How will the monetary policy be affected by the launch of Ethereum 2.0?


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After Ethereum 2.0 “Phase 1.5”, the ETH inflation rate may drop below 1%. At that time, Ethereum’s inflation rate will be much lower than Bitcoin.

Written by: Ryan Watkins, Messari Research Analyst Translation: Lu Jiangfei

Ethereum is often criticized for its “easy” monetary policy, but the situation may change as ETH 2.0 starts to be launched.

The real change will happen in “Phase 1.5”-that is, after the merger of Ethereum 1.x into Ethereum 2.0. At that time, the annual inflation rate of ETH tokens may drop significantly. Even if negative inflation cannot be reached in a short period of time, it will drop below 1%. At this time, the inflation rate of Ethereum will be much lower than that of Bitcoin.

Why is Ethereum’s inflation rate lower than Bitcoin?

If you are an “Ethereum skeptic”, you might think at this time: How can the inflation rate of Ethereum be lower than that of Bitcoin? In fact, all of this is related to the shift from a Proof of Work (PoW) consensus mechanism to a Proof of Stake (PoS) in the Ethereum blockchain.

In theory, one of the core value propositions of the equity proof mechanism is that the token pledger is willing to pay higher capital costs when receiving rewards. The reason for this is that on Ethereum 2.0, the token pledger only needs to face the opportunity cost of investment, and will not bear any depreciation risk (such as ASIC mining machine depreciation).

In fact, the slightly higher cost of funds is a good thing, because it will increase the cost of Ethereum attacks. It also means that Ethereum only needs to provide less dollar rewards, that is, ETH issuance, and it can get the same level of security . In other words, the proof-of-stake consensus mechanism allows Ethereum to issue fewer ETH tokens to achieve the same security.

In the Ethereum improvement proposal EIP 1559, a proposal to reduce the consumption of transaction fees is proposed. If this proposal is combined with the continuously lower ETH issuance, it is likely to mean that the annual issuance rate of Ethereum will become negative in the future, but at the same time, the network Security will not be affected.

“Minimum necessary circulation”

However, we expect to wait 12-24 months to complete “Phase 1.5”. During this period of time, the annual issuance of ETH tokens will actually continue to increase, because before the merger of Ethereum 1.0 and Ethereum 2.0, token issuance will still be carried out on the Ethereum 1.x blockchain.

It should be noted that this incremental issuance trend is only temporary.

How will the monetary policy be affected by the launch of Ethereum 2.0?

The above picture shows the ETH token issuance trend from the upgrade of Ethereum 1.0 to Ethereum 2.0. Some people may doubt this: “The monetary policy of Ethereum seems to be too liquid and unstable.”

Indeed, because Ethereum’s monetary policy is not strict, it is normal to have this suspicion to some extent, but at the same time, they also ignore the real Ethereum monetary policy.

In fact, the monetary policy of Ethereum can be defined as the “minimum necessary issuance”, that is, the minimum issuance necessary to ensure that Ethereum can maintain security. Although this concept may seem subjective, in fact, like any other protocol deployment parameters, Ethereum’s monetary policy is also implemented through community consensus.

Not only that, but Ethereum’s monetary policy is also optimized specifically for security. This is obviously different from Bitcoin’s monetary policy. Bitcoin follows a “perfect monetary policy” that not only has a fixed money supply, but also a clear currency issuance schedule. Of course, the advantage of Bitcoin’s monetary policy is that it is easier to understand.

Security vs. Perfect Monetary Policy

However, there are trade-offs between the two monetary policy methods of Ethereum and Bitcoin, and there are also some problems, such as:

  • Ethereum’s monetary policy may be difficult to quantify and communicate;
  • Bitcoin’s monetary policy may be difficult to determine a cybersecurity budget.

The monetary policies adopted by Ethereum and Bitcoin are not the same. The consequences of this and how different monetary policies will affect their role as “currency” deserve community attention.

For cryptocurrency networks, is security more important? Or is “perfect monetary policy” more important? It seems that there is no final answer yet.

Finally, we want to raise a question: if Ethereum transforms to a consensus mechanism for proof of equity, ETH tokens will become more rare than BTC, and the security model will be more sustainable. At this time, it means that the currency attribute of ETH and the currency attribute of BTC also means what? This question deserves more discussion, and there is no standard answer.

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