Does Ethereum have a supply limit (and why this is an important question)?





We often hear the argument that BTC is the ultimate inflation hedge since its supply is capped at 21 million and it halves every four years. This has led to a misperception that crypto– Currencies without a supply cap are inflationary, which means their value decreases over time. It is therefore questionable whether Ethereum (ETH) has a supply cap.

On April 1, 2018, Vitalik Buterin jokingly suggested that the total supply of ETH be capped at 120 million. His reasons? Ensure a more stable and sustainable economy for Ethereum. Although this is just an April Fool’s joke, it brings us to the inflationary vs deflationary discussion surrounding the supply of cryptocurrencies.

Ethereum’s offer

During the Ethereum ICO in 2014, the total supply of Ether was around 72 million; Fast forward eight years later, to June 2022, and Ethereum’s total ETH supply is just over 121 million. This may interest you: These 3 cryptos could make their investors millionaires: Calyx Token (CLX), Dogecoin (DOGE) and Monero (XMR).

Ethereum has no supply cap, but that doesn’t mean we’ll have billions of Ether in circulation. The number of ETH issued is steadily declining, which means that inflation is not a major concern for Ethereum. It is also important to note at this point that Ethereum and Ethereum Classic are completely separate protocols.

Besides the annual supply cap, the future supply of Ethereum is highly dependent on its monetary policy.

Ethereum monetary policy

While capping the supply of a coin is an effective way to curb inflation, it is not the only one. It could be argued that supply capping could prove counter-intuitive in the future as decentralized finance (DeFi) continues to grow. Read also: Solana (SOL) and Terra (LUNA) investors are now jumping on this crypto for its rapid growth!. As used on Ethereum, monetary policies can be implemented to curb inflationary pressure without relying on supply caps.

It should be noted that Ethereum does not have a fixed monetary policy – ​​its monetary policy is subject to change based on Ethereum Improvement Proposals (EIP). These EIPs played a crucial role in determining Ethereum’s supply schedule. An EIP is the common way to propose and make changes to the Ethereum network.

This monetary policy is best defined by the rewards paid out on Ethereum at any given time. These rewards, which tend to increase the supply of ETH, include Ether issued per block and fees rewarded to miners.

The history of Ethereum is punctuated with cases of reduction of the estimated minimum emission. It should be noted that Ethereum does not have a fixed supply, unlike other altcoins like Cardano, which is why its monetary policy can be described as “minimum issuance to secure the network.” Currently, the annual emission on Ethereum is around 3.68% and has steadily decreased over time.

In the future, it is impossible that Ether emission will ever increase. This is due to the deployment of Ethereum 2.0, whose proof-of-stake is designed to reduce issuance, and EIP-1559, which introduced burning, effectively ensuring that more ETH will be burned than created. Also, the upcoming Ethereum merger will drastically reduce the emission rate to less than 1%. And that brings us to the question: Is Ethereum deflationary?

Is Ethereum deflationary?

Ethereum may soon be deflationary. Ethereum has managed to contain inflation, through the use of a Proof-of-Work consensus mechanism, two main factors are used to control inflation, block time and block rewards. Read also: PlaceWar: a promising new P2E project in the NFT and Metaverse universe in 2022?. But with the rollout of Ethereum 2.0, EIP-1559, and the upcoming Ethereum merger, the network is expected to become deflationary.

Ethereum 2.0 introduced the PoS consensus mechanism, and is expected to significantly reduce the issuance rate. The introduction of PoS has made mining rewards under PoW obsolete. Instead, it introduces a sliding scale between the amount of ETH staked by network validators and the interest they will earn, further incentivizing miners to mine ETH rather than PoW coins. like Litecoin.

What is EIP-1559?

One of the most consequential EIPs in determining Ethereum’s supply is EIP-1559, which introduced a deflationary mechanism via the destruction of the base fee. It came into force in August 2021 and introduced the ETH burning mechanism.

First, EIP-1559 introduced a base fee on all transactions, calculated based on network activity. Once the basic tax is paid, it is instantly burned. This means that miners no longer have an incentive to validate transactions with higher gas fees since they will not receive this gas fee.

EIP-1559 explains that if more ETH is burned on the base fee compared to the mining rewards generated, Ethereum will be deflationary. After EIP-1559, Ethereum became deflationary on several occasions, when the number of ETH burned exceeded the number of ETH created. In this case, fee burning can be described as a scarcity mechanism dependent on the transactional utility of the Ethereum network.

This means that the overall supply of ETH decreases as more ETH is destroyed by fee burning. As fee burning depends on network activity, the more transactions on the Ethereum network, the more ETH is burned and the lower the issuance.

Fee burning is designed to destroy the base ETH fee that users pay for transactions on the Ethereum blockchain. Note that the base fee is the minimum required for a transaction to be added to an Ethereum block. Typically, users can also pay a priority fee to get their transactions cleared faster. However, only the base fee is burned.

Since EIP-1559 went live, over 2.5 million ETH has been burned, as of July 2022.

The Ethereum merger

The Ethereum merger (EIP-3765) is the official move from proof-of-work consensus to proof-of-stake consensus. On March 15, 2022, the Ethereum Foundation announced that the merger was ready to be deployed on the public Ethereum mainnet. It should come into full effect in the third or fourth quarter of 2022. What is the impact on the supply of the cryptocurrency and on the Ethereum cap?

The most significant aspect of the Merger is the triple halving of ETH issuance – that’s the equivalent of three halves of Bitcoin. The merger represents the final step in the total deflation of Ethereum. It occurs when the Mainnet merges with the ETH2 beacon chain, effectively reducing ETH issuance by up to 90%.

It is estimated that daily issuance will drop from 15,000 ETH to around 1.5 ETH when the merger is complete. This will lead to a drastic drop in the annual emission rate to less than 1%, and in the longer term it could fall below zero.

Using the Ethereum Merge Simulator on Ultra Sound Money, we can see that the annual supply growth is around -1.9%.

Conclusion

So, does Ethereum have a supply cap? No. While Ethereum has been considered an inflationary crypto, a series of updates ranging from Ethereum 2.0, EIP-1559, and the upcoming Ethereum merger are making Ethereum deflationary. The EIP-1559 update is one of the biggest in the Ethereum network. It introduces a deflationary mechanism via the destruction of the base fee. And the upcoming Ethereum merger will drastically reduce the emission rate to less than 1%.

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Thomas E.
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