Burning Ether: Quantifying the Ethereum inflation
Summary: Last week the Ethereum network added a feature to limit inflation by burning a part of the Ether paid in transaction fees. How big is the effect of the burning mechanism? Based on the current data, we estimate that it will reduce inflation by slightly more than a third for the next year.
On Thursday the 5th of August, the London update was implemented on Ethereum, containing several improvements to the network. The most notable improvement was EIP 1559.
In short, EIP 1559 changes the way users pay transaction fees on the network, making the fee sizes more predictable. From being solely based on an auction, the fees are now based on a fixed fee with the option to tip miners. In addition to the fees, the miners are rewarded with newly issued Ethereum, which introduces inflation. But to limit the inflation in the new upgrade, the majority of fees are now getting burned instead of solely being compensated to miners. It essentially means that the more Ethereum is being used, the more Ether is being burned, as usage makes the fees higher.
As the burning mechanism has been live for 8 days, we now have some key figures, making us able to interpret the result so far:
- In total, 37,000 ETH worth $113,000,000 has been burned. That is an average of around 4,625 ETH per day.
- At the same time, around 103,130 new ETH has been issued to miners in mining rewards.
- Simultaneously, around 9,450 new ETH has been issued to stakers in the ETH 2.0 staking contract. These are likely locked for the next year until the merge between the main Ethereum network and ETH 2.0 happens. Thus, they cannot impact the price short-term, but they can long-term.
So the net result is: 103,130 + 9,450 - 37,000 = 75,580 ETH has the total supply increased for this period.
The ether issued in the ETH 2.0 staking contract should not be considered short-term, as it will be locked until somewhat next year. Thus, short-term the supply has been impacted by: 103,130 - 37,000 = 66,130 ETH, still making Ethereum inflationary, but with significantly lower inflation compared to when there was no burning mechanism in place.
Looking a year ahead, it is expected that newly mined Ether accounts for 4.7mn ETH. This would correspond to the inflation if the burning mechanism would not have been implemented. Out of a total supply of around 117mn ETH, inflation without burning Ether would be around 4%.
However, inflation is now highly affected by the two unknowns: The number of transactions carried out and the average fee on Ethereum, thus the amount of Ether burned. This is close to impossible to predict – but for simplicity, let us assume that the burning mechanism will burn the same amount yearly as it has been the past 8 days. This is likely the level to expect. This leaves us with a yearly total burn of between 1.6mn-1.7mn ETH.
As the mining rewards are expected to be constant, the burned Ether should be deducted from the newly mined Ether. Thus, leaving us with a total issuance of new ETH between 3mn – 3.1mn ETH for the next year – without accounting for the Ether being issued to stakers. This will result in an inflation when accounting for burning of Ether of around 2.6%.
Conclusively, this makes Ethereum around slightly more than a third less inflationary short-term compared to before. There is a strong similarity between the Bitcoin halving occurring every fourth year cutting the Bitcoin inflation in half and this burning mechanism update for Ethereum. It has an extensive impact on both blockchains. Similar to Bitcoin, while it has reduced the reward for miners, it has increased the potential economics of Ethereum holders.