Ethereum has made its next step toward its 2.0 upgrade. With its London hard fork, Ethereum is now changing its payment structure.
This change has an economic impact on Ethereum, and with it, we have seen the price of ETH go up for 15 of the past 16 trading sessions, even with it overbought. With this post, we will describe the changes and economic impact that the London fork brings and take a stab at an ETH price prediction.
London Fork Changes
The Ethereum network upgrade was delayed a day to August 5 and code-named the “London Fork.” Within this upgrade was the Ethereum Improvement Protocol 1559 or EIP-1559. There are four critical aspects to this upgrade that have some significant effects on Ethereum going forward.
- More Predictable Transaction Fees– The smart contracts that run on the Ethereum network require fees to execute them. The system previously used an auction system with users bidding against each other to have transactions processed by the Ethereum miners. These fees can be very high if the network’s traffic is high as well. This volatility makes the use undesirable, not knowing what will be paid beforehand.
Graph courtesy of coinmetrics.io
With EIP-1559 a base fee is determined by an algorithm rather than bids and depends on the network use, making the transaction price clear without jumping around as much, letting users wait if desired. However, a “tip” can still be provided to move ahead in the line.
- Coins are being burned– The crypto world is excited to see that with the shift toward a Proof of Stake model with EIP-1559, a process of burning ETH will occur. Minors no longer receive the base fee; if they did, they could artificially congest the network, keeping fees high. With 1559 part of the fee is destroyed. Some believe that this burning could cause the ETH price to explode.
However, this is no certainty and depends on other factors like transaction volume and amount staked that determine the gas fees algorithm and the amount that is destroyed. That said, since the deployment of 1559, 36% of the new coins issued were burned, and the price of the crypto has climbed 18%.
- The Gas Prices May Not be Less Expensive- While the transaction fees on the network will be more predictable with 1559 and may go down by preventing high bidder overpayment. The EIP-1559 fork does not explicitly reduce the prices; it only increases them with a congested network and reduces them back down when the network slows. As of mid-August, Ethereum’s Average Gas Price is at a current level of 50.74, down from 68.31 one year ago, a change of -25.72%.
- More Changes Are Coming- When compared to the entirety of Ethereum 2.0, the EIP-1559 is just the beginning. The network overhaul to a Proof of Stake model with Shards (side networks) is planned to be completed in 2022. Proof of Stake changes the entire mining system, providing rewards to those who stake Ether and thus gaining a right to verify transactions. JP Morgan thinks that staking could become a business worth 40billion a year. The system of Shards is expected to increase the throughput of the network and reduce costs.
ETH Deflation
On the creation of the Ethereum network, there were 72 million generated at the launch, and 18 Million Ether can potentially be mined every year. In reality, this has gone down due to the complexity of mining, increasing the computational time, and slowing the rate of block creation.
Graph courtesy of Etherscan
The London hard fork has meant that the network is now burning thousands of ETH, which immediately changes the inflation dynamic of the potential 18million ether/ year creation. Previously there was a fear that eventually, the supply of ETH could outpace demand, creating a never-ending supply and its value to zero. With the 1559 change, the variable base fee system has lowered the number of ETH created by not paying the miners the total fee and forever removing it from the network by burning.
The “blocks” of the blockchain contain the transactions, and their speed of processing is limited to the number that can fit on one block. On the Ethereum network, this happens about every 10 seconds, and Ether is the reward. The current inflation rate for ETH is 4%, down from 25% in its first year.
EIP-1559 allows for changes in the block size, up to double the previous size, which nearly doubles the network’s throughput, and which should also reduce transaction fees when the network sees heavier traffic. This fee reduction should also increase demand for network use and the creation of more applications for the network.
Ethereum fees, measured in Gwei (0.000000001 ETH), is the gas price times the gas used (how much work is needed) in a transaction. The more complex the smart contract or data stored, the higher the fee. Before 1559 the gas price was related to the network strain, and now the blockchain sets a “base gas price,” with fewer transactions getting held back and everyone paying the same amount (unless a tip is offered).
The sharding and switch to PoS in Ethereum 2.0 will further reduce the issuance of new ETH, which many believe may make Ethereum deflationary. With Ethereum 2.0, the rate of new issuance will depend on the amount of ETH that is staked. The more staked coins, the higher the issuance rate, but this also means the more the network is being used.
If we look at Ultrasound Money’s inflation and burning tracking tool:
Graph Courtesy of Ultrasound.money
With 10 million ETH staked at an average gas price of 20 Gwei, the total supply of ETH will flatten to 119.3M, and inflation should stop around February 2nd, 2022, and go deflationary (0.33%) from this point. Burning around 2000 ETH a day or about 400,000 the first year. This is about when the Ethereum 2.0 upgrade should switch to PoS, and the new shards system will be implemented as well.
However, as stated after 1559, the gas price is sitting around 50 Gwei, and if it stays there, we can see a transition supply of 118M but burn at a rate of 5K per day, which results in 1.1% deflation the first year. We don’t know what the amount will be staked after Ethereum 2.0 transition, but this has a lesser effect than the gas price. If the gas price is above 17 Gwei with 10 million staked, deflation occurs. In the worst-case, if the price remains at the current 50 Gwei level, this could be a big deal.
ETH Price Prediction
At writing the ETH price stands at $3,146/ETH.
This is up 81% from $1734/ETH on July 20th and nearly 700% in the past year.
While ETH briefly hit the $3,200 resistance level and went above its long-term trend line, it has since fallen back.
ETH has been overbought for 15 days and has likely caused some profit-taking to bring it back down. If the long-term trend continues then, we could see a price of $5,000 by the end of the year on the high end, making this an all-time high for ETH. Looking at the rate of increase since the beginning of the year (of around $275/month), we would see a year-end price of around $4,150, which is more likely, and if the bulls stop buying on a worst-case, ETH could first drop back to the minor $2,800 or even major $1,875 support line before continuing up again. The only indicator that the drop to major support could materialize is due to regulatory moves against Proof of Stake, which are always possible.
In the long term, the deflationary trend of ETH could have a tremendous effect on the price, especially if actual inflation exceeds the expected USD inflation which is in the range of 1.6 to 2.8% for 2021 and an average of 2.3% through 2024. With that, an ETH of $6,000/ETH is easily possible.
Summary and Likely Scenario
The changes of the EIP-1559 and the buzz that it caused had an immediate effect on the ETH price. The continuing evolution to Ethereum 2.0 will likely have a similar impact and boost ETH’s price. If, in the long term, the gas price does not go below 17 Gwei then ETH will begin to deflate. There may be a balancing act that will bring in more stakers wishing to gain from the difference. This will have a twofold effect.
If the number of stakers increases (let’s say to 20M ETH), then the number of ETH issued also increases to 2000 a day; this increased throughput will likely bring down fees to approximately 20 Gwei and a fee burn of 2000 ETH/day, a perfect balance. These will probably not be the exact numbers; however, there will be an acceptable balance point reached that will likely be between -0.1 and +1% inflation. Only time will tell.
Disclaimer: The author of this text, Jean Chalopin, is a global business leader with a background encompassing banking, biotech, and entertainment. Mr. Chalopin is Chairman of Deltec International Group, deltecbankstag.wpengine.com.
The co-author of this text, Robin Trehan, has a Bachelor’s degree in Economics, a Master’s in International Business and Finance, and an MBA in Electronic Business. Mr. Trehan is a Senior VP at Deltec International Group, deltecbankstag.wpengine.com.
The views, thoughts, and opinions expressed in this text are solely the views of the authors, and do not necessarily reflect those of Deltec International Group, its subsidiaries, and/or its employees.
