This article discusses the negative impact of technology on Ethereum from several supply-side perspectives. The article is written by Ping Chen, the founder and CEO of Pelith.
Table of Contents:
1. Technology Driving Prices?
2. Examples of EIP4844
3. Examples of Restaking
4. Future Outlook
Whenever there is news about new technology, the market often believes that it will drive demand and therefore increase the price of some coins while lowering the price of others. For example, some people believe that this year will be the “staking year” and that after the introduction of EigenLayer, the application of Restaking will increase the staking volume of Ethereum, leading to an increase in demand for Ether and a rise in price.
However, when considering the impact of technology on coin prices, there is another perspective from the changes in the supply-demand curve and the fundamentals of economics. For example, the EIP1559 article is related to the issuance of currency and we need to understand how new technologies in the blockchain field shape price equilibrium in a more long-term way.
Once the supply-demand curve shifts, the impact of fundamentals is stronger and more long-lasting. For example, the newly 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 and makes them more affordable and user-friendly.
In theory, the reduction in transaction fees should increase the usage of Ethereum. With increased demand, the price of Ether should rise. However, the burning of transaction fees is the source of Ethereum’s deflation, and a significant reduction in transaction fees means a lower burn rate of Ether, resulting in an increase in the circulating supply of the currency. At this point, the supply curve of Ether is moving to the right, and the price will decrease due to the increase in supply.
However, the impact of fundamentals may be more profound. EIP4844 will significantly reduce transaction costs and may increase the number of Ethereum users, leading to network effects that surpass the loss of low transaction fees. Therefore, most people still believe that the impact of EIP4844 on the protocol is positive. More precisely, the reduction in transaction fees will shift the supply curve of Ether to the right, but if the number of Ethereum users increases significantly, the shift in the demand curve will be even greater, resulting in an increase in price.
How does this dynamic relationship between supply and demand reach equilibrium? No one can say for sure. Once the updates are implemented and operational, they will disrupt the market. We may see price fluctuations due to changes in supply and demand. This does not contradict short-term price stimulation, but long-term market changes are obviously more worthy of our attention.
Another popular topic, Restaking, is also suitable for explaining how new technology can rewrite the supply-demand balance in the long term.
Currently, 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 up, 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 of restaking encourages more people to buy Ether as collateral, which naturally increases the demand for Ether and reduces its circulation. With increased demand and decreased supply, the price of Ether will rise. This seems logical and in line with rational reasoning in economics, 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 or assist in running oracles (or any other applications). So no matter which side you do something wrong, it will be the same collateral that is slashed, resulting in incalculable risks. Currently, Restaking is generally favored in the market, partly due to the bull market in cryptocurrencies, which temporarily eliminates concerns about the liquidity issues caused by a large number of lock-ups.
In addition, although the economic incentives of Restaking seem to stimulate an increase in coin prices, it is actually bad news for the monetary policy of the currency. The mining reward formula for Ethereum PoS is different from PoW. PoW has a fixed output, with each person receiving 1/n when there are n miners. PoS has a smoothing square root relationship between the number of mining nodes and the mining reward. For example, when there are 100 nodes, each time 1 ETH is produced, each person receives 0.01 ETH. When there are 400 nodes, each time 2 ETH is produced, each person receives 0.005 ETH.
This design is to prevent the impact of staking volume on income from being too drastic. The problem is that PoS mining rewards will increase as the number of nodes increases, and the economic incentive of Restaking will increase the willingness to stake, thus increasing the number of stakers. Assuming that before Restaking appeared, the original supply-demand equilibrium point was 4% PoS interest, and Restaking provided an additional 2% interest. This would increase the number of stakers, and the original mining interest would decrease. The new equilibrium point might be 3% (PoS) + 2% (Restaking), and players who restake can earn a total of 5% interest. However, as the number of nodes increases, Ether will be printed at an accelerated rate, leading to inflation.
While it may seem that individuals are benefiting, when viewed from a broader perspective, the result of inflation is a decrease in the price of the currency. Players who restake hold more Ether, but the total value of their assets may depreciate. Those who do not participate in restaking are even more unlucky as they do not earn any coins but are still affected by inflation. Therefore, this technology that aims to increase additional income to PoS nodes is actually harmful to the underlying protocol’s monetary policy.
Of course, there is a possibility that Restaking does 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 pressure to the chain. To address this, protocol developers are actively developing the concept of minimum viable issuance and discussing several solutions to reduce inflation and limit ETH 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-demand curve. However, the short-term incentives driven by the information aspect are quite attractive. So, it’s a good idea to buy more ETH.
Related Reports:
– Understanding “Restaking”: Risks and Responses
– Why A16z is Heavily Invested in EigenLayer? Detailed Explanation of the Value and Economic Security of Ethereum Restaking
– Commentary: Is Restaking an “Interest-bearing Debt” or “Mild Inflation”?