The depletion of Ether (ETH) supply, a trend that has been rapidly gaining momentum in recent weeks, experienced a notable upswing. Ether is the cryptocurrency that fuels the Ethereum blockchain, known for its smart-contract capabilities and dominance in the realm of Decentralized Finance (DeFi).
Last Saturday, the annualized burn rate, a consequence of Ethereum Improvement Proposal 1559, surged to its highest level since May, reaching 5.679%. This surpassed the Ether issuance rate of 0.578% by a substantial 5.101%. Although the deflation rate has since moderated to approximately 1.75% as of March 15th, it signifies a significant shift.
During a weekend marked by extreme volatility in cryptocurrency markets, coupled with uncertainty stemming from major regional US bank collapses and the subsequent policy responses, Ether traded around the upper-$1,600s. Earlier in the week, it had reached multi-month highs exceeding $1,700.
The spike in the Ether burn rate coincided with an increase in Ethereum gas prices, the fees imposed on users of the network, reaching levels not seen since May. A sustained rise in demand for the Ethereum network, leading to heightened network congestion, is expected to drive further increases in Ethereum gas fees. This, in turn, would contribute to an accelerated deflation rate for the cryptocurrency. Such a trend in deflation is anticipated to act as a long-term positive factor for the price of ETH.
Explainer – What is Driving the Accelerating ETH Deflation Rate?
To comprehend the factors driving the increase in the ETH deflation rate, it’s essential to first understand why ETH experiences deflation. This involves delving into the Ethereum network fee structure.
Network fees on Ethereum are comprised of two main components. The first is a mandatory base fee that all users must pay to ensure their transaction is accepted and processed on the blockchain. Additionally, there is an optional tip that users can include to expedite the processing of their transaction. The Ethereum network autonomously calculates the base fee, which escalates during periods of heightened network activity.
The pivotal Ethereum Improvement Proposal (EIP) 1559, integrated into the Ethereum code during the London hardfork in August 2021, mandates that all base fees paid by users are burned, permanently removing the corresponding tokens from circulation.
Consequently, as the base gas fee increases, the rate at which Ether is burned also rises. When this burn rate surpasses the ETH Issuance Rate, which stands at around 0.55%, the overall supply of ETH diminishes. ETH is issued to the nodes and stakers responsible for securing the Ethereum network.
In essence, the deflationary mechanism is a consequence of the intentional burning of Ether through network fees, a process initiated by EIP-1559, which, in turn, affects the balance between the deflation rate and the issuance rate.