What effects will the decline in inflation have on Ethereum?
2022 was disastrous for most digital currencies, and Ethereum and Bitcoin made no exceptions. However, they kicked 2023 with a bang and surged in prices in January as worldwide inflation continued to moderate.
Ethereum greatly benefited when the market regained some of its strength and registered a 31% increase in market capitalization during the year's first weeks. Experts believe that factors like the heightened anticipation among the crypto community and the moderation of inflation are the main triggers. It's crucial to highlight that inflation impacts digital currencies' stability and value over time. If you want to find out what is the price of Ethereum currently, visit an online exchange platform that provides information about the evolution of cryptocurrencies. During times of low inflation rates, the cryptocurrency supply is shorter, which triggers an increase in demand and a spike in value. On the other hand, high inflation rates often result in lower demand and, therefore, a decrease in digital assets' value.
In addition, some digital currencies like Bitcoin have been designed with a limited supply, and the mining process decreases the supply as the coin gets closer to the moment it'll reach its maximum amount. Controlled inflation is a linchpin of the flagship asset. Even if Ethereum wasn't initially created to have a limited supply, it's moving toward a state of scarcity.
Drop in Ethereum Inflation
In June 2021, the Ethereum ecosystem launched the EIP-1559 upgrade, which took it closer to deflation. The upgrade introduced fees for all transactions completed on the Ethereum network, limiting the amount of cryptocurrency circulation on the blockchain and solving the excessive transfer demand issue.
Unfortunately, the upgrade isn't enough to transform Ethereum into a deflationary asset because there's still a huge amount of coins in circulation; even part of them are being burned. The Merge, completed in September 2022, could mark a turning point in Ethereum's journey toward deflation.
The Ethereum community highly awaited the Merge, and it didn't disappoint them because it allowed the blockchain to switch from a proof-of-work to a proof-of-stake model, cutting down the block mining needs and boosting the network's efficiency. The Merge caused the supply of Ethereum to slow down, which could cause deflation in the long run.
This is tremendous news for Ethereum investors because the blockchain had burned more tokens after the Merge than it did since the start of 2022.
What does this mean for Ethereum?
As mentioned earlier, a low inflation rate is generally beneficial for cryptocurrencies, but it could have a couple of drawbacks. One issue is the lack of incentive to spend digital currencies, which can trigger a decline in innovation and a possible deflation spiral.
Nevertheless, Ethereum supporters believe this won't affect the ecosystem because it has the most diverse utility cases in the sector, like non-fungible tokens, stablecoins, decentralised finance, and smart-contract characteristics. Ethereum will likely experience growth in the following months due to its deflation. However, investors wait for it to demonstrate its ability to overcome inflation in the long run before making significant investments.
Industry experts also highlight that the preparations for the Shanghai event in March could divert attention away from the blockchain's deflationary momentum, which might mean it won't benefit from it for a while.
What to expect from Ethereum 2.0?
The Merge allows Ethereum to transition to the proof-of-stake consensus mechanism. The update brought a new version of the blockchain, which experts refer to as Ethereum 2.0, which is less energy-intensive and more accessible and scalable. However, investors want to know how the ETH prices will react to this update because it impacts the altcoin's value.
The switch from a PoW to a PoS transformed miners into stakers, requiring them to put their ETH tokens in smart contracts if they wanted to get a reward for validating blockchain transactions. Ethereum developers stated that validators need to stake at least 32 ETH to qualify for getting a reward. Crypto reports state that the Merge and the staking will cut down the circulating supply of Ethereum. Before completing the Merge, by 29 August 2022, over 13.7 million tokens were staked on the Beacon Chain.
Let's remember that Ethereum also introduced the improvement proposal EIP-1559 which institutes a burning of base gas fees that aims to reduce the number of coins circulating on the blockchain. Ethereum supporters state that the fee burning and the staking process will dampen the supply of ETH coins and position Ethereum into a deflationary monetary policy. Compared to Bitcoin's limited supply, Ethereum's updates could cause a more robust inflation reduction in the long term.
Investors could perceive Ethereum's switch towards a deflationary monetary policy as an extra benefit besides offering the smart contracts feature. Now that Ethereum no longer relies on PoW, it's also less scrutinised regarding energy consumption because it reduced it by 99.95% compared to previous expenditures.
At the same time, some crypto experts state that Ethereum's deflationary supply can be a double-edged sword because it makes it a world computer instead of a world currency (and it's supposed that digital currencies were created for the second purpose). A lower ETH supply benefits investors but becomes a drawback for those who want to create, run, and use smart contracts on the blockchain because they deal with pricier transactions. And while the Merge didn't solve the blockchain's expensive gas fees, Ethereum developers state that they'll provide scaling solutions to cut down the associated costs. They highlighted that switching to a PoS consensus is an essential precursor to cutting down gas fees. And data shows that the rate of ETH issuance decreased dramatically since the Merge.
Even if a couple of months have passed since the Merge, things are still far from settling. Making a long-term prediction for Ethereum's value is challenging, but the ETH price will also increase as the blockchain gets more widely adopted. At present, Ethereum is the most popular and used network by developers of dApps, and the Shanghai upgrade will most likely transform it into a more attractive digital asset.