Published: October 4th, 2023
As 2023 continues to post declines in NFT sales, meme coin trading, and DeFi uptake, Ethereum’s supply dynamics are in a state of flux.
ETH has been both deflationary and inflationary in recent weeks, depending on the time frame you analyze. Data from Etherscan has found that ETH becomes scarcer on a seven-day model, while on an annual model, more is being issued than burned.
What’s happening with the blockchain’s supply mechanisms, why are gas fees prices falling at all, and what does it mean for ETH holders?
Etherscan points to August 2021, when Ethereum implemented the EIP-1559 fee update. It came with a fee burning system that was connected directly to gas prices. Lower gas prices meant less ETH getting burned and higher gas prices meant the burn rate went up.
That set the stage for 2022’s merge and the shift from proof-of-work to proof of stake. The change reduced issuance of ETH by close to 90 per cent, leading some to suggest that ETH had become ‘ultra sound money’. BTC enthusiasts often call Bitcoin ‘sound money thanks to its 21 million supply cap. After EIP-1559 and The Merge, Ethereum bulls started referring to ETH as ‘ULTRA sound money,’ as it had gained a dynamic supply-restricting mechanism.
Now the label is being tested by falling gas prices and smaller transactional volumes.
Gas fees for sending ETH via the protocol were USD 0.27 at time of writing. Etherscan says that a trade on Uniswap currently costs USD 2.75, significantly lower than the USD 4.17 fee level seen in early September.
Etherscan’s head of research, Kris Martin, told Bloomberg there are three reasons why gas prices are falling.
‘Moves to scale the network such as Ethereum 2.0 have had huge benefits for network users, making both more affordable and more secure. The growth of Layer-2 networks have also had the benefit of moving transaction volume off the mainchain.’
In June of 2022, an extended crypto sell-off saw the price of ETH fall below USD 1,000.
ETH eventually bottomed out at USD 975, its lowest level since February 2021 and an 80 per cent drop in value from record highs seem the previous November. The decline happened amid worries about The Federal Reserve’s 75bp rate hike. Jittery investors responded by sending both stock markets and cryptocurrencies into bearish territory.
‘The Fed has hardly even begun to raise interest rates and they have yet to sell anything on their balance sheet,’ wrote Econometrics in an analyst note, warning that ‘that strongly suggests that more downside is on the way.’
Crypto traders were nervously following ETH’s trajectory over the previousd seven days, worried that a decisive break below USD 1,000 could trigger margin calls or liquidations of large leveraged bets. If that were to happen, ETH would face even more downside pressure.
Nerves began to fray when two crypto lending platforms, Celsius Network and Babel Finance, halted withdrawals due to worries about ‘undue market volatility’.
However, the real sweating started when crypto hedge fund Three Arrow Capital, which had USD 10 billion under management, was unable to beef-up collateral to cover its riskier bets. It had been less than a month since Terra, a USD 40 billion stablecoin project collapsed. Some inventors were clearly feeling a dizzying sense of deju vu.
Those events coincided with two large-scale capital withdrawals from Ethereum’s blockchain ecosystem that severely diminished its benchmark total value locked (TVL) metric. The unwind happened in two parts. The first occurred across Ethereum's decentralized finance (DeFi) projects in May 2022, when TVL fell by USD 93 billion after the Terra collapse. In June 2022 another USD 30 billion in withdrawals took place.
‘The deleveraging underway on Ethereum is observably painful, with characteristics that make it look like a financial crisis in miniature,’ said on-chain analytics platform Glassnode in an analyst note. ‘One only hopes that with the pain comes an opportunity to rid the network of excessive leverage and make space for a less risky rebuild on the other side.’
Glassnode believed that a more hawkish Fed and the ongoing implosion in the DeFi market would lead to further bearish moves for ETH.
From a technical perspective, Ether’s price needed to lift above the psychologically significant USD 1,000 level to regain support. Otherwise, it might break downside and plumb depths as low as USD 840 as its next target. That’s the resistance level that became a benchmark back in February 2018, before collapsing into a 90 per cent decline that left it hovering around USD 80 eight months later.
Meanwhile, ETH/USD was also threatening to fall to as low as USD 420 if ETH’s correction were to mimic the 2018 bear cycle. It's worth noting however that USD 420 also proved instrumental as support in July-August 2018, and resistance in September-October 2020.
While June 2022 saw most cryptocurrencies suffer losses of more than 90 per cent from their all-time highs (ATH’s), there was good news for traders from a stubborn group of holdouts.
Data from CoinGecko released in late June 2022 showed that, despite a crypto bear market that hammered 70 out of the top 100 tokens, the coins with the biggest market capitalizations were suffering least. Looking at the top ten, nine fell by less than 90 per cent. Bitcoin (BTC) was down 70.2 per cent from its November 2021 high of USD 69,000. ETH was in second place, down 77 per cent from its high of USD 4,876.
Others in the top table included Cardano’s ADA, Binance’s BNB, Polkadot’s DOT, and Solana’s SOL which were all down between 67 and 86 per cent. The average fall from grace for the top ten coins was still a whopping 78 per cent. Extend your view to the top 20 coins and the average drop from ATH was 81.2 per cent.
Amid all the carnage, tokens issued by crypto exchanges fared better. Cumulatively they posted an average drop in price of only 68 per cent.