Crypto

What will be the long-term impact of the rising Ethereum (ETH) deflation rate on the price?

Ethereum logo. Source: Adobe

The ETH supply deflation rate recently reached its highest level in a year. On Wednesday, the annual burn rate of EIP-1559 exceeded the issuance rate of ETH by 1.425%, an all-time high since the unexplained incident in May 2022, when the deflation rate exceeded 17% in a single day.

When the rate of deflation increases, this means that individual ETH tokens are becoming scarce at a faster rate. Most analysts believe that this should increase the price of the cryptocurrency in the long run.

ETH/USD’s drop of almost 5.0% on Friday as crypto markets were hit by concerns over Silvergate bank and reports that Tether committed fraud to keep access to the global banking system suggests traders are not paying much attention on the latest events regarding the rate of ETH deflation.

ETH is currently trading around $1,570, about 10% off its recent highs in the mid-$1,700 range. While ETH has been falling since the beginning of February, its deflation rate is not following the same trajectory and is showing an uptrend.

Traders should keep in mind that deflation is one of the elements that could boost ETH later this year. Other factors that could also give a boost to ETH are upcoming network upgrades, including the launch of ETH withdrawals next month, a potential DeFi resurgence and a possible improvement in the macro environment, and the possibility of avoiding a US recession and lowering. inflation gives the US Federal Reserve the opportunity to cut rates.

Explanation – what is accelerating the deflation of ETH?

Before answering this question, it is necessary to understand the underlying causes of ETH deflation, which requires an understanding of how the fee structure works on the Ethereum network. Network fees are divided into two components. The first is the base fee that all users must pay to make sure their transaction is accepted and processed on the blockchain.

Also, there is an optional tip that users can pay to get their transaction processed faster. The Ethereum network automatically calculates a base fee that increases as network traffic increases. Ethereum Improvement Proposal (EIP) 1559, which was implemented in the Ethereum code during the London hard fork in August 2021, requires that all of these base fees paid by users are then burned, which permanently removes token traffic.

Therefore, when the base charge increases, the burning rate also increases. When this burn rate exceeds the ETH emission rate, which is around 0.55%, the supply of ETH decreases. ETH is distributed among the nodes and stakers that secure the network. The chart below shows how the Ethereum (base) network gas fee has gradually increased over the past few months.

ETH deflation rate may continue to accelerate

Due to high network congestion, the daily annual ETH burn rate (EIP 1559) steadily increased to 6.0% in early 2022. At that time, the Ethereum blockchain was still running on a proof-of-work consensus mechanism. much more energy-intensive, and due to energy costs and high mining rig costs, the rate of Ethereum issuance was much higher, around 4.4-4.6% per year.

This means that ETH’s deflation rate peaked at only around 1.5%. While a rally in the crypto and DeFi market could push the burn rate to an early 2022 high, the new, much lower ETH issuance rate means the ETH deflation rate could reach a staggering 5.5%.

What is the price trajectory of ETH?

While ETH deflation may seem very exciting, bulls must be patient as the short-term outlook for the world’s second largest cryptocurrency by market cap is complex. The latest drop in ETH has sent it below the uptrend that has persisted since early 2023.

This is potentially a bad omen for the short-term price outlook, with a potential test of the February lows in the mid-$1,400 range. Of course, an aggressive rally in US stock markets on Friday, if continued into next week, could prevent crypto markets from falling further. Despite this, ETH is likely to continue to fluctuate in its February range of $1,400 to $1,700.

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