Ethereum’s Merge has done a lot to change the dynamics of ETH issuance, delivering on most of what analysts and the Ethereum Foundation loved before the transition.
However, there are still some nuances that need clarification about if and when ETH can become deflationary and its supply would stop expanding.
Let’s dive in.
Ethereum: Not very deflationary
Seconds ultrasound. moneythe amount of ETH in circulation has increased by more than 5,990 ETH since then the Fusion on September 15, at the time of writing (September 24). At current prices, that’s roughly $8 million worth of ETH that has gone into circulation.
That doesn’t mean, however, that the merger hasn’t made a difference. Issuance is still far below the projections of a continued proof-of-work model I would have expected – over 112,000 ETH more on September 24th.
It is also much lower than Bitcoin’s current issuance rate of 6.25 BTC every 10 minutes.
How Issuing ETH Works
ETH issuance ultimately comes down to two variables: the block grant and the burn rate.
The block grant represents all the ETH newly generated with each block, which occurs approximately once every 12 seconds from the merge. The size of the grant depends on the amount of ETH staked on the network. At the current stake rate (approximately 14 million ETH), around 1700 ETH are rewarded every day.
Burn rate refers to the amount of ETH that is burned through gas fees. Naturally, the burn rate increases along with fees, which increase when Ethereum experiences high transaction volume.
The combustion mechanism was introduced during the London hard fork last year and it has led to some net-deflationist periods for Ethereum already. Meanwhile, this month’s merger reduced Daily ETH issuance from 14,600 ETH to just 1600 ETH, a decrease of almost 90%.
For ETH to be deflationary, the number of tokens that are generated through the block grant must be less than what the network burns. In other words, ETH becomes more deflationary as fewer people participate and more people transact. At current stake levels, the base transaction fee needs to be at least 15 Gwei (0.000000015 ETH) for ETH to be deflationary.
As of September 20, this is no longer the case. Average transaction fees. Average transaction fees are only 11 Gwei, an amount that would burn 412,000 ETH per year. Meanwhile, current stake levels would see 603,000 ETH generated per year. That’s a net annual inflation of 191,000 ETH, or 0.16%, every year.
Will ETH ever be deflationary?
It remains to be seen how this number will change over time.
On the one hand, one might expect inflation to increase as more people enter the participation arena. The Ethereum network currently offers approximately 4.5% APR to stakers, denominated in ETH. Meanwhile, staking services like Binance.US currently offer up to 6% in staking rewards.
Considering the relative risk-reward profile of the bet compared to other forms of performance (e.g. loan), this could prove very attractive to future ETH bulls.
Staking also seems to be a relatively untapped market in Ethereum. Other major crypto networks have roughly that 50% of its token supply is being staked, compared to Ethereum’s 14%.
On the other hand, those who expect Ethereum to evolve into a high-volume network for decentralized trading can expect transaction fees to rise, increasing the burn rate and pushing ETH issuance into deflationary territory. Arthur Hayes, former CEO of BitMEX, has theorized that this could create a bullish feedback loop for the asset, reflexively incentivizing the purchase, use and deflation of ETH.
However, as Hayes pointed out during a interview this month, there may be limits to the increase in transaction fees before users sing.
“Let’s say deflation gets so severe that it gets so expensive that nobody uses it… well, guess what? They’re going to change the inflation rate,” he said.
For this reason, Hayes does not believe that Ethereum can compete with Bitcoin as a monetary network. In his view, ETH’s additional role as gas interferes with its ability to be money, while Bitcoin’s value “can’t be matched with the real utility of other things.”
Paulo Arduino of Bitfinex offered one similar argument leading to fusion. He stated that Ethereum’s narrative “continues to change” and has too many other priorities to compete with Bitcoin as money.
Ethereum’s “ultrasound money” narrative is a spin-off of Bitcoin’s “sound money” meme due to its absolutely fixed supply and immunity to monetary degradation.
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