As July approaches, we are about to see a major change in Ether. As previously reported, in March this year, EIP-1559 was officially included in the Ether London hard fork upgrade, and the proposal is tentatively scheduled to be deployed to the Ether mainnet on July 14.
Ether has been a leader in innovative crypto technology, with two highly anticipated upgrades, ETH2.0, EIP1559, and the Layer2 scaling solution. These changes have significantly improved Ether’s scalability, thereby easing network congestion and reducing high gas costs.
We know that one of the reasons Bitcoin has been at the top of the crypto asset heap is that it is capped at 21 million. Scarcity is expensive and will be magnified over time when market demand outstrips supply.
With the successful upgrade of EIP-1559 and ETH2.0, the infrastructure of Ether will change, so how will the token economy change? How will the change of issuance rate affect the price of ETH?
Most of the articles I have read only analyze the unilateral changes of Ether, but this article integrates ETH2.0, EIP-1559 and Layer2 expansion, and provides a detailed analysis of how these infrastructure changes will affect the supply and demand side of the ETH token economy. This article was adapted from Hacker Noon by Gideon Tay Yee Chuen, an analyst from Singapore, and translated by Rhythmic BlockBeats.
Ether will see major changes in the near future, this time on a scale that will exceed most upgrades since Ether went live in July 2015, including ETH2.0, EIP-1559, and the increasing adoption of Layer2 scaling in the protocol.
The main purpose of these changes is to increase Ether’s scalability, ease network congestion, reduce high gas fees, and improve network efficiency. These highly anticipated changes come against a backdrop of surging demand for Ether applications, particularly DeFi and NFT applications, that have exceeded Ether’s current limits. The high demand has led to a spike in Ether fees and the growing success of competitors such as Solana and BSC.
While we are looking forward to this upgrade of Ether, it is also quite interesting to understand how the changes in its infrastructure will affect the token economy (and price) after the upgrade. Here we outline these infrastructure changes, their timeline, and the potential impact on the ETH token economic model (and price) in the short and long term. This paper hopes to :
Integrate information and bring all Ether changes together. Most articles cover only one aspect, some do not cover the token economy, and do not analyze how changes to the infrastructure will affect the token economy.
Exploring the impact of Layer2 on token prices, a point that is not often discussed.
In addition to the usual discussion of the supply side, possible changes on the demand side will be explored.
Considering the length of the article, you can skip the parts you are familiar with.
Overview: ETH 2.0 can be divided into two main upgrades: PoS and sharding
PoS Consensus Mechanism
The Beacon Chain setup is the first step in the ETH2.0 upgrade, which runs in parallel with the main Ethernet network, introducing the PoS consensus mechanism to the Ethernet network and setting the stage for a move away from the current PoW consensus mechanism.
Under PoW, blockchain transactions need to be verified by miners who solve cryptographic problems and who have high computing power. The first miner to solve a problem creates a block and is rewarded with a newly minted ETH. Meanwhile, in PoS, users lock in 32 ETH as pledged equity to become a validation node and create and validate blocks just like miners in the PoW mechanism. However, they are not in competition for solving problems, but are randomly selected to create blocks and receive rewards. Thus, participants will be rewarded according to the amount of ETH invested.
This reduces the energy consumption of the network, ensures decentralization by reducing the need for expensive hardware and encouraging the creation of more nodes, and makes the network more secure since a large amount of ETH is required to launch an attack. this solves both the security and decentralization aspects of the blockchain triad paradox. At the same time, the sharding technology of ETH 2.0 solves the problem of scalability. 2.
Graphical visualization of sharding, from Quantstamp
Slicing splits large databases into smaller parts, called shards. This increases scalability because verifiers do not need to store data for the entire network, only for the slices they are assigned. Currently, ETH 2.0 plans to have 64 slices, with interactions between the slices coordinated through Beacon Chain. There is still debate as to whether the slices should just provide additional data or whether they should also have code execution capabilities.
Timeline: Beacon Chain goes live in late 2020. The roadmap will include slices in 2021 and join Beacon Chain until it is finally merged with the main Ethernet network in 2022. At that stage, the existing old Ethernet chain will become one of the many shards in the network.
Impact of ETH 2.0 on token economy (supply side)
Under the current PoW system, the reward is 2 ETH per block and 1.75 ETH per uncle block (created when multiple blocks are mined at the same time, as only one block can be verified and added to the ledger). Please note that the rewards are higher until February 2019. At the current level of mining difficulty, the average block mining time is about 13.15 seconds and the annual incremental rate is about 4.5%.
Under the PoS mechanism of ETH 2.0, the incremental rate is much lower and is expected to be between 0.5% and 1% based on some reasonable assumptions. It is difficult to give a precise rate as the rate of increase depends on several factors:
Number of ETH pledged/number of validators: More validators usually result in more ETH pledged in the network. However, as the return on verifier pledges decreases, their willingness to pledge decreases with the presence of more verifiers, and ultimately the amount of ETH pledged is limited.
Verifier misbehavior: If verifiers go offline or intentionally verify incorrect transactions, they are penalized by forfeiting ETH.
The above factors may lead to a decrease in the incremental rate.
In general, ETH2.0 will lead to a short-term increase in supply rates during the pilot phase before merging with the main network, as both PoW and PoS systems will issue ETH; however, the merged ETH2.0 will lead to a significant decrease in supply rates.
Overview: EIP-1559 changes the fee structure of Ether, introducing the destruction of the base fee
According to EIP-1559, transaction fees currently consist of two components: a base fee (which is destroyed) and an optional tip fee for miners. The tipping fee provides an incentive for miners to prioritize transactions when there is a high volume of transactions.
The gas limit per block is 12.5M to 25M, but over time the average block size is targeted to be 50% or 12.5M. This can be achieved by increasing the base fee when block capacity exceeds 50% (when the network is congested) and decreasing the base fee when block capacity is below 50%.
These changes reduce the need for users to guess the price of gas needed for their transactions, resulting in a more efficient fee system and fewer fee payments than the previous “first bid model”.
Timeline: The London hard fork in July 2021 will be included with the other EIPs.
Impact of EIP-1559 on the Token Economy (Supply Side)
The base fee for destruction will reduce the supply of ETH accordingly to the amount of activity in Ether, as it increases when the network is congested in order to meet the 50% block utilization target. It is difficult to estimate the magnitude of the impact as it is heavily dependent on the amount of Ether network activity. It is also not accurate to use the current transaction fees as a measure because we are not sure of the ratio between base fees and tipping fees. Some believe that the implementation of EIP-1559 will significantly reduce the net increase in ETH issuance, thus sending ETH into deflation.
Layer2 / Non-Layer1 Scaling Solutions
Overview: These solutions do not change the Ethernet infrastructure (Layer1). Instead, they reduce network congestion by processing transactions off-chain. In addition to improving scalability, some solutions provide privacy to a blockchain world where all transactions are public.
We call them Non-Layer1 scaling solutions because some solutions (e.g., sidechains) are not technically part of Layer2, and they are not directly protected by Layer1. Here is a brief overview of some of the scaling solutions:
ZK Rollups: Only transaction data about the before and after state (e.g., account balance) is recorded on the main Etherchain, and both transaction state and execution are performed off-chain. Smart contracts process transactions in batches at Layer2, update the final state at Layer1, and confirm that the final state recorded at Layer1 is accurate by using cryptographic proofs (SNARK).
Optimistic Rollups: Essentially the same principle as ZK Rollups, but instead of using SNARK to prove the accuracy of the final state of each record at Layer1, Optimistic Rollups assumes that all updates to the records are accurate. Only when someone challenges a state update is verified, the fraudster is penalized, and the challenger is compensated for the cost.
State channel: A channel is established between parties to form an off-chain network, where frequent transactions are made and the final state of their transactions is updated on Ether.
Side chain: Transactions are conducted in a separate blockchain with its own consensus mechanism. Assets and data are transferred with Ether through smart contracts that lock assets on the main chain and recreate assets and data in the same amount in the side chain.
Plasma chain: Similar to a sidechain, it acts as a separate chain with its own consensus mechanism. The child chain periodically submits the root hash to the main chain for consensus, which gives the system higher security but limits its ability to perform complex business operations.
Non-Layer1 Scaling Solution Changes to the Token Economy (Supply Side)
Until the implementation of EIP-1559 in July 2021, scaling solutions will not really affect the ETH growth rate. However, as these solutions are strongly tied to network activity and transaction fees, and as EIP-1559 increases the relationship between transaction fees and ETH supply, a number of interesting effects will emerge.
Dampening effect: The reduction in unit transaction volume generated by on-chain activity and applications leads to a reduction in the base cost of burning under EIP-1559, which damps the deflationary effect of EIP-1559.
Counterbalance effect: The lower transaction fees offered by the scaling solution attract new price-sensitive users and increase user engagement in the application. The increase in engagement somewhat offsets the decrease in base fee destruction caused by low activity on the main chain. Overall, the ‘real demand’ for the Ethernet network is likely to remain the same.
New activity effect: It can be argued that the nature of some scaling solutions will enable new types of economic activity on Ethernet. For example, high-frequency interaction between two parties through state channels, which would not be possible on the main network. If these new types of economic activities are introduced into Ether, the periodic off-chain and on-chain interactions can still generate the destruction of the base fee, and then the supply of ETH will be further reduced.
Over time, it is difficult to determine the ultimate effect of the possible changes. The ultimate effect depends on :
The level of adoption of scaling solutions.
The number of new types of economic activities that will enter the Ether ecosystem.
The net impact of the scaling solution on the “real demand” for transactions on the Etherchain.
Changes to the token economy from Non-Layer1 scaling solutions (demand side)
These changes are likely to lead to an increase in demand for ETH and an increase in fiat inflows, and to attract investors by
Increasing the attractiveness of ETH as an asset: ETH2.0 transforms ETH into a productive asset, capable of generating cash flow through pledging. The deflationary impact of EIP-1559 on ETH supply appears to be attracting many investors based on media reports and ETH price increases prior to the implementation of EIP-1559 in July.
Raising awareness through use: ETH2.0’s sharding and Layer2 scaling solutions have improved Ether’s scalability and reduced transaction fees per “unit” of network demand. This makes Ether more accessible to users with smaller transaction sizes, driving greater use and awareness of the applications in the ecosystem and ETH itself. This increases the pool of investors interested in buying and holding ETH.
Combining the above.
Graph of the impact of changes in the Ethernet infrastructure on ETH supply and demand. Arrows indicate expected changes over time, and the size of the box indicates uncertainty
The above diagram explains the development process and timing of “ETH 2.0” and “Scaling Solutions”.
Below is a brief overview of the positioning of the 3 elements in the chart:
Short term: ETH2.0 will increase the rate of ETH accretion during the beta period. Investors are buying ETH for the purpose of pledging it for a return, thus leading to an increase in demand.
Long term: ETH2.0 merges with the Ether mainnet and the accretion rate decreases significantly. As awareness of ETH2.0 increases, the demand for ETH will increase as well.
When EIP-1559 is implemented in July, it will lead to a significant drop in ETH issuance rate as the base fee will be destroyed. On the demand side, this is the main factor influencing ETH prices to break all-time highs in April and May 2021.
While the impact of the implementation of EIP-1559 on the accretion rate is expected to be significant, the exact extent of the impact is difficult to determine due to the uncertainty of future network activity and the ratio of base fees to miners’ tips.
Short-term: Prior to the implementation of EIP-1559, the rate of ETH accretion was not impacted. As some scaling solutions were implemented, they gradually attracted users with smaller transaction sizes and increased their participation in Ether, which had a positive impact on the demand for ETH.
Long term: Based on the 3 effects discussed earlier, we can know that the final effect of the scaling rate cannot be predicted exactly. We would venture a guess that it will converge to zero. Due to the “new activity effect”, more new economic activities will be added to Ether over time through the scaling solution, which will result in a slightly lower accretion rate in the long run. This is expected to have a significant positive impact on the demand for ETH, as it will increase the participation of potential Ether users and thus the number of potential investors interested in buying ETH.
All the above charts and our discussion point to the fact that changes in the Ether infrastructure will have an impact on both supply and demand, which creates a strong driving force for the ETH price. However, as the price of ETH continues to break all-time highs, many people are starting to wonder just how high the price of ETH can go and whether these positive factors have been fully absorbed.
My personal opinion is that even if ETH experiences more bulls and bears, it will be worth much more than it is today in 10 to 15 years. Here’s my three-step reasoning:
Innovations in the cryptocurrency space will disrupt multiple industries, especially finance, and will create and capture a lot of value in the process.
That Ether has been a leader in innovative crypto to date and that infrastructure changes are increasing its scalability and thus its ability to dominate the market.
EIP-1559 connects the success of Ether to ETH.
Posted by:CoinYuppie，Reprinted with attribution to:https://coinyuppie.com/the-biggest-change-in-history-how-does-it-affect-the-economic-model-of-ether-and-the-value-of-eth/
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