does it not appear that the overall trading volume of NFTs after the Merge increased, it even appears to have contracted further. In fact, most likely the Merge had no impact on the overall volume of NFTs exchanged: it only shifted some exchanges from Ethereum to Polygon or other blockchains. 

Layer 2 solutions

However, the scenario could change completely if, as is hoped, second-layer solutions begin to proliferate. 

Indeed, it is no coincidence that currently the main alternative to Ethereum for NFTs is precisely Polygon, which is an Ethereum layer 2 solution. 

But Polygon is for all intents and purposes another blockchain, whereas second-layer solutions integrated within the Ethereum protocol would be needed in order to make Ethereum grow. 

In other words, an NFT minted on Ethereum cannot be traded on Polygon. To do so would require minting another NFT on Polygon that represents the original token on this other blockchain. 

A completely different matter would be if there were layer 2 solutions that would allow very low-cost exchange of minted and existing NFTs directly on the Ethereum blockchain. 

For example, Bitcoin’s main second layer, Lightning Network, allows the exchange of BTC residing on Bitcoin’s blockchain by simply adding a top layer dedicated only to exchanges. 

Something similar would be needed to enable rapid and very low-cost exchanges of Ethereum NFTs. 

In fact, it could even allow for continuous exchanges of tokens, for example in online gaming where trades need to be very fast and need to be able to be done on a continuous basis. 

After all, NFTs are an excellent solution for the exchange of digital assets in online games. 

Conclusion

Hence for now, a month and a half later, the Merge has not had a positive impact on the NFT industry on Ethereum, and has in fact increased its fees on operations. 

But with the development of layer 2 solutions, facilitated by the move to PoS, sooner or later there may also be positive impacts on the NFT industry.