Can inflation neutral or deflationary currencies be successful?
I want to first start of by saying that this is an honest economic question and not a hit piece! I am a huge supporter of the Ethereum project and am really excited about the technology, it's vision, and it's strong community 🙂
TLDR Question:
Ethereum has several internal mechanisms that have many projecting it will become a deflationary or inflation neutral currency.
While the decentralized technology and strong developer community gives Ethereum the brightest future as a currency and technology, what are the benefits to these deflationary pressures in terms of being a functioning currency (not just an appreciating asset)?
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One of the main arguments that I hear against many cryptocurrencies (including Ethereum) is that over the long haul, it is a deflationary, or inflation/netural currency.
"Deflation is a decrease in the general price level of goods and services; it is the opposite of inflation, which occurs when the cost of goods and services is rising"
While certain assets such as real estate, precious metals, and art are deflationary and appreciate over time, deflationary currencies disincentivize economic activity, as they reward owners that instead hold for a profit.
There are many causes for deflation that are generally considered to be positive, such as:
- an increase in the supply of goods
- increases in technology/process efficiency (i.e. industrial revolution, 1817-1860 during the 19th century)
There are also negative causes for deflation, which include
- an increase in the demand for money (i.e. Great Depression, a fall in the demand for goods and services and a preference to hold dollars)
- a decrease in the supply of money
- a decrease in the availability of credit (i.e. Great Recession '07-'09)
Background on Ethereum Issuance Rate
In the Ethereum genesis block, 60,000,000 ETH was issued and assigned to purchasers, with annual issuance was fixed at 18,000,000 ETH per year. This means that while the inflation rate of Ethereum was high in year 1 (24%), it will generally tend towards zero over time, and will eventually reach an equilibrium supply (see inflation graph attached to post). This can be thought of the point at which each year the amount of ETH lost into the void is approximately balanced out by the ETH issued.
Fast forward to 2021 and the ETH 2.0 changes, the transaction BASEFEE introduced by EIP-1559 will be burned, removing ETH from the overall supply.
Ethereum "Deflationary Pressures"
Therefore, the deflationary pressures that I'm aware of in the Ethereum ecosystem include
- Fixed issuance amounts, resulting in a decrease in the rate of issuance over time
- Burned transaction fees
- Lost crypto (an estimated 20% of all Bitcoin is lost, so one can assume a similar proportion for Ethereum).
Albeit not a strictly "deflationary" pressure, Vitalik Buterin has stated that Ethereum 2.0 will drop it's inflation rate by over 50%.
Albeit not having close to the same level of adoption and community support, other coins such as Peercoin have planned to tackle this problem by adopting a fixed inflation rate.
In closing…
Ethereum's been on a tear over the past year and as of late, in part due to the current crypto bull market, and Ethereum's technical merits and vision for 2.0, which include this steep drop in the rate of change of inflation. Many individuals and institutions are anticipating this, which is undoubtedly leading to the rapid increase in valuation (ETH/USD). While there are undoubtedly people purchasing goods and services with Ethereum, there is currently a strong incentive to hold and accumulate ETH as an asset, instead of utilizing it as a currency.
In fact, analysis shown by the crypto analytics firm Santiment showed as of earlier this year, Ethereum whales are currently holding 68% of the total ETH supply. However, at the same time, the number of Ethereum transactions per day recently hit a record number of transactions and has been on a steady uptrend since February 2019, albeit I was unable to find the proportion of the transactions that were currency based (ETH/USD) instead of for goods/services.
Which leads me back to my main question, in the long term, how will Ethereum function as a currency when it's increasing valuation over time causes people to utilize it as more of an asset? Are there historical examples of deflationary or inflation neural currencies leading to economic prosperity or …working out?
References
submitted by /u/Ahead_of_the_slurve
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