The changes in the Ethereum infrastructure will have an impact on both the supply and demand sides, which creates a strong impetus for the price of ETH.
Original title: “The biggest change in history, what impact will it have on the Ethereum economic model and the value of ETH?” 》
Written by: Gideon Tay Yee Chuen
Translation: Block Rhythm
As July approaches, we are about to usher in a major change in Ethereum. According to previous news reports, in March this year, EIP-1559 was officially included in the Ethereum London hard fork upgrade, and the proposal is tentatively scheduled to be deployed to the Ethereum mainnet on July 14.
Ethereum has always been a leader in innovative encryption technology. The two major upgrades of ETH2.0 and EIP1559 and the Layer2 expansion solution are highly anticipated. These changes have significantly improved the scalability of Ethereum, thereby alleviating network congestion and reducing high amounts. The gas cost.
We know that the price of Bitcoin has always been at the top of encrypted assets. One of the reasons is that its upper limit is 21 million. The scarcity of things is expensive. As time goes by, when market demand exceeds supply, its scarcity will be magnified.
After the successful upgrade of EIP-1559 and ETH2.0, the infrastructure of Ethereum will change, so what will happen to its token economy? Will the issuance rate of ETH be affected by it? How will the change in the issuance rate affect the price of ETH?
Most of the articles I have read only analyze the unilateral changes of Ethereum. This article integrates ETH2.0, EIP-1559, and Layer 2 expansion, and discusses how these infrastructure changes will affect the ETH generation. A detailed analysis was made on the supply and demand aspects of the currency economy. This article is excerpted from Hacker Noon, the author is Gideon Tay Yee Chuen, an analyst from Singapore. Rhythm BlockBeats translated this article:
Ethereum will usher in a major change in the near future. The scale of this change will exceed most of the upgrades since Ethereum went live in July 2015, including ETH2.0, EIP-1559, and the increasing adoption of Layer 2 in the protocol. Expansion.
The main purpose of these changes is to increase the scalability of Ethereum, alleviate network congestion, reduce high gas fees, and improve network efficiency. These highly anticipated changes have emerged in the context of a surge in demand for Ethereum applications (especially DeFi and NFT applications), which have exceeded the current limits of Ethereum. High demand has led to a surge in Ethereum fees and the increasing success of competitors such as Solana and BSC.
While we are looking forward to this upgrade of Ethereum, it is also quite interesting to understand how changes in its infrastructure after the upgrade will affect the token economy (and price). Here, we outline these infrastructure changes, their timeline, and their potential impact on the ETH token economic model (and price) in the short and long term. This article hopes:
Integrate information and integrate all changes in Ethereum. Most articles only cover one aspect, some do not involve the token economy, and do not analyze how changes in the infrastructure will affect the token economy;
Discuss the impact of Layer2 on the price of tokens, which is not often discussed;
In addition to the usually discussed supply side, possible changes in the demand side will also be discussed.
Considering the length of the article, you can skip the parts you are familiar with.
ETH2.0
Overview : ETH2.0 can be divided into two main upgrades: PoS and sharding
PoS consensus mechanism
The setting of Beacon Chain is the first step in the ETH2.0 upgrade. It runs in parallel with the main Ethereum network. It introduces the PoS consensus mechanism into the Ethereum network and lays the foundation for breaking away from the current PoW consensus mechanism.
Under PoW, blockchain transactions need to be verified by miners who solve cryptographic problems, and these miners need to have high computing power. The first miner to solve the problem creates a block and is rewarded with newly minted ETH. At the same time, in PoS, users lock 32 ETH as pledge rights to become a verification node, and create and verify blocks like miners under the PoW mechanism. However, they will not compete for solving problems, but will be randomly selected to create blocks and get rewards. Therefore, participants will receive corresponding rewards based on the amount of ETH invested.
This reduces the energy consumption of the network, ensures decentralization by reducing expensive hardware requirements and encouraging the creation of more nodes, and makes the network more secure, because a large amount of ETH is required to launch an attack. This solves the security and decentralization problems of the blockchain ternary paradox. At the same time, the sharding technology of ETH2.0 solves the scalability problem.
Sharding
Graphical visualization of shards, from Quantstamp
Sharding divides a large database into smaller parts, called sharding. This increases scalability because verifiers do not need to store data for the entire network, but only need to store data for their allocated shards. Currently, ETH2.0 plans to have 64 shards, and the interaction between the shards is coordinated through the Beacon Chain. Whether shards should only provide additional data or whether they should also have code execution capabilities is still controversial.
Timeline: Beacon Chain will be launched at the end of 2020. The roadmap will include sharding in 2021 and join the Beacon Chain until it is finally merged with the Ethereum mainnet in 2022. At that stage, the existing old Ethereum chain will become one of many shards in the network.
ETH2.0’s impact on the token economy (supply side)
Under the current PoW system, the reward is 2 ETH per block and 1.75 ETH per uncle block (created when multiple blocks are mined at the same time, because only one block can be verified and added to the ledger). Please note that the rewards are higher before February 2019. At the current mining difficulty level, the average block mining time is about 13.15 seconds, and the annual issuance rate is about 4.5%.
Under the PoS mechanism of ETH2.0, the additional issuance rate is much lower. Based on some reasonable assumptions, the additional issuance rate is expected to be between 0.5% and 1%. Since the issuance rate depends on several factors, it is difficult to give an accurate rate:
- The number of ETH pledged / the number of validators: More validators usually result in more ETH pledged in the network. However, as the rate of return of staking by validators decreases, their willingness to staking also decreases as more validators appear, and the amount of ETH that is ultimately staked will also be limited.
- The verifier’s malicious behavior : If the verifier is offline or deliberately verifying the wrong transaction, they will be punished with ETH forfeiture.
The above factors may lead to a decrease in the issuance rate.
In general, the pilot phase of ETH2.0 before merging with the mainnet will result in a short-term increase in the supply rate, because both PoW and PoS systems will issue ETH. However, the combined ETH2.0 will lead to a significant drop in the supply rate.
EIP-1559
Overview : EIP-1559 changes the fee structure of Ethereum and introduces the destruction of basic fees
According to EIP-1559, the transaction fee currently consists of two parts: the basic fee (to be destroyed) and an optional tip for miners. Tips incentivize miners to process transactions first when the transaction volume is large.
The gas limit of each block is 12.5M to 25M, but over time, the target for the average block size is 50% or 12.5M. This can be achieved by increasing the basic fee when the block capacity exceeds 50% (when the network is congested) and reducing the basic fee when the block capacity is below 50%.
These changes reduce the need for users to guess the gas price required for their transactions. Compared with the previous “first bidding model”, this change has resulted in a more effective charging system and less fee payment.
Timeline: The London Hard Fork in July 2021 will be included along with other EIPs.
The impact of EIP-1559 on the token economy (supply side)
The basic cost of burning will reduce the supply of ETH according to the amount of activity in Ethereum, because when the network is crowded, in order to meet the goal of 50% block utilization, the basic cost will increase. It is difficult to estimate the extent of its impact, because it is heavily dependent on the amount of Ethereum network activity. It is also inaccurate to use the current transaction cost as a measurement standard, because we are not sure of the ratio between the basic cost and the tip. Some people believe that the implementation of EIP-1559 will greatly reduce the net additional issuance of ETH, thereby causing ETH to enter deflation.
Layer2 / Non-Layer1 expansion solution
Overview : These solutions will not change the infrastructure of Ethereum (Layer1). Instead, they reduce network congestion by processing transactions off-chain. In addition to improving scalability, some solutions also provide privacy for this blockchain world where all transactions are public.
We call them Non-Layer1 expansion solutions, because some solutions (such as side chains) are not technically Layer 2 and they are not directly protected by Layer 1. Below is a brief overview of some expansion solutions:
ZK Rollups : Only the transaction data about the state (such as account balance) before and after will be recorded on the Ethereum main chain, and the state and execution of the transaction will be performed off-chain. The smart contract processes transactions in batches in Layer2, updates the final state in Layer1, and uses encrypted proof (SNARK) to confirm that the final state recorded in Layer1 is accurate.
Optimistic Rollups : The principle is basically the same as ZK Rollups, but Optimistic Rollups does not need to use SNARK to prove the accuracy of the final state of each record in Layer 1, but assumes that all records are updated accurately. Only when someone doubts that the status update is incorrect will it be verified, the fraudster will be punished, and the doubter will be compensated for this.
State channel : Establish a channel between parties to form an off-chain network, perform frequent transactions on the off-chain network, and update the final state of the transaction on Ethereum.
Side chain : Transactions are carried out in an independent blockchain and have their own consensus mechanism. Assets and data are transmitted with Ethereum through smart contracts. The smart contract will lock the assets on the main chain and recreate the same amount of assets and data in the side chain.
Plasma chain : Similar to a side chain, it has its own consensus mechanism as an independent chain. The sub-chain will periodically submit the root hash to the main chain for consensus, which makes the system more secure, but limits its ability to perform complex business operations.
Non-Layer1 scaling solution changes to the token economy (supply side)
Until EIP-1559 is implemented in July 2021, the expansion solution will not really affect the ETH issuance rate. However, since these solutions are closely related to network activity and transaction fees, and EIP-1559 improves the relationship between transaction fees and ETH supply, some interesting effects will follow:
Dampening effect : The reduction in unit transaction volume generated by on-chain activities and applications will reduce the basic cost of burning under EIP-1559, which inhibits the deflationary effect of EIP-1559.
Counterbalance effect : The lower transaction fees provided by the expansion solution attract new price-sensitive users and increase user participation in the application. To a certain extent, the increase in participation can offset the decrease in the amount of destruction of basic expenses caused by low activity on the main chain. Overall, the “real demand” of the Ethereum network may remain unchanged.
New activity effect : It can be considered that the nature of some expansion solutions will make possible new economic activities on Ethereum. For example, high-frequency interaction between the two parties through the status channel is impossible if it is on the main network. If these new economic activities are introduced into Ethereum, the periodic interaction between off-chain and on-chain can still produce the destruction of basic expenses, then the supply of ETH will also be further reduced.
Over time, it is difficult to determine the final effects that may change. The final effect depends on:
The degree of adoption of the expansion solution;
The number of new economic activities that will enter the Ethereum ecosystem;
The net impact of the scaling solution on the “real demand” of transactions on the Ethereum chain.
Non-Layer1 expansion solution changes to the token economy (demand side)
These changes are likely to lead to an increase in the demand for ETH and an increase in the inflow of legal currency, and attract investors through the following methods:
Improve the attractiveness of ETH as an asset : ETH2.0 converts ETH into productive assets, which can generate cash flow through pledges. According to media reports before the implementation of EIP-1559 in July and the rise in ETH prices, the deflationary impact of EIP-1559 on ETH supply seems to have attracted many investors.
Improve awareness through use : ETH2.0’s sharding and Layer2 expansion solutions improve the scalability of Ethereum and reduce transaction costs per “unit” network demand. This makes Ethereum easier to be used by users with smaller transaction scales, prompting users to further use and understand the applications in the ecosystem and ETH itself. This increases the pool of investors interested in buying and holding ETH.
Combine the above:
A graph showing the impact of changes in the Ethereum infrastructure on the supply and demand of ETH. Arrows indicate expected changes over time, and the size of the box indicates uncertainty
The above figure explains the development process and time point of “ETH2.0” and “scaling solution”
The following is a brief overview of the positioning of the 3 elements in the chart:
ETH2.0
Short-term: ETH2.0 will increase the issuance rate of ETH during the test period. The purpose of investors buying ETH is to obtain a return through pledge, which has led to an increase in demand.
Long-term: After ETH2.0 merged with the Ethereum mainnet, the issuance rate dropped significantly. As people’s awareness of ETH2.0 increases, the demand for ETH will also increase.
EIP-1559
When EIP-1559 is implemented in July, the basic fee will be destroyed, which will cause the ETH issuance rate to drop significantly. In terms of demand, this is the main factor influencing the ETH price to continue to break historical highs in April and May 2021.
Although the impact of the implementation of EIP-1559 on the issuance rate is expected to be significant, it is difficult to determine the exact extent of the impact due to the uncertainty of the future network activity volume and the ratio between the basic cost and the miner’s tip.
Expansion solution
Short-term: Before the implementation of EIP-1559, the issuance rate of ETH was not affected. With the implementation of some expansion solutions, it has gradually attracted users with smaller transaction scales and increased their participation in Ethereum, which has had a positive impact on the demand for ETH.
Long-term: According to the three effects discussed above, we can know that the final effect of the issuance rate cannot be accurately predicted. We boldly guess that it will be close to zero. Due to the “new activity effect”, more new economic activities will be added to Ethereum through expansion solutions over time. In the long run, this will lead to a slight decrease in the issuance rate. This is expected to have a significant positive impact on the demand for ETH, as it will increase the participation of potential users of Ethereum, thereby increasing the number of potential investors interested in buying ETH.
to sum up
All the above graphs and our discussions point to the fact that changes in the Ethereum infrastructure will affect both supply and demand, which creates a strong impetus for the price of ETH. However, as the price of ETH continues to break historical highs, many people begin to think about how high the price of ETH can reach, and whether these positive factors have been completely digested.
My personal opinion is that even if ETH will experience more bulls and bears, its value will be far more than it is now in 10 to 15 years. Here is my three-step reasoning:
Innovation in the cryptocurrency field will disrupt many industries, especially the financial industry, and will create and obtain a lot of value in the process;
So far, Ethereum has been a leader in innovative encryption technology, and changes in infrastructure are improving its scalability, thereby improving its ability to dominate the market;
EIP-1559 links the success of Ethereum with ETH.
