Ethereum has like Bitcoin a fixed block reward. That reduces global inflation rates over time. Does this alone make Ethereum deflationary?
No, Ethereum is not deflationary because it has no fixed supply. The global inflation rate gets reduced over time because Ethereum has a fixed block reward.
Understanding fixed block rewards
The table below gives you a simple example of how most crypto projects benefit from fixed block rewards. With fixed block rewards, the mined coin rate stays the same every year. But the global inflation rate goes down every year. Let’s imagine a cryptocurrency has already a supply of 100 coins and there are 100 coins mined every year.
|Year||Supply||New coins / year||Inflation rate|
The table above shows you that the inflation rate is measured in percentage. It gets lower every year. This is good because mined coins don’t have a huge influence anymore if there are more coins in circulation. What would happen if let’s say the inflation rate is 100% every year?
|Year||Coins in circulation|
As you can, it grows fast and you want to spend your coins as soon as possible because they are worth 100% less every year. So, let’s say you had 1 coin in year 0 and it had the purchasing power of 1. At the end of year 3, you would still have 1 coin, but it would have a purchasing power of 0.125.
So, why is Bitcoin deflationary and Ethereum not?
Bitcoin is deflationary because it has a fixed supply. So, if somebody loses his coins, all others in the Bitcoin network enjoy it. Afterward, there are fewer coins in the Bitcoin network. Besides that, nobody replaces the lost coins. So, the asset is deflationary.
With Ethereum, there is no maximum supply and thus, there is always inflation. For instance, if somebody loses his coins, the supply of Ethereum would be reduced. Sooner or later, the supply will get to the point where the supply is equal to the older supply.
Why locking up 32 ETH for staking doesn’t mean that the asset is deflationary
People are talking about the validator nodes in ETH 2.0 have to lock up 32 ETH to take part in the network. A validator earns some block rewards with staking. But, this makes Ethereum not deflationary. It reduces the supply of Ethereum until this person decides to use the coins. For instance, to sell it. If the validator gets penalized, sooner or later, the network would increase the supply by 32.
The reason why Ethereum will never be deflationary
Ethereum supports smart contracts. This is one of the main reasons why the Ethereum ecosystem needs new coins. Developers need new coins to launch new platforms or services, also called dApps. Ethereum is a platform for tokens. So, it has low block times to execute smart contract changes as fast as possible.
By inflating the ecosystem, you can stabilize the prices of the asset. It means you don’t have to pay $10 per transaction because the price of Ethereum exploded. I’m excluding the fact here that cryptocurrencies are volatile.
You have to pay for every interaction with a smart contract. Let’s have a look at the Defi system of Ethereum. If you want to lock up assets in a liquidity pool, you have to make a transaction. If you want to withdraw the profits, you have to make a transaction. If you want to withdraw the generate governance tokens, you have to make a transaction. If you want to withdraw your tokens from the liquidity pool, you have to make a transaction.
When would Ethereum be deflationary?
If the circulating supply of ETH gets reduced faster than new coins get mined. Theoretically, Ethereum would then be deflationary even with no maximum supply. Ethereum currently has a block reward of 2 and an average block time of 15 seconds. That results in 4.204.800 ETH/year. There are only two ways to reduce the supply of ETH.
- Burn coins
- Tokenize it
Burning coins or ETH means that you send your coins to a burn address. The significant catch here is that nobody can find the private keys for a burn address. That’s why the addresses are called burn addresses. The most common Ethereum burn addresses is 0x000000000000000000000000000000000000dEaD.
You could also reduce the supply of ETH by wrapping it into WETH. You could reduce the ETH supply this way. You do that to take part for instance in the Defi space and get earning for your ETH. You can only do this by tokenizing your ETH. On the other side, you can always unwrap that WETH and get your ETH back.
We know that Bitcoin has a maximum supply. If coins get burned, they reduce the total supply, even in the future. That makes the asset deflationary and a good store of value.
Does Ehereum has block halvings?
No, Ethereum has no block halvings like Bitcoin every 4 years. In the past, Ethereum had block rewards of 3 ETH. Now, after Constantinople, ETH block rewards are 2.