ETH's Scarcity Engines - The Daily Gwei #317

3 engines to power a rocket ship to the moon and beyond.

You may have heard/watched Ethereum researcher Justin Drake speak about ETH’s “scarcity engines” on a recent series he did with Bankless. In these podcasts, he describes how ETH has 3 major scarcity engines that will, over time, compound in nature to turn ETH into the most scarce and in-demand asset the world has ever seen. In today’s piece, I’m going to extend on his work and give my own breakdown of how this all comes together.

Alright so ETH’s first scarcity engine is its use as a staking asset on the Beacon Chain and there’s now over 7 million ETH ($22.5 billion) actively staking. While this ETH is being staked, it is locked up and cannot be used elsewhere within the crypto ecosystem (though there are derivatives of this staked ETH). The rate of return on this staked ETH is currently around 5.9% a year (from just protocol issuance) and is ETH-denominated which effectively turns staked ETH into Ethereum’s “native bond”. Though this only tells half the story - the other half is that this staked ETH is being used to directly secure the network which strengthens Ethereum’s decentralization and gives people more confidence in building on it and using it.

ETH’s second scarcity engine is its use as a trustless collateral asset within Ethereum’s bustling DeFi ecosystem. According to DeFi Pulse, there is 9.6 million ETH currently being put to work across over 50 DeFi applications. Now, to be clear, not all of this ETH is actually “locked in DeFi” as much of it is being used to provide liquidity to DEXs such as Uniswap, Curve, SushiSwap and Balancer where this ETH is actively traded. Though I don’t think this diminishes the effect DeFi has as one of ETH’s scarcity engines - it simply shows that there is a diversity of use-cases for ETH within DeFi.

ETH’s third scarcity engine is everyone’s favorite EIP-1559 burn mechanism and this mechanism has now burned more than 67,000 ETH (over $200 million) in just the first 15 days of it being live on the network. EIP-1559 is special because it has a far greater impact on ETH’s scarcity than the other 2 engines as the ETH burned is literally gone forever - whereas with staking and DeFi collateral, the ETH can always be reintroduced to the market at a later date. Though I don’t view these facts as a negative - I actually think EIP-1559 offsets the possible release in supply of the other 2 engines due to its burn which brings me to my final point about how this all ties together to form a near-perfect scarcity system.

Let’s talk about these scarcity engines in the context of Ethereum under a proof of work system vs a proof of stake system. Currently, under PoW, the Ethereum network is issuing roughly 4.2% a year in new ETH to pay miners to secure the chain and if we take the annualized burn amount into account, this new issuance nets out to roughly 3.2% a year (because 1% is being burned yearly). Now, the real fun begins when we consider what this issuance looks like under a full PoS Ethereum where the yearly issuance (based on current staked ETH amount) is 0.6% and is paid to stakers/validators for attesting to and proposing blocks. If we apply the annualized burn to this number, the yearly issuance works out to -1.1% a year. Yes, that’s right, the yearly issuance of ETH would be net negative under a PoS system (based on current fee burn rate and ETH staked amount).

As you can see, ETH is well on its way to becoming the most scarce asset in the crypto ecosystem (and possibly the world). Though of course, scarcity is only one side of the equation, there also needs to be demand for ETH to take advantage of the scarce supply - luckily, ETH has an incredible demand side. This is because demand for staking ETH will continue to skyrocket (as it’s effectively Ethereum’s native bond), demand for using ETH in DeFi will obviously increase greatly over time (as its the most valuable, liquid and trustless collateral asset on Ethereum) and all of the activity on the Ethereum network will only continue to increase (as will fee revenue) which means ETH will keep getting burned.

None of us own enough ETH.

Have a great weekend everyone,
Anthony Sassano

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All information presented above is for educational purposes only and should not be taken as investment advice.