Ethereum - Modification of monetary policy underway

The Ethereum Foundation once again wants to change Ethereum’s monetary policy. The reason behind this is the growing number of validators…

Monetary Policy Change during the Electra Fork?

In response to Vitalik’s proposal to establish a maximum limit on the number of validators, Mike Neuder is advocating for a reduction in the issuance of new Ether awarded to validators instead.

“We believe that modifying the reward issuance curve should be seriously considered for the Electra fork,” declared a researcher from the Ethereum Foundation in an article published on March 30th.

Some are already opposing it, arguing that such changes to Ethereum’s monetary policy would undermine trust in the Ethereum network.

Eric.eth, co-author of a significant Ethereum Improvement Proposal (EIP-1559, about transaction fee calculation), stated:

“I see more and more researchers considering changing the pace of ETH issuance. The general contempt for the efforts we’ve put in over a decade to make ETH a currency is disturbing. I will fight this idea with all my strength.”

Seeing some growing discussion from researchers and others in the community about tweaking the PoS issuance curve.

The general disregard for how hard we've worked for a decade establishing ETH being money is concerning.

I'll fight this idea with anything I have.

— eric.eth (@econoar) March 30, 2024

His comments echo those who believe that frequent changes to monetary policy erode the confidence of users and investors. For them, such instability does not align with Ethereum’s slogan of “Ultra Sound Money.”

In this context, don’t miss our article comparing the issuance rates of ETH and bitcoins: Bitcoin vs Ethereum. We wrote in it:

“Ethereum’s monetary supply depends on two parameters. ETH is created via rewards paid to validators. The more validators there are, the faster the quantity of ETH increases. This system is called ‘staking.’

The monetary creation is more or less offset by the destruction of a part of the transaction fees (‘burn’). The increase in the number of transactions causes an exponential increase in transaction fees, and thus the number of ETH destroyed.”

From PoW to PoS

Block rewards have decreased several times throughout Ethereum’s history. They were at 5 ETH at its launch in 2015. They fell to 3 ETH following the Byzantium fork in 2017. And then to 2 ETH from 2019 onwards.

Everything changed with the transition to Proof of Stake in 2022. Rewards are now issued at a rate of 166 times the square root of the sum of ETH staked. This formula means that the pace of new ETH creation increases as staking increases.

Samuel Haig explains in this article that one million ETH staked generates rewards of 166,000 ETH per year. If 100 million ETH are staked, the annual issuance rises to 1.66 million ETH.

Currently, roughly 31 million ETH have been staked, amounting to about 26% of all ETH in circulation. However, for Mike Neuder, another researcher at the Ethereum Foundation, staking is expected to increase further in the coming years.

Knowing that ETH staked are ETH that are no longer in circulation. It’s that much ETH that will no longer generate transaction fees. In other words, the increase in the number of validators triggers a vicious cycle:

Increased ETH awarded to validators and reduced ETH ‘burn’.

It looks quite like the concept of Proof of Stake is turning into a fiasco…

The Problems with a Growing Number of Validators

For developers @adietrichs and @casparschwa, the turn of events is concerning for several reasons:

-Decrease in the actual yield of staking: “The actual yields tend to zero as the staking nears 100% of ETH in circulation.”

Indeed, if everyone stakes their ETH, no one gains. The rewards are negated by the inflationary effect.

-Expropriation of users: “Staking close to 100% would greatly increase the inflationary pressure on users,”.

And naturally so. The more validators receiving more ETH, the higher the inflation. These newly issued ETH dilute the value of the common user’s ETH.

-Centralization: “Several staking tokens like Lido (which currently holds 30% of all staked ETH) could exert excessive influence over the Ethereum protocol. This poses risks to the network’s decentralization and governance,”.

In summary, now that Staking is no longer the exclusive preserve of a minority of profiteers, the rules change… It is now necessary to reduce the incentive to become a validator. The idea is that rewards should trend towards zero beyond a certain level of staking.

The yield is currently 2.65% per year for validators. At 80 million ETH staked, this yield would drop to 2%. It would only be 1% with the new formula that some Ethereum Foundation researchers propose.

Thus, eighteen months after The Merge, we find out that Ethereum, not having any real utility, will have more and more validators and fewer and fewer transactions.