ETH Issuance: A Historical Overview and Current State
Introduction
With the current number of active validators on the network crossing the millionth mark, the percentage of ETH staked is now over 26%. At the time of writing, there are approximately 10,000 validators in the queue to join the network, contributing to the increasing amount of ETH staked.
The current ETH staking annual percentage rate (APR) is roughly 2.5%, and it could exceed 3.5% when utilizing MEV-boost. The recent introduction of restaking services will also enhance validator earnings, making Ethereum staking a lucrative endeavor while ensuring the security of the Ethereum network.
In light of the growing percentage of ETH staked, ETH researchers and the community alike are pondering whether the network is overpaying its validators in terms of issuance at the expense of diluting ETH value for the broader community. But before delving into that debate, we’ll take a look back at Ethereum’s issuance history from its genesis through The Merge until now to better understand the issue at hand.
Issuance History
The Genesis block distributed a total of 72,009,990.50 ETH in the pre-mined supply. Of this, 60 million ETH went to participants in Ethereum’s initial coin offering, which lasted for 42 days, while the remaining 12,009,990.50 ETH was allocated to Ethereum’s early contributors and the Ethereum Foundation (EF).
During Ethereum’s Proof-of-Work era, approximately 50 million ETH (or roughly 42% of the current total supply) was issued in the form of mining block and uncle rewards to network miners. Ethereum initially issued 5 ETH as block rewards until block 4,369,999, which was then reduced to 3 ETH per block after the Byzantium fork in October 2017.
This was further decreased to 2 ETH per block during the Constantinople fork in February 2019. Before this upgrade, the yearly inflation rate stood at 7.5%, sparking discourse around the issuance reduction. Arguments in favor of EIP-1234 suggested that Ethereum was overpaying miners to secure the network and advocated for the issuance to align more closely with Bitcoin’s market cap ratio vs miner payout ratio.
The chart below illustrates a clear step decline in daily block rewards following both the Byzantium and Constantinople upgrades.
As the first step in transitioning to a Proof-of-Stake network, the Beacon Chain was launched and began producing blocks in December 2020 after accumulating 16,384 deposits of 32 staked ETH. With this, ETH staking rewards officially commenced, earning stakers on the Beacon Chain daily rewards while miners continued earning mining rewards until the Merge. Today, a total of 2 million ETH has been issued as staking rewards, representing a 1.66% increase over approximately 3.5 years.
Post-Merge, daily ETH issuance only arises from staking rewards. The annual inflation rate is currently at -0.22%, with a net decrease in supply of 432,752.28 ETH at the time of writing as a result of EIP-1559.
Proof-of-Stake Issuance
Blockchain issuance generally serves two purposes: supply distribution and security subsidy. During Ethereum’s early days, roughly 50 million ETH was distributed by the network as mining rewards, representing approximately 70% inflation over 7 years. These issuances were used to incentivize secure block production as well as subsidize miners’ capital expenditures. As Ethereum transitioned to PoS, validators only had to lock up 32 ETH to validate the network, thereby reducing capital expenditures.
Then came liquid staking providers that receive ETH deposits of any amount from users to stake it on their behalf. In return, users receive a token representing their amount of staked ETH + reward that they can then use freely in DeFi activities. This not only lowered the capital requirement to stake but also freed up users’ capital and eliminated the need to operate and maintain their own nodes, while still receiving staking rewards at the same time.
With the ease of staking coupled with the increasingly lucrative exogenous yields (from MEV, DeFi, restaking) available to stakers, there has been an upward trend in the total number of validators, with active validators crossing the millionth mark at the time of writing, especially since ETH withdrawals were enabled in April 2023.
This exponential increase in the validator count has led to the maximum churn limit per epoch being set at 8 in the recent Dencun upgrade, and a potential increase in the validator max effective balance being considered for inclusion in the upcoming Pectra upgrade in an attempt to reduce the total network validator count and the number of P2P messages over the network.
With the increase in active validators, the total ETH staked is now more than 1/4 of the total supply. According to researchers from the EF, Justin Drake and Vitalik Buterin, a simple calculation demonstrated that Ethereum’s optimal security budget is around 1/4 of all ETH staked, and anything above that could potentially be overpaying for security. Justin also hinted at a potential upgrade that lowers issuance as total stake gets close to a cap (stake capping).
Proposal to Reduce Issuance
Recently, EF researchers Ansgar Dietrichs and Caspar proposed a plan aimed at maintaining the current staking ratio by reducing the incentive for new stake inflow. This proposal is intended to be implemented during the Electra upgrade as an interim solution, while a new issuance architecture with a floating yield and a target percentage of staked ETH is developed.
The current issuance curve could potentially lead to most ETH being staked in the long run, with validators still earning approximately 1.35% yearly when the total ETH supply is staked. Additionally, staking ETH enables validators to accrue multiple yields from MEV, liquid staking, restaking, liquid restaking, and other opportunities, making staking ETH highly attractive. The proposal also argues that the continuous increase in ETH staked is driven by liquid staking providers due to economies of scale, and eventually, most ETH will be staked via LSTs.
Both the proposal and EF researcher Mike Neuder advocate for an issuance reduction in the upcoming upgrade as an interim measure until a long-term issuance architecture is ready. They argue against waiting until the subsequent upgrade, when the total ETH staked could exceed 50%.
However, this proposal has faced significant pushback from the community, primarily due to concerns that a mere change in the issuance curve now would have minimal impact but could introduce numerous unknown consequences. Some argue that it would be better to directly upgrade to a new issuance architecture for the long term.
Opposition to reducing issuance now includes concerns about reduced incentives for solo stakers, potential acceleration of staking centralization, and downstream consequences in DeFi from making staking less attractive. Furthermore, the growth of ETH staked isn’t directly tied to staking rewards, as exogenous rewards allow validators to stack yields from multiple sources.
Closing Thoughts
ETH issuance has evolved over the years and continues to function soundly, thanks to continuous development and feedback from the community. It’s important to note that Ethereum transitioned to a PoS network only in September 2022, compared to its PoW era starting in August 2015.
As things continue to play out, all stakeholders in the ecosystem should closely monitor the risks associated with high staking ratios, as highlighted by EF researchers, and work together to mitigate them by slowing the rate of ETH staked. Perhaps a new innovation could emerge to address these risks without necessitating a protocol-level change in the issuance curve. Only time will tell.
