A Case for Ethereum Block Reward Reduction to 2 ETH in Constantinople (EIP-1234)
UPDATE: I’ve posted some updated graphs and arguments here: https://twitter.com/econoar/status/1034137784154382336
Cryptocurrency supply models have long been a hot topic of conversation and no one has the “right” answer. However, I do think there are some metrics that can be used to justify certain supply models and enough years of history have passed to help us with the decision.
It is well known that once Proof of Stake is implemented on Ethereum, inflation will drop to around 0.5–1% on the network. However, the recent delay in Casper has once again brought up the debate around the built in “difficulty bomb” on the protocol along with what block rewards should be until Casper is implemented.
In the Metropolis hard fork, Ethereum reduced block reward issuance from 5 to 3. This was justified due to a large jump in Ether price and had no adverse effects on the network. Currently, Ethereum is rewarding 3 ETH per normal block and 2.625 ETH per uncle block to miners. This is creating around 25,500 ETH ($12mn) per day putting us at a yearly inflation rate of around 7.4%. Here is a snapshot of historical inflation:
And for the sake of comparison here is Bitcoin:
As you can see, Bitcoin’s current yearly inflation rate sits around 4.25%.
One proposal on the table for Ethereum’s Constantinople fork is EIP-1234 which would reduce block rewards from 3 ETH to 2 ETH until Casper is implemented. I’m strongly in favor of this proposal to be put into the Constantinople fork and will do my best to justify it below.
There are a myriad of factors in play when it comes to cryptocurrency supply models. However, it’s important to understand that miner rewards and fees are paid out in order to secure the network. Given this, I think it’s important to look at total miner rewards and fees paid out daily in order to help fully understand miner incentives and network security. To see this we can translate daily payouts (block rewards + fees collected) to miners in both BTC and ETH to USD and compare them across time.
As seen above, the two are pretty close and at times Ethereum has actually paid more out to miners than Bitcoin. It’s hard to compare network security and the financial incentives involved across chains but I think a simple baseline we can use is coin market cap. If a network is a factor more valuable than another, its users should be willing to pay that factor more in value to protect it. We can therefore use market cap as a metric to analyze if a network is overpaying miners. So, let’s compare the ETH to BTC market cap ratio to the ETH to BTC miner payout ratio over time. In theory, these should be aligned. However, they are not at this time:
Ethereum is at 34% the market cap of Bitcoin but is paying out miners at an 80% rate compared to Bitcoin. This appears to be well overpaying and justifies the idea of another block reward issuance reduction. In theory, these ratios when compared to each other should be close to 1 but it’s currently closer to 2.5:
Let’s take a look at what Ethereum’s inflation and supply graphs would look like if block rewards stay the same until the end of 2019 versus if we drop issuance to 2 ETH.
Most importantly, how would the market cap versus payout ratios look if supply was reduced (assuming flat price from today):
They become much closer, aligning the value of the networks versus how much is being paid to keep them secure.
In conclusion, I think EIP-1234 should be strongly considered by the community and included in the upcoming Constantinople fork. Even more importantly, if Casper is delayed again and supply continues to grow at the current rate, we are setting ourselves on a better path by reducing inflation now.