The Flippening: How ETH will replace BTC as crypto gold
Bitcoin was launched with a hard cap on its maximum supply. There will never be more than 21 million BTC in circulation, and the new BTC created to reward miners is issued in ever decreasing amounts until the last one is minted sometime in 2027. This ensures that BTC doesn’t lose its value through runaway inflation. This trait of having a limited supply (and being the first on the scene) is a key reason why Bitcoin is regarded as the gold standard of crypto.
Ethereum, on the other hand, does not have a cap on its supply and there are already over 120 million ETH in circulation right now. Just like Bitcoin, Ethereum has to mint new ETH to reward the miners securing its network. The rewards have declined over the years, first with the Byzantium hard fork (EIP-649) which reduced the block reward from 5 ETH to 3 ETH, then with the Constantinople fork (EIP-1234) which lowered it further to 2 ETH (known as ‘The Thirdening’ since the rewards were cut by one-third).
Unlike Bitcoin, however, Ethereum has to reward a second set of people securing the network. In December 2020, the Proof of Stake Beacon Chain was launched, and the validators maintaining consensus on it began receiving ETH as block rewards. This naturally led to an increase in ETH’s issuance, and hence contributed to the dilution of ETH’s intrinsic value through an increase in its supply.
Now there are two ways to enforce a currency’s scarcity: limit the future supply or reduce the current supply. Ethereum chose the second option by introducing the concept of ‘burning’ — the destruction of ETH tokens to remove them from circulation. This mechanism was enabled with the London fork (EIP-1559) in 2021 to both offset issuance and tackle the problem of highly volatile gas fees on the mainnet.
The difference in how transaction fees were calculated before and after the London fork is fairly straightforward.
Pre London fork: Total fee = Gas units * Gas price per unitPost London fork: Total fee = Gas units * (base fee + tip)
Before EIP-1559, the total transaction fee went to the miners. After it, only the tip went to the miners while the higher base fee was burned, thus offsetting ETH’s issuance to an extent by reducing its supply.
The block rewards earned by miners are in addition to this tip. Currently, Ethereum miners earn 2 ETH per canonical block, and a maximum of 1.5 ETH for an uncle/ommer block. This averages out to 2.08 ETH per submitted block (2 ETH for canonical block + an average of 0.8 for uncle blocks). With Ethereum’s block time of 13.3 seconds, this amounts to 9.38 new ETH issued per min, or ~13,500 ETH per day. For ether’s current supply of 120.2 million, this results in an annual issuance rate of just over 4% only from miner rewards.
Validators don’t perform economically and computationally-intensive work like miners, which is why they receive significantly less ether as block rewards. The rate of ETH issuance for validator rewards amounts to 1.1 ETH/min or ~1600 ETH/day. For the same ether supply of 120.2 million, this results in an issuance rate of 0.49%. So the total annual issuance rate of Ether comes out to:
Total annual issuance rate = 4% + 0.49% = 4.49%Issuance going to miners = (4/4.49)*100 = 89%Issuance going to validators = (0.49/4.49)*100 = 11%
The burning of base gas fees offsets this issuance to an extent. For the 10.48 new ETH being issued every minute (9.38+1.1), approximately 0.9 ETH is burned. But the amount of ETH burned is trivial compared to the amount of ETH being created, thus barely putting a dent in ether’s inflationary nature. With ~473k ETH burned per year and 5.5M new ETH added to the network, the net increase of ether amounts to:
New ETH added to circulation/year = 5500000 - 473000 = 5.027M ETHNet annual inflation rate = (5.027M/120.2M) * 100 = 4.1%
A 4.1% annual supply growth cements ETH as an inflationary token, but that’s set to change once the Merge finally takes place.
Ether aka ‘Ultrasound Money’
The Merge will transition Ethereum’s consensus mechanism from Proof of Work to Proof of Stake, nothing less, nothing more. But that in turn will completely alter ether’s tokenomics.
New ETH will still be issued to reward validators, but none to reward the soon-to-be-defunct miners. For a PoS blockchain, the amount of ETH issued and the value of block rewards are directly proportional to the amount of staked ETH. If the total ETH staked is low, issuance is low and the rewards per validator increase, and if the staked amount is high, issuance is high and rewards per validator decrease.
There is around 13.3 million ETH staked right now on the Beacon chain by 417k validators who collectively receive ~1600 ETH/day in addition to a share of the total tips garnered through all executed transactions. So the post-merge ether issuance is essentially the same as the pre-merge Beacon chain issuance:
Post-merge issuance rate = 0.49%Reduction in annual ETH issuance = (1-0.49/4.49)*100 = 89.1%
A ~90% drop in issuance is massively significant when you consider that Ethereum’s transition from PoW to PoS won’t lower its gas fees, i.e., similar amounts of ETH get burned (for now) while a far smaller amount of ETH gets added to the network.
Assuming that the burn rate remains at its current level of ~473,000 ETH per year and the amount of new ether created to reward validators remains ~584,400 ETH per year, the net increase in ETH supply comes out to:
New ETH added to circulation/year = 584400-473000 = 111,400 ETHNet inflation rate = (111,400/120.2M)*100 = 0.09%
ETH will still be inflationary in this scenario, but maybe not for long. As Ethereum usage increases, the amount of ether being destroyed via fee burn also increases. It’s expected that ETH issuance will also see a hike as more validators join the network and the amount of total staked ether rises.
However, if everything goes according to plan, the amount of ether being burned will eventually overtake the amount of new ether being created, leading to ether supply becoming deflationary rather than inflationary — a likelihood which has led to the creation of the ‘Ethereum is ultrasound money’ meme derived from the premise:
If fixed-supply gold is sound money, then decreasing-supply Ether is ultrasound money!
The burn rate is expected to overtake the issuance rate sometime next year, after which the total ETH supply will continue to decrease until it reaches a state of equilibrium (in about 2 centuries, so don’t hold your breath).
The reason why Bitcoin is considered to be crypto gold is because its a good store of value thanks to its scarcity and demand. This has led to many DeFi protocols and stablecoins holding BTC as collateral, similar to how fiat currencies were initially backed by gold, which has had use in the making of jewelry and electronic components among other things. But Bitcoin doesn’t have any use beyond storing value.
Ether, on the other hand, functions as as a lot more than a store of value. It serves as the base currency in a vast ecosystem of DeFi protocols, games, Metaverse platforms, NFT markets and more. The largest liquidity pools are paired with ETH, lending/borrowing protocols stake ETH as collateral, and users bridging to Ethereum from other L1s like Cosmos and Avalanche swap their tokens for ETH.
As the Ethereum ecosystem continues to expand and draw more users through its rollup-centric roadmap, it’s easy to imagine a world where ETH overtakes BTC in value and cements itself not only as crypto gold, but as global ‘ultrasound money’.
