The Final Puzzle-Piece to Ethereum’s Monetary Policy
Ethereum doesn’t depend exclusively on fees for economic security. Ethereum guarantees a security budget to pay validators with block-rewards.
Because Ethereum pays validators by block rewards, also paying them BASEFEE would overpaying for security. Validators are employees to Ethereum, and when Ethereum generates extra revenue, there is no reason as to why the employees should be paid this extra revenue. That revenue is paid to the business. The Employees are free to keep the tips that are placed in the tip-jar, for serving the highest paying customers first, but BASEFEE belongs to the network.
Burning ETH = Paying the Network
The title of this section has Ethereum in air-quotes for a reason. If we’re not paying BASEFEE to the validators, who should get it?
Burning BASEFEE pays everyone, equally. Whether you are Staking your ETH, or have it inside of MakerDAO, Uniswap, Augur, in your wallet, in a game, BASEFEE is paid to your ETH. If you hold ETH, you receive BASEFEE indirectly.
This is similar to how MKR holders receive the Stability Fee in MakerDAO; the SF burns MKR from the interest payments of those with debt to MakerDAO. If you hold MKR, your share of MKR is increasing due to the burning of MKR that isn’t yours.
By burning ETH, all Ethereum stakeholders benefit. EIP 1559 is solves a “tragedy of the commons” problem in Ethereum, by paying for one’s externalities by adding to the scarcity of Ether.
After staking, holding Ether and keeping it off the secondary market is the second-best way to add to the security of Ethereum. BASEFEE is the mechanism to which these Ethereum stakeholders benefit from the growth of Ethereum at large.
When the U.S. government pulls in more revenue from taxes, it spends more. When Ethereum pulls in more revenue from gas fees, it issues a stock-buyback.
Burning BASEFEE is Paying for Future Security
Every day that Ethereum runs, BASEFEE will remove more and more ETH from the supply. The BASEFEE amount that Ethereum could have paid directly to validators, instead is being paid to ‘Future Ethereum’.
The ability to attack Ethereum 2.0 will be a function of how much ETH is available for purchase on the secondary markets. If there is high ETH supply on the market, then buying enough to attack Ethereum is less expensive. If there is low ETH supply on the secondary market, then the price is higher, and attacking Ethereum requires much more capital.
By adding to the scarcity of Ethereum today, Ethereum’s security tomorrow is secured.
EIP 1559 puts constant downwards pressure on the supply of ETH. When Ethereum brings in little revenue, there is little downwards pressure, but when Ethereum is a fully-fledged economy, moving trillions of USD-value each day, and has the throughput of 1024x shards, the burn-rate of ETH could become significant.
Reducing Inflation, based on Aggregate Spending
EIP 1559 will introduce 2 new metrics to add to the list of the growing number of Ethereum economy metrics: The ETH-Burn Rate, and the ETH Burn:Issue Rate Ratio.
- ETH Stake Rate
- ETH Issuance Rate
- ETH Locked in Open Finance
- Dai Savings Rate
- Dai Average Borrow/Supply Rate
- ETH Burn Rate
- ETH Issue:Burn Ratio
The ETH Burn Rate tracks the scale of the Ethereum economy. As economic activity on Ethereum grows, the ETH Burn Rate will follow it. The ETH Issue:Burn Ratio is a metric that shows the trend of ETH scarcity. If the ratio is below 1, then ETH supply is decreasing.
How much could EIP 1559 burn relative to total issuance?
Modeling how much ETH could actually be burnt is a little premature. Having 1024x the transaction capacity makes the economics of Ethereum 2.0 wholly different than Ethereum 1.x
However, we can do some napkin math.
It’s a well-articulated goal for Ethereum 2.0 that 10M total ETH staking is desirable. At this number of total ETH staking, Ethereum is issuing 1550 ETH/Day.
Ethereum 2.0 will have 1024x shards, at 15 TPS each (current TPS of Ethereum 1.x). This is 22M transactions / day.
In order to bring in 1550 ETH/Day in revenue, BASEFEE would need to be 0.00007045 ETH per transaction. To compare, a simple-ETH send costs 0.000021, at 1-Gwei gas price.
These calculations are extremely rough, and we will have much more data when Ethereum’s economic system is fully operational in Ethereum 2.0. Many variables go into this calculation, including changes to how gas is calculated and overall network congestion at scale.
If there is one thing that the reader walks away from this article with, I hope it is this: EIP 1559 represents Ethereum’s taxation system.
Ethereum is a permissionless cyber-economy. It is like a nation-state economy, except all human input/coordination/governance/politics has been replaced by code. The U.S. Dollar economy, the most successful economy ever on Earth, presents a model for how the ideal economy is structured. Ethereum takes that model, and commits it to code, enabling a digital value layer on-top of the internet.
Published at Mon, 21 Oct 2019 17:06:30 +0000
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