This article examines the negative impact of technology on Ethereum from several supply perspectives. The article is written by Ping Chen, the founder and CEO of Pelith.
(Table of Contents:
Outlook for Q2 Cryptocurrency Market: Bullish on Bitcoin, Focus on Restaking, AI, and Modular Track
)
(Background:
Ethereum Researcher: Electra Upgrade Should “Reduce ETH Issuance” to Benefit Individual Stakers
)
Contents:
Technology Drives Prices (Right?
Example of EIP4844
Example of Restaking
Outlook for the Future
Whenever there is news about new technology, the market often believes that it will drive demand and increase the price of some coins while lowering the price of others. For example, some people call this year the “staking year,” and after the launch of EigenLayer, applications like Restaking have emerged one after another. The market believes that the amount of Ethereum staked will increase, therefore increasing the demand for Ether and causing the price to rise.
However, when it comes to the impact of technology on coin prices, there is also a perspective from the standpoint of changes in the supply-demand curve and basic economics, such as in this EIP1559 article. Because protocol changes are closely related to currency issuance, we need to understand how new technologies in the blockchain field shape price equilibrium in a longer-term manner.
Once the supply-demand curve moves, the impact of fundamentals is stronger and longer-lasting. For example, the recently launched EIP4844 is expected to reduce the cost of Ethereum transactions by 90-99%, and the cost of computation has already become very low due to Layer 2. This significantly reduces transaction fees, making them more affordable and user-friendly.
In theory, the reduction in transaction fees should promote an increase in Ethereum usage. Increased demand should lead to a price increase. However, burning transaction fees is the deflationary source of Ethereum. A significant reduction in transaction fees means a lower amount of Ether burned, resulting in an increase in the circulation of the currency. At this point, the supply curve of Ether moves to the right, and the price of Ether will decrease due to the increase in supply.
However, the impact of fundamentals may be more profound. After all, EIP4844 will make transaction costs very low, which may significantly increase the number of Ethereum users, surpassing the loss of low transaction fees with network effects. Therefore, most people still believe that the impact of EIP4844 on the protocol is positive. More precisely, the reduction in transaction fees will cause the supply curve of Ether to move to the right, but if the number of Ethereum users increases significantly, the demand curve will move even further to the right, resulting in a price increase.
How does this dynamic relationship between supply and demand reach equilibrium? No one can say for sure. Once the updates are implemented and start operating, they will disrupt the market. We may see price fluctuations due to changes in supply and demand. This is not contradictory to short-term price stimulation; it’s just that long-term market changes are obviously more worthy of our attention.
Another hot topic, Restaking, is also suitable for illustrating how new technologies rewrite supply-demand balance in the long term.
Now Ethereum PoS validators can use the same collateral to earn additional income. We can observe a significant increase in the demand for Ether in the market. People buy Ether as collateral, lock it, and then re-stake the same collateral to earn additional profits. This is a typical credit creation model in the traditional financial world.
You don’t need to understand complex currency theories; just think about the following statement: the economic incentive for restaking encourages more people to buy Ether as collateral, thus increasing the demand for Ether, while locking it reduces the circulation of the currency. With increased demand and reduced supply, the price of the coin will naturally rise. It seems logical and fully consistent with rational economic reasoning. But is it really that simple?
There are some blind spots that need to be clarified. Once you restake your assets, you cannot immediately respond to market fluctuations during the lock-up period. Moreover, your collateral can be used to run nodes and help run an oracle (or any application), so no matter which side you do something wrong, the same collateral will be slashed, resulting in immeasurable risks. Currently, Restaking is generally viewed positively in the market, partly because of the bullish cryptocurrency market, which temporarily avoids liquidity issues caused by a large amount of locking.
In addition, although the economic incentives of Restaking may stimulate price increases on the surface, it is actually bad news for monetary policy.
Because the mining reward formula for Ethereum PoS is different from PoW. PoW has a fixed yield, with each person receiving 1/n when n people mine. PoS has a smooth square root relationship between the number of mining nodes and mining rewards. For example, when there are 100 nodes, 1 ETH is produced each time, and each person receives 0.01 ETH. When there are 400 nodes, 2 ETH is produced each time, and each person receives 0.005 ETH.
This design is to make the impact of the staked amount on income less drastic. The problem is that the PoS mining reward will increase with the increase in nodes, and the economic incentive of Restaking will increase the willingness to stake, thereby increasing the number of stakers.
Suppose the original supply-demand equilibrium point was a 4% PoS interest rate. Restaking provides an additional 2% interest rate, which will increase the number of stakers, while the original mining interest rate will decrease. The new equilibrium point may be 3% (PoS) + 2% (Restaking), and players who restake can earn a total of 5% interest. However, Ethereum will accelerate its inflation due to the increase in nodes, resulting in price inflation.
Although it does increase individual benefits, when viewed from the overall environment, the result of price inflation is a decrease in the coin price. At this time, players who restake hold more Ether, but the total value of their assets may depreciate. Players who do not restake are even more unlucky, as they do not earn coins but suffer from inflation. Therefore, this technology that increases more returns on PoS nodes is actually harmful to the underlying protocol’s monetary policy.
Of course, it cannot be ruled out that Restaking may indeed create a large number of new applications (and corresponding new “value”), but it also inevitably brings excessive collateral that does not contribute to security and additional inflationary pressures to the chain. For this reason, protocol developers are actively developing the concept of minimum viable issuance and discussing several solutions to reduce inflation and restrict ETH from entering PoS staking.
When we look at EIP4844 or Restaking, the market should consider not only whether the demand for Ether will increase and whether the price will rise, but also the unknown impact of new technologies on the supply curve. However, the short-term incentives driven by information are still attractive. It’s better to buy more ETH.
Related Reports
Fully Understand “Restaking”: What Are the Risks and Countermeasures?
Why is A16z heavily invested in EigenLayer? Detailed Explanation of the Value and Economic Security of Ethereum’s Restaking Protocol
Commentary: Is Restaking an “Triangle Debt” or “Mild Inflation” Cryptocurrency Product?)