Ethereum deflation mechanism: Will ETH become a scarce asset?

Ethereum (ETH) has the potential to become a scarce asset due to its deflation mechanism. The transaction fee combustion mechanism of EIP-1559 and the lower ETH issuance rate under the PoS consensus mechanism jointly lead to a decrease in the supply of ETH. The growth of active DeFi, NFT markets and Layer2 expansion solutions further promoted the destruction of ETH and enhanced its scarcity. However, future technological upgrades (such as EIP-4844) may change the amount of ETH destroyed, and uncertainties such as market sentiment, macroeconomic situation, and regulatory policies may also affect the scarcity of ETH and pose a challenge to its future trend.

Ethereum's deflation mechanism makes ETH more likely to become a scarce asset, but there are also some uncertain factors. The specific analysis is as follows:

Deflation mechanism makes ETH scarce

• EIP-1559 Destruction mechanism: EIP-1559 has changed the transaction fee structure of Ethereum, and the basic fee in each transaction will be permanently destroyed. When network activity is active, a large amount of ETH will be destroyed due to transactions, directly reducing the amount of ETH in circulation. For example, from the end of 2022 to the beginning of 2024, Ethereum network activity was frequent, and a large amount of ETH was destroyed, which promoted the deflation trend of Ethereum.
• PoS low issuance rate: After the "merger" in September 2022, Ethereum has changed from PoW to PoS mechanism, and the issuance rate of new ETH has been significantly reduced. In the PoW era, about 13,000 ETHs were dug out every day, while the number of newly issued ETHs per day under the PoS mechanism dropped to about 1,600, and the annual issuance volume dropped from about 4.8 million to about 584,000, and the inflation pressure was greatly reduced.
• Network activity continues to increase: The Ethereum ecosystem continues to develop and continues to prosper in areas such as DeFi and NFT. The NFT market was booming in 2023, with frequent transactions on platforms such as Opensea, and popular NFT series transactions brought a large amount of ETH destruction. At the same time, lending, trading and other activities on DeFi platforms such as Uniswap and Aave have also increased significantly, and the transaction fees generated are destroyed by the combustion mechanism, further reducing the supply of ETH. In addition, the rapid growth of Layer2 expansion solutions has also led to the continuous incurring main network transaction fees, accompanied by a large amount of ETH burning.

Uncertain factors may affect scarcity

• Changes brought about by technology upgrades: For example, EIP-4844 in the "Dencun" upgrade introduced a new data storage mechanism, which significantly reduced transaction fees, led to a reduction in ETH destruction, causing a certain degree of inflation in Ethereum in 2024, indicating that there is uncertainty in the impact of future technology upgrades on ETH supply.
• Market and macroeconomic factors: The cryptocurrency market is greatly affected by market sentiment, investor preferences, macroeconomic situation, etc.If the market is generally sluggish and investors sell ETH in large quantities, it will increase market supply; macroeconomic fluctuations may also lead to investors' funds withdrawing from the crypto market, affecting the demand and price of ETH and weakening its scarce asset attributes.
• Regulatory policy risks: The regulatory policies of various countries for cryptocurrencies are different and constantly changing. If strict regulatory policies are introduced to restrict the use, transactions or pledge of Ethereum, it may undermine market confidence, affect the development of the Ethereum ecosystem, and thus affect the demand and supply of ETH, making it difficult for it to become a scarce asset.

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