The Evolution of Ethereum’s Monetary Policy

This article originally appeared in Valid Points, CoinDesk’s weekly newsletter breaking down Ethereum 2.0 and its sweeping impact on crypto markets. Subscribe to Valid Points here.

Ethereum’s native asset was once discredited by bitcoiners and investors alike for its lack of hard monetary policy and ever-inflationary “tokenomics.” However, the combination of decentralized finance (DeFi), Ethereum Improvement Proposal (EIP) 1559 and the coming transition to proof-of-stake has worked to create what ether holders call “Ultra Sound Money.”

Ethresear.ch recently introduced multiple new models to predict the circulating supply of ether after the Merge takes place. To understand their findings and the variables involved in their models, it’s essential to know the following:

• Ether is distributed to reward miners for producing blocks under proof-of-work (PoW) and, under Ethereum 2.0, will be used to reward validators for proposing blocks in proof-of-stake (PoS).
• EIP 1559 introduced a deflationary mechanism to the network, creating a base transaction fee for utilizing block space on the network and then burning that fee out of existence.
• Ethereum 2.0 has an adaptive yield demand curve that attempts to ensure “minimum viable issuance,” or that enough validators are working to secure the network.

Since EIP 1559 was implemented on Aug. 4, 620,000 ETH at a market value of $2.6 billion has been burned through transaction fees. Using that burn rate and the current network demand metrics, Ethresear.ch found that around 2.5% of ether’s circulating supply would be burnt annually. Under proof-of-work, the 2.5% burn only offsets a portion (~39%) of ether’s emission schedule. However, emissions fall drastically post-Merge, potentially even making the asset deflationary.

Going back to Ethereum 2.0′s adaptive yield curve, the blockchain looks to incentivize enough validators to properly secure the network and not any more. Assuming that staking yield falls around 3%, Ethresear.ch’s model predicts that the long-term supply of ether may fall anywhere between 27.3-49.5 million ETH or 23%-42% of today’s supply.

Such a reduction in supply could easily be met with the expectation that ether will be infinitely more scarce than it is today. However, the model requires assuming that demand for blockspace will stay at current levels, which is harder to predict now than ever. Alternative layer 1s continue to grow in popularity, but layer 2 systems built atop Ethereum are just getting started.

Read more: The Success of Ethereum’s Alternative Ecosystems

Welcome to another edition of Valid Points.

Pulse check

The following is an overview of network activity on the Ethereum 2.0 Beacon Chain over the past week. For more information about the metrics featured in this section, check out our 101 explainer on Eth 2.0 metrics.

Disclaimer: All profits made from CoinDesk’s Eth 2.0 staking venture will be donated to a charity of the company’s choosing once transfers are enabled on the network.

Validated takes

• Terraform Labs CEO Do Kwon is suing the U.S. Securities and Exchange Commission (SEC) after being served with a subpoena at Messari’s conference last month. BACKGROUND: Do Kwon believes the SEC may have violated its own rules by serving him as a South Korea resident. Furthermore, the founder announced that Terra and Mirror are decentralized and cannot simply be “shut down,” contrary to what regulators might believe.
• Polymarket, the largest DeFi predictions market, is said to be under investigation by the Commodities Futures Trading Commision (CFTC). BACKGROUND: Amid a potential billion-dollar funding round, the CFTC is looking into whether Polymarket offered unregulated swaps or binary options. The firm hired the CFTC’s former head of enforcement to deal with the investigation.
• A large interoperable Merge developer network is aimed for release during November. BACKGROUND: Eth1 and Eth2 clients came together to launch a test network earlier this month and now aim to release a larger version with further client interoperability. The symbiosis between execution and consensus clients and the creation of successful test networks are positive signs for a successful Merge.
• Uniswap has done over $500 billion in trading volume since its inception in November 2018. BACKGROUND: Uniswap is the most popular decentralized exchange on Ethereum Layer 1 and is continuing to expand on Arbitrum and Optimism. According to Token Terminal, the protocol has also returned $1.6 billion in revenue to its liquidity providers.
• Decentralized stablecoins have come back to the DeFi spotlight as FXS and SPELL surge in price. BACKGROUND: Regulation of stablecoins and the demand for cheap leverage has led to recent growth in the Maker, Abracadabra and Frax ecosystems, with decentralized stablecoins chipping away at USDT and USDC’s market share.

Factoid of the week

Open comms

Valid Points incorporates information and data about CoinDesk’s own Eth 2.0 validator in weekly analysis. All profits made from this staking venture will be donated to a charity of our choosing once transfers are enabled on the network. For a full overview of the project, check out our announcement post.

You can verify the activity of the CoinDesk Eth 2.0 validator in real time through our public validator key, which is:

0xad7fef3b2350d220de3ae360c70d7f488926b6117e5f785a8995487c46d323ddad0f574fdcc50eeefec34ed9d2039ecb.

Search for it on any Eth 2.0 block explorer site.