Ethereum Aims For Store Of Value Crown

October 07, 2021

A huge part of bitcoin’s value proposition comes from the promise, baked into code, that the number of coins that will ever exist will be no greater than 21 million. 

Bitcoin supply will grow until that 21 million mark is hit, at an ever-decreasing rate. But that means over the next 120 years (when the last bitcoin is expected to be minted), bitcoin supply will increase only slightly from the 18.8 million coins that are currently in circulation.

Source: Coin Metrics

It’s this scarcity and the credible commitment to maintain this scarcity that give people that confidence that bitcoin will maintain its value over the long haul. Scarcity alone isn’t enough to guarantee that bitcoin will maintain its value, but it’s one of the key features of the asset and its perception as a store of value.

For much of its history, ether, the native currency of the Ethereum platform, took a very different approach to its monetary policy. There is no supply cap on ether, which means that the number of coins should continue to increase into perpetuity.

Fees Burned Under EIP-1559

At least that was the expectation until recently. EIP-1559, an upgrade of the Ethereum protocol that went into effect in August, has completely changed the monetary outlook for ether. The upgrade’s main aim was to make Ethereum transaction fees more predictable by replacing a first-price auction mechanism with a fixed fee (called a base fee) and optional tip.

While all transaction fees previously went to Ethereum miners, under the new system, the coins that make up the base fee are “burned,” or removed from circulation, and only the tip goes to miners (think of “burning” as the crypto equivalent of a stock buyback). 

Users who want their transactions to execute faster—for instance, to take advantage of a fleeting arbitrage opportunity—can pay a higher tip to make that happen. But in most cases, where speed is not of the essence, users can simply pay the base fee and a negligible tip for a high likelihood of having their transaction added to the blockchain.

In essence, the protocol is now calculating the market clearing transaction fee, rather than having each individual user try and figure it out on their own.

User experience was the main impetus for EIP-1559, yet the upgrade’s impact goes beyond just fees. Base fees are burned to prevent miners from making off-chain agreements that could hinder the goal of more predictable transaction costs. But the design has the side effect of reducing the growth of ether supply, which many investors view as bullish for the token.

According to the site, since the upgrade, nearly 450,000 ETH has already been burned, equal to 5 ETH/minute. At the current rate, 2.6 million ETH would be burned in a year, or 2.2% of current circulating supply of 117.6 million coins.

Source: Coin Metrics

From Inflationary To Deflationary

The fee burns from EIP-1559 alone don’t mean that Ethereum’s monetary policy is no longer inflationary. Supply is still growing, because new coins are being awarded to miners for their efforts in validating transactions and securing the network. Including those block rewards, ether supply is growing at about a 2.3% annual rate.

But EIP-1559 isn’t the final word on Ethereum’s monetary policy. Eth2, a series of upgrades to Ethereum that are scheduled for 2022, will introduce proof-of-stake to the Ethereum network, replacing the current proof-of-work consensus protocol.

With proof-of-stake, validators will replace miners as the arbiters of which transactions are included in the blockchain. It is a much less compute- and energy-intensive process, and one that anyone who holds a certain amount of ether can be a part of.

Validators don’t compete; they are chosen at random. That means they don’t have to have supercomputers to participate in the process.  Would-be validators simply stake a certain amount of ether—at least 32 ETH based on the current rules—for a chance at proposing a new block of transactions.

Because of the nature of proof-of-stake (i.e., there is no need for expensive computers and huge amounts of energy), the number of new coins that must be issued to get network participants to validate transactions and secure the network is much less than under a proof-of-work system.

That’s why analysts expect that once Eth2 goes into effect, Ethereum’s issuance will drop significantly. Combined with the aforementioned fee burns, net ether supply growth may actually turn negative, which is why some Ethereum bulls are starting to call ether “ultra sound money.”

Bitcoin Still Holds SoV Crown 

Even with the prospect of ether supply growth potentially turning negative, some bitcoin bulls argue that their coin has a better claim to the store-of-value mantle. Their main argument hinges on the fact that bitcoin’s monetary policy doesn’t change. The 21 million coin cap is as close to set in stone as you can get. While it can technically be changed if enough network participants agree to it, given the culture of bitcoin, it’s unlikely to happen for the foreseeable future.

On the other hand, Ethereum’s monetary policy is on track to change dramatically. And even though it’s changing in a way that makes it more scarce, it does reinforce the idea that its monetary policy is more malleable than that of bitcoin.

Next year, ether supply could fall. The year after that, a protocol change could lead to an entirely different outcome. At some point in the future, Ethereum’s monetary policy could become more stable and predictable, but it doesn’t yet have the credibility of bitcoin.

Which cryptocurrency ends up being the better store of value is still an open question. Ether is on the right track, but it has a ways to go to take bitcoin’s throne. 

Email Sumit Roy at [email protected] or follow him on Twitter sumitroy2

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