Why Is ETH A Scarce Asset?

Which factors drive scarcity of ETH and how much of an impact do they make?


Hey DEFI TIMES community,

Justin Drake is probably the most influential thinker when it comes to ETH’s scarcity as an asset.

He explained the term “scarcity engines” quite a lot of times already. Scarcity engines are basically the main drivers for ETH’s scarcity. In essence, there are three of them:

  • Staking

  • DeFi

  • EIP-1559

Each of them reduces the available supply of ETH sold on the open market.

In this newsletter, we talked a lot about the effects of EIP-1559. By burning the majority of the transaction fees, we will reach a deflationary environment at some point in the future - at least when the merger happens.

However, EIP-1559 is not the only reason why ETH is a scarce asset. Today, we go through each of these scarcity engines and explain their long-term effects!


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Why Is ETH A Scarce Asset?

ETH’s Scarcity Engines

There are basically three different types of scarcity engines. Each of them reduces the available supply of ETH that is sold on the open market.

1) Burn: The first and most obvious one is EIP-1559 - We talked about it so often in this newsletter! EIP-1559 introduced a BASEFEE - a universal transaction fee that almost guarantees block inclusion. This particular transaction fee is burned. 

That means, every time you send a transaction, you contribute to ETH’s scarcity as an asset. The more Ethereum is being used, the scarcer ETH gets. EIP-1559 alone could turn ETH into a deflationary asset, which will happen after the merger is implemented. 

As of right now, more than $280 million have been burned already, which is an incredible amount of money considering the fact that EIP-1559 launched only three weeks ago! Without EIP-1559, these $280 million dollars would have directly to the miners, who would have dumped them to cover their electricity bills! 

However, with EIP-1559 the majority of transactions fees is paid indirectly to the users. Ultimately, the community profits because ETH becomes scarcer. What does that do to the ETH price?

EIP-1559 is probably the most important factor when it comes to ETH’s long-term value proposition. EIP-1559 is truly game-changing in the long run!

2) Staking: The second (and maybe less obvious) scarcity driver is staking in general. With the launch of the Beacon Chain, the era of ETH staking has officially begun. It all started in November 2020. Since then, over seven million ETH have been deposited into the ETH 2.0 staking contract… And it is steadily growing every day!

Whenever you put your ETH into the staking contract, you are unable to move them for some time. This, of course, means that you cannot sell them, which ultimately reduces the amount of ETH sold on the open market. Staking ETH makes ETH scarcer - at least as long as it’s sitting inside the contract.

Right now, you have to wait a long time before you receive your ETH back. In fact, you won’t be able to unstake it before the merger. It’s unclear when this will happen. Some people believe that the merger will happen by the end of this year. However, I think it’s very unlikely because we usually face unexpected bugs in software development. In my opinion, it’s realistic to expect the merger in Q1 or Q2 2022.

Until then, all ETH in the staking contract is locked and cannot be sold. Every time someone stakes their ETH, ETH is getting a little bit more scarce... Slowly but surely!

When ETH is staked, it cannot be used anywhere else in the DeFi ecosystem. You cannot provide liquidity, you cannot sell it, and so on.

Another positive effect is that staked ETH is actively securing the network, which also contributes to ETH’s value proposition. The more ETH are staked, the more secure the network. People are incentivized to stake because they receive inflation rewards and part of the transaction fees (the tip).

3) DeFi: Another scarcity driver for ETH is DeFi. DeFi users can lock up their ETH into protocols to earn a yield. It’s a very similar concept to staking, but with the difference that their ETH is not actively securing the blockchain. However, they can lend it, provide liquidity, or do other useful things.

As of right now, 9.6 million ETH are locked in DeFi protocol - more than 8% of the total ETH supply!

Again, whenever you lock ETH, you cannot use them somewhere else. When they are locked, it’s impossible to move them.

However, not all of the 9.6 million ETH are completely locked away. For example, some of them are sitting in Automated Market Makers, such as Uniswap, SushiSwap, etc. When ETH are locked in Automated Market Makers, they are actively being traded.

That means, not all of the locked ETH is actually off the market. 

However, I think that the amount of ETH locked in DeFi has a big impact on ETH’s scarcity nonetheless.

Combining the Forces

The magic happens when all scarcity drivers come together in the long run.

EIP-1559 will burn the majority of transaction fees. After the successful merge of the Beacon Chain with the PoW chain, the inflation rate will decrease from 4.2% to only 0.6%. After that, ETH is officially deflationary. As I explained many times in this newsletter, the true effect of EIP-1559 will only be visible in the long run. It’s very similar to the Bitcoin halving.

When ETH is deflationary and most of ETH is staked or locked in smart contracts, we could reach a point where there is a massive demand for ETH but very little supply. In fact, the supply decreases every single day.

Conclusion

In the long term, ETH’s three scarcity drivers will greatly reduce the available ETH supply on the open market. Remember, the more use cases we have for ETH, the more ETH are deposited into smart contracts. 

In my opinion, it’s very reasonable to assume that the amount of ETH in staking and smart contracts is going to grow over time.

I’m going to leave open what this will do to the ETH price =)


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DISCLAIMER: All information presented above is meant for informational purposes only and should not be treated as financial, legal, or tax advice. This article's content solely reflects the opinion of the writer, who is not a financial advisor.

Do your own research before you purchase cryptocurrencies. Any cryptocurrency can go down in value. Holding cryptocurrencies is risky.