Does Ethereum Have a Supply Cap?


We often hear the argument that BTC is best hedge against inflation as its supply is capped at 21 million and cut in half every four years. This has led to a misperception that cryptocurrencies with no supply limit are inflationary, meaning their value decreases over time. This begs the question: does Ethereum (ETH) have a supply limit?

On April 1, 2018, Vitalik Buterin jokingly suggested that the total supply of ETH be capped at 120 million. Your reasons? To ensure a more stable and sustainable economy for Ethereum. While this was just an April Fool’s joke, it brings us back to the inflationary versus deflationary discussion surrounding the supply of cryptocurrencies.

The supply of Ethereum

During Ethereum 2014 ICO, the total supply of Ether was about 72 million; Fast-forward eight years later to June 2022 and Ethereum’s total ETH supply is just over 121 million.

Font: etherscan

Ethereum does not have a supply limit, but that does not mean that we will have billions of Ether in circulation. The amount of ETH issued has been 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 they are completely separate protocols.

In addition to the annual supply limit, the future supply of Ethereum is highly dependent on its monetary policy.

Ethereum Monetary Policy

While limiting the supply of a currency is an effective way to curb inflation, it’s not the only way. It could be argued that limiting supply may prove counterintuitive in the future, as decentralized finance (DeFi) keep growing. As used in Ethereum, monetary policies can be implemented to curb inflationary pressure without relying on limiting supply.

It is worth noting that Ethereum does not have a fixed monetary policy – ​​its monetary policy is subject to change depending on Ethereum Improvement Proposals (EIPs). These EIPs have played a crucial role in determining the Ethereum supply schedule. An EIP is the common way of proposing and bringing changes to the Ethereum network.

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

The history of Ethereum is marked by instances of reduction of the estimated minimum emission. Please note that Ethereum does not have a fixed supply, unlike other altcoins What Cardano, so its monetary policy can best be described as “minimum issuance to secure the network”. Currently, Ethereum’s annual issuance is around 3.68% and has been steadily declining over time.

Ethereum Annual Issuance Rate
Font: mesari

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

Is Ethereum deflationary?

Ethereum could soon be deflationary. Ethereum has managed to keep inflation in check. With Ethereum using a Proof-of-Work consensus mechanism, two main factors are used to control inflation, lock time, and lock rewards. But with the release of Ethereum 2.0, EIP-1559 and the next Ethereum mergerthe network is expected to become deflationary.

Ethereum Supply Peak
Font: ultra sound money

Ethereum 2.0 introduced the PoS consensus mechanism and is set to greatly reduce the issuance fee. The introduction of PoS 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, giving miners even more incentive to mine ETH rather than PoW Coins like Litecoin.

What is EIP-1559?




One of the most important EIPs to determine the supply of Ethereum is EIP-1559, which introduced a deflationary mechanism through the destruction of the fee base. It came into force in August 2021 and introduced the mechanism for burning ETH.

First, EIP-1559 introduced a base fee on all transactions, calculated based on network activity. Once the base fee has been paid, it burns instantly. This means that miners no longer have an incentive to validate transactions with higher gas fees, as they will not receive these gas fees.

EIP-1559 explains that if more ETH is burned in base fees compared to mining rewards generated, Ethereum will be deflationary. After EIP-1559, Ethereum went deflationary on several occasions where more ETH was burned than was created. In this case, fee burning can be described as a scarcity mechanism that depends on the transactional utility of the Ethereum network.

This means that the overall supply of ETH decreases as more ETH is destroyed through fee burning. Since the burning of fees depends on the activity of the network, the more transactions there are on the Ethereum network, the more ETH will be burned and the lower the issuance will be.

Fee burn is designed to destroy the base ETH fees that users pay for transactions on the Ethereum blockchain. Please note that base fees are the minimum required to add a transaction to an Ethereum block. Users can also usually pay priority fees to get their transactions validated faster. However, only the base rates are burned.

Since EIP-1559 went live, more than 2.5 million ETH have been burnedfrom July 2022.

Ethereum Total Burnt Fees
Font: etherscan

The Ethereum merger

The Ethereum merger (EIP-3765) it’s the official change from a proof-of-work to a proof-of-stake consensus. On March 15, 2022, the Ethereum Foundation announced that Merge was ready to be deployed on the public Ethereum mainnet. It is expected to go into effect in the third or fourth quarter of 2022. How does this affect the supply of the cryptocurrency and if Ethereum has a limit?

The most significant aspect of the merger is the triple halving of ETH issuance: this is the equivalent of three Bitcoin Halvings. The Merge represents the final stage of Ethereum becoming fully deflationary. It occurs when the Mainnet merges with the ETH2 Beacon Chain, effectively reducing ETH issuance by up to 90%.

Daily issuance is estimated to drop from 15,000 ETH to around 1.5 ETH when the merger is complete. This will cause a drastic drop in the annual emission rate below 1% and, in the longer term, it may drop below zero.

Using the Ethereum Merge simulator in Ultra Sound Money, we can see that the annual supply growth is about -1.9%.

conclusion

So does Ethereum have a supply limit? No. While Ethereum had been considered an inflationary crypto, a series of upgrades ranging from Ethereum 2.0, EIP-1559, and the upcoming Ethereum merger make Ethereum deflationary. The EIP-1559 update is one of the most important on the Ethereum network. It introduces a deflationary mechanism through the destruction of the base fee. And the upcoming Ethereum merger will drastically reduce the issuance rate to less than 1%.

image source

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