Understanding the economics of Ethereum 2.0: ETH will be scarce

Editor's Note: This article comes fromChain News ChainNews (ID: chainnewscom)Editor's Note: This article comes from

Chain News ChainNews (ID: chainnewscom)

Chain News ChainNews (ID: chainnewscom)

, Author: Nick Tomaino, founder of venture capital firm 1Confirmation, Compiler: Perry Wang, published with authorization.

An investor in an endowment fund recently said to me: "I believe BTC is digital gold, but I don't know what the long-term value of ETH is? Unlike a business, it has no underlying cash flow. Throughout history, when a certain When the total market cap of an asset reaches billions of dollars but there is no fundamental support, it will eventually collapse. This must be the likely outcome of ETH.”

Many traditional investors feel similarly. They now believe in the rationality of investing in BTC, but they don't understand the rationality of investing in ETH. The monetary policy of BTC is simple and will not change, so it has a clear narrative of value storage-digital gold. Unlike BTC, ETH's monetary policy is confusing and changing, and its store-of-value narrative is ambiguous.

Eth 2.0 is about to launch and things will change. The exciting technical upgrades of Ethereum accompanying Eth2 have attracted most of the attention, however, the impact of its economic upgrades may be even greater.

Economic upgrade 1: Consolidate monetary policy

A new feature of cryptocurrencies is that there is no central bank that can change its monetary policy at will. Many central banks around the world have recently increased the money supply to the detriment of citizens (see what happened in Lebanon for a recent example). The BTC community has a culture of keeping the protocol immutable, enabling it to build trust around a BTC monetary policy designed with the primary goal of maintaining digital scarcity.

The early innovation culture of Ethereum was different from that of Bitcoin, led by its famous founder Vitalik Buterin, who had a significant influence on the community. Some of Ethereum’s early protocol changes led some to believe that its monetary policy could easily be changed by the whims of a few. The DAO hard fork is the most exposed protocol change. In fact, since the creation of the Ethereum creation block on July 30, 2015, there have been two other hard forks that have adjusted the block reward.

The reality is that the governance of Ethereum today is closer to Bitcoin than most people think. Ethereum's plan is to change its monetary policy again when Eth 2.0 launches (details below). Once Eth 2.0 enters the main network, the possibility of Ethereum's monetary policy changing again will be similar to the possibility of BTC's monetary policy changing. Both are likely to change, but both are highly unlikely, subject to consensus and approval by developers, miners, and users.

Economic upgrade 2: reduce the issuance rate

At the time of the genesis block, Ethereum distributed 72 million ETH tokens to the initial contributors. Since the genesis block, 39.2 million ETH has been allocated to Ethereum miners through a proof-of-work (PoW) consensus mechanism similar to Bitcoin. Since July 2015, the PoW-based ETH inflation rate has been approximately 11.20% per year, which is twice the 5.58% annual inflation rate of BTC during the same period.

With the launch of Eth 2.0, the consensus mechanism of Ethereum will change from PoW to Proof of Stake (PoS), and the amount of coins issued will be greatly reduced. The theoretical maximum coin issuance triggered when Phase 0 starts is 2 million ETH per year. This means that the ETH inflation rate will drop: 4.5% over the past year, compared to a maximum of 1.80% for the first full year of ETH 2.0. Based on conservative assumptions about the number of validators, total ETH staked, and transaction fees, the inflation rate could be significantly lower than this (details below).

Economic upgrade 3: burning transaction fees, which may cause ETH inflation to approach 0 much earlier than 2140

Currently, ETH miners capture all fees associated with transactions on the Ethereum network. Transaction activity in this area has grown rapidly, with miners earning approximately 259,823 ETH ($59.7 million) in fees over the past year.https://docs.google.com/

With the introduction of Ethereum Improvement Proposal EIP 1559, a large amount of transaction fees will be burned instead of being paid directly to miners. This means that if more transaction fees are burned than new ETH is issued, the net inflation rate could even be negative. This table on Google Doc explains its economic model in detail: what net inflation rate Eth2 will exhibit based on various assumptions about PoS participation and transaction behavior.

image description

Excerpt from:

As we all know, from now on, in the next 120 years, that is, by 2140, the total supply of BTC will reach 21 million, and its inflation rate will drop to 0. Because this monetary policy is written into the code of Bitcoin, BTC holders have full belief in the digital scarcity of BTC. However, such policies of ETH have not yet been finalized, so people have little confidence in ETH's digital scarcity. However, once Ethereum’s new policy is finalized and people start to take a closer look at it, they may realize that ETH is much more scarce than commonly believed.

ETH's Evolving Investment Narrative