Ethereum potentially becoming more popular for holders

Cryptocurrencies
Mads Eberhardt

Cryptocurrency Analyst

Summary:  Since Bitcoin launched in 2009, Bitcoin and almost every cryptocurrency launched since has been inflationary and external miners received the fees provided for validating the transactions - including freshly minted crypto. By summer, however, Ethereum might turn into the first large deflationary cryptocurrency which furthermore compensates holders with newly minted cryptos instead of miners. This will likely make Ethereum more appealing for holders.


Since Bitcoin launched in early 2009, Bitcoin and other later introduced cryptocurrencies have been based on a proof-of-work framework. In this framework, crypto miners are running and securing the network. In return, they are rewarded partly by fees paid by users of the network and partly by newly issued Bitcoins. The latter dilutes the value of Bitcoin held by Bitcoin holders due to the increased supply. In similarity with other assets such as gold and silver, Bitcoin is a so-called inflationary asset. To draw a parallel, you do not have to own gold to mine it. However, if you succeed in mining it, you fundamentally dilute gold holders due to the increase in supply. The fact that Bitcoin and other proof-of-work cryptocurrencies are inflationary has inevitably been a drawback to cryptocurrencies and decreased the appetite for investors to hold cryptocurrencies.

The rather newly deployed proof-of-stake consensus protocol has partially offset the aforementioned drawback with cryptocurrencies being inflationary. Proof-of-stake has been the consensus protocol in the majority of newly launched cryptocurrencies in the past years. As an alternative to compensating miners in proof-of-work, the proof-of-stake protocol compensates the fresh supply alongside the paid fees to the actual holders, providing they stake the native cryptocurrency, hence verifying transactions on the network instead of miners. This essentially means holders are not necessarily diluted by the fresh supply, fundamentally making proof-of-stake superior to proof-of-work for holders.

A true deflationary crypto-asset arises with transaction fees

By locking a part of your cryptocurrency in a staking protocol, you assist in validating transactions on the blockchain. The compensation received by stakers consists partly of newly minted cryptocurrency, partly with transaction fees paid by users of the blockchain. To make it attractive for holders to stake their cryptocurrency, at least one of these parts need to be large enough to put in the staking effort.

The main challenge in proof-of-stake arises from the fact that few cryptocurrencies generate substantial transaction fees to make it financially viable to stake without issuing a substantial fresh supply to reimburse stakers. For instance, the 9th largest cryptocurrency measured on market capitalization, proof-of-stake blockchain Solana with a significant ecosystem has on average generated $82,000 in transaction fees per day the last 7 days. With a market capitalization of $26bn, the yearly $30mn in transaction fees for Solana is not enough to sufficiently compensate stakers. To fairly compensate them, Solana allocates current yearly inflation of 6% – 8% by the issuance of new Solana to stakers. Based on this, the proof-of-stake protocol does not by nature turn the certain crypto into a deflationary asset.

Ethereum is the titan of transaction fees

At the time of writing, there is purely one crypto generating sufficiently high transaction fees to run the network with a limited net addition of newly issued cryptocurrency. This is the second-largest cryptocurrency namely Ethereum. Ethereum has generated an average of $9.6mn per day in fees for the past 7 days. In 2021, the cryptocurrency generated a total of $9.9bn from transaction fees. To put it into perspective, Coinbase achieved total revenue of $7.35bn in 2021.

The fees generated by Ethereum in 2021 have surely been impacted by Ethereum’s present scalability issues alongside the surged demand for speculative transactions such as NFTs. This has jointly increased users’ willingness to pay high fees for Ethereum’s limited transactional output. However, looking at the outlook, Ethereum might actually turn into a long-term deflationary asset.

It starts with a burn

In August 2021, the so-called London update was implemented on the Ethereum network. The London update contained a new fee market mechanism known as EIP-1559. In short, instead of compensating miners the entire transaction fee, it burns the majority, whereas it still compensates miners the newly issued Ether per block, around 2 Ether per block, which amounts to a total issuance of around 5.4mn ETH yearly.

By interpreting the numbers since August, the impact of the London update is surely vast. In total, around 1.97mn Ether has been burned, essentially offsetting the yearly 5.4mn ETH issuance by 60%.

Source: ConsenSys

Goodbye, miners

However, unless fees significantly increase, the burning mechanism does not turn Ethereum into a deflationary asset. Here, we must turn our attention towards Ethereum’s transition from proof-of-work to proof-of-stake. By around June or July, Ethereum will complete its consensus transition to proof-of-stake known as the merge, phasing out miners completely. Instead, holders are able to stake their Ether to verify transactions on the network. In return, stakers receive the non-burned part of the transaction alongside the new issuance. However, at the time of the merge, the issuance drops from the 5.4mn to 0.5mn ETH yearly, so stakers are compensated less than miners are today.

The less issuance entails, though, that the supply will most likely turn deflationary due to the Ether burned by transaction fees. If we assume that the burned Ether rate stays identical following the merge, the Ethereum supply is expected to decrease by 2.3% yearly. This signifies that non-staking Ether holders are also expected to benefit following the merge. On top of the deflationary supply, stakers are compensated the yearly issuance of 0.5mn Ether plus the non-burned transaction fees. The staking reward is expected to be as high as 10% yearly, depending on the total amount of stakers and non-burned transaction fees. In reality, if this will be the case, Ethereum will in our view not only turn deflationary but also disburse stakers considerably.

Source: ultrasound.money

The pull by traditional investors

Ethereum definitely has challenges to overcome, for instance, severe scalability constraints, regulation, and elevated competition from other smart-contract cryptocurrencies such as Solana, Cardano, and Polkadot. On the other hand, if Ethereum confidently belie these issues and ensures a constant and sustainable demand from users to execute transactions on its blockchain it turns deflationary while compensating stakers appreciable rewards. If such a demand is proven over time, as we see it, the new unique economics of Ethereum will make it more appealing for particularly investors not previously familiar with crypto. Not to mention that greater demand for handling transactions on Ethereum in the future will enhance the economics further since it increases the transaction fees. As we see it, this economic transition simply has the prospect of changing the broad sentiment to hold Ethereum. Likewise, this is true for other proof-of-stake cryptocurrencies in case they demonstrate substantial revenue from fees similar to Ethereum.

Quarterly Outlook 2024 Q3

Sandcastle economics

01 / 05

  • Macro: Sandcastle economics

    Invest wisely in Q3 2024: Discover SaxoStrats' insights on navigating a stable yet fragile global economy.

    Read article
  • Bonds: What to do until inflation stabilises

    Discover strategies for managing bonds as US and European yields remain rangebound due to uncertain inflation and evolving monetary policies.

    Read article
  • Equities: Are we blowing bubbles again

    Explore key trends and opportunities in European equities and electrification theme as market dynamics echo 2021's rally.

    Read article
  • FX: Risk-on currencies to surge against havens

    Explore the outlook for USD, AUD, NZD, and EM carry trades as risk-on currencies are set to outperform in Q3 2024.

    Read article
  • Commodities: Energy and grains in focus as metals pause

    Energy and grains to shine as metals pause. Discover key trends and market drivers for commodities in Q3 2024.

    Read article
Disclaimer

The Saxo Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-hk/legal/disclaimer/saxo-disclaimer)

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments. Saxo does not take into account your personal investment objectives or financial situation and makes no representation and assumes no liability as to the accuracy or completeness of the information nor for any loss arising from any investment made in reliance of this presentation. Any opinions made are subject to change and may be personal to the author. These may not necessarily reflect the opinion of Saxo or its affiliates.

Saxo Capital Markets HK Limited
19th Floor
Shanghai Commercial Bank Tower
12 Queen’s Road Central
Hong Kong

Contact Saxo

Select region

Hong Kong S.A.R
Hong Kong S.A.R

Saxo Capital Markets HK Limited (“Saxo”) is a company authorised and regulated by the Securities and Futures Commission of Hong Kong. Saxo holds a Type 1 Regulated Activity (Dealing in Securities); Type 2 Regulated Activity (Dealing in Futures Contract); Type 3 Regulated Activity (Leveraged Foreign Exchange Trading); Type 4 Regulated Activity (Advising on Securities) and Type 9 Regulated Activity (Asset Management) licenses (CE No. AVD061). Registered address: 19th Floor, Shanghai Commercial Bank Tower, 12 Queen’s Road Central, Hong Kong.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Trading in leveraged products may result in your losses exceeding your initial deposits. Saxo does not provide financial advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo does not take into account an individual’s needs, objectives or financial situation. Please click here to view the relevant risk disclosure statements.

The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit www.home.saxo/en-hk/about-us/awards.

The information or the products and services referred to on this site may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and services offered on this website are not directed at, or intended for distribution to or use by, any person or entity residing in the United States and Japan. Please click here to view our full disclaimer.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the US and other countries. AppStore is a service mark of Apple Inc. Android is a trademark of Google Inc.