Ethereum Inflation Highlights The Necessary Definition Of This Blockchain

Ethereum inflation highlights the necessary definition of this blockchain

Currently, one of the big debates in the Ethereum ecosystem is related to the unstoppable inflation of this cryptocurrency.

An issue that has attracted the attention of both specialists in the Ethereum ecosystem and outside of it. Let us remember that since its creation, the Ethereum network has had no limit on its issuance. This means that as many ETH ( ERC20 development ) can be created as the computers in charge of running its nodes can write.

Considering the 64-bit computing world we live in, it means that the theoretical issuance limit would be 10^(38), a number so large that you could easily describe with it all the money issuance of the crypto and traditional financial system and still have room for more. The fact that Ethereum’s inflation is in practice “almost infinite” has led to the search for solutions to avoid the undesirable effects of this situation: the continuous devaluation of Ether, the platform’s native token.

It should be remembered that the supply of Ethereum currently exceeds 120 million ETH. The future perspective, after the elimination of EIP-1559 and other measures for the evolution and development of Ethereum 2.0, could trigger the issuance of Ethereum in the long term.

Solving inflation in Ethereum

Although Vitalik Buterin and his team have tried to find solutions to this problem, the reality is that the measures taken have proven insufficient. For example, on August 5, 2021, when Ethereum was still working under the Proof of Work scheme, a controversial improvement was activated: EIP -1559 . This improvement sought to solve some of the serious tokenomics problems that Ethereum was facing then:

First, stabilize transaction fees. Episodes of high volatility made it too expensive to use this network. At that time, many Ethereum DeFi users were forced to pay fees of up to $500 to make a trade. Most of the time they were basic token withdrawal operations from DeFi pools.

On the other hand, EIP-1559 sought to solve the problem of transaction delays, which caused price fluctuations. This was reflected in operations that took hours to be confirmed or that failed outright.

Finally, resolve the inefficiencies of price auctions by confirming operations within the chain. This last situation also impacts security, since Ethereum has a block confirmation model that allows so-called “Uncle Blocks.” Uncle Blocks are sister blocks of those blocks that are part of the main chain. Basically, they are valid blocks that are issued at the time of confirmation of a block, but since they do not meet all the consensus criteria, they are set aside and are part of an alternate history of Ethereum.

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Insufficient reach and negative effects

EIP-1559 sought to solve the issuance problem with two important adjustments: changing the measurement formula in the Ethereum gas price and adding a burning factor in each new block. Thus, the aim was to subsidize (yes, it is a subsidy, even if Ethereum devs don’t like the word) the cost of Ethereum operations and at the same time burn ETH to reduce inflation.

A study carried out in 2022 indicates that although the measure had a strong impact on fees and the issuance of Ethereum, it was insufficient to correct the problem. For example, the gas expense for each ETH block after the hard fork that activated EIP-1559 (London) varied between 0 and 30 million Gas, when before the hard fork it was 15 million. Although this may seem like progress, the reality is that the real impact on the price of Gas is minimal, as seen in the following graph. Please note from 2021 onwards that it already shows the corresponding subsidy.

In addition to this, the measures taken by EIP-1559 encouraged the arrival of MEVs and their manipulation of operations, making this practice more profitable and exposing operations to censorship practices, as has actually happened. In any case, the issuance of ETH has been unstoppable and, although growth has flattened in the last year, the supply continues to increase.

The arrival of Merge and Ethereum 2.0

Issues regarding Ethereum issuance remained throughout the development of Ethereum 2.0. They even continue with this update already deployed. In fact, EIP-1559 is still active, which, together with a mathematically regulated percentage issuance, has helped the issuance of ETH to flatten out in the last year. However, Ethereum’s plans include the demise of EIP-1559. The elimination of this subsidy will once again make Ethereum an inflationary network, with a rate of 6.5% per year, necessary to maintain the tokenomics of this network.

Please note that the Ethereum network depends on there being a flow of ETH to perform operations on it. Said ETH has many uses. Such as network staking for validators (where the ETH is frozen) or stakes and pools, which allow the operation and security of the cross-chain bridges of this chain. Maintaining an adequate flow of new tokens is vital for validators to earn their rewards and for the rest of the ecosystem to sustain itself. In that sense, continuing to burn ETH with EIP-1559 is counterproductive in the long term. Hence, the need to eliminate this system.

Changes that do not know when they will arrive

When will the changes happen? Not even Vitalik Buterin himself can offer a clear answer. The last thing known about this measure was provided by Buterin with the second roadmap of Ethereum 2.0, whose fifth phase, called Splurge, would eliminate EIP-1559 and make a Fix-ALL in Ethereum. However, after that, Buterin has already presented two new roadmaps for Ethereum 2.0 that have changed the priorities of the project, so there is no date. Not even the project creator knows what exactly to do about the problem.

What is known is the main effect of the problem: inflation, which can erode the value of ETH. If the supply of ETH increases too quickly it could cause the price of the coin to decrease. Which could make it difficult to create erc20 token . Ethereum to be used as a reserve currency or means of payment. Although the latter may not be what they are looking for from Ethereum. It seems increasingly clear that Ethereum is becoming a hub for financial applications. If they take a tokenomic perspective more like that of fiat currencies, which is what they basically have now, they could maintain the system and grow little by little.

What seems clear is that the decision must be addressed. Above all, to offer clarity to the community that is building on Ethereum. Still, it’s important to be aware of the risks that Ethereum inflation could pose to the network. Ethereum investors and users should stay tuned for updates on the migration to PoS and other measures being taken to address inflation.