Vitalik’s Serious Joke: The Case for Ending Ethereum Inflation

It turns out, Vitalik wasn’t exactly joking.

Sure, that might be what most people thought when ethereum’s creator published a controversial proposal on April Fool’s Day, but the post has prompted a very real, very serious conversation about whether the underlying economics of the world’s second-largest cryptocurrency should be altered.

In fact, in the weeks since the concept was first floated, dialogue has only gotten more heated about the idea that a limit could be placed on the total number of ether, ethereum’s cryptocurrency, that could ever be created. And while it’s long been a contentious topic (there isn’t currently a cap), the rate at which new coins are being introduced into the market has been growing.

Buterin appears aware of the concern, citing “economic sustainability” as the reason he wants to stop creating new ether when 120 million are introduced. In fact, he believes limiting the market supply to exactly that figure, twice the number of ether sold in the platform’s 2014 ethereum fundraising, could help long term.

In a developer meeting last week, Buterin outlined his rationale further, and while his comments were initially greeted with giggles from other core developers, the atmosphere quickly gave way to serious reflection.

From a technical standpoint, the change would be easy to implement, and pending sufficient community support, it could be executed with a simple code fix as part of ethereum’s next system-wide software update.

On one side, the concept has been applauded by ether investors. Lacking a formal stance on similar to say, bitcoin’s limited 21 million bitcoin supply, some investors have remained cautious, if not confused, about whether they should put their money in.

Nevertheless, the proposed issuance cap has also been the brunt of heavy criticism.

For one, critics cite ether’s role for the platform’s security and are warning that the introduction of a cap would make the cryptocurrency a pure speculative investment play, something that many developers worry will make updating the protocol more challenging. Others take offense with what they claim is a poorly timed, if not poorly researched issue.

“I don’t think that we have the understanding required to actually meaningfully know what we would be consenting to,” Vlad Zamfir, a leading developer behind ethereum’s upcoming proof-of-stake consensus mechanism, wrote in a blogpost. “The numbers seem completely arbitrary,” another critic wrote.

And a vocal opponent of the proposal, ethereum developer Nick Johnson tweeted:

“[The post] has degraded into a bunch of people arguing pseudo economics with each other, as if ethereum were designed first and foremost to be an economy and not a computing system.”

The arguments against

Sure enough, the critics seem particularly worried about what the economic incentives could mean for ether’s role as a “crypto fuel” for the network.

“Ether has a primary intrinsic purpose on the ethereum protocol, that is, to be consumed as a resource with which to run calculations upon a computational machine,” an independent ethereum developer, Darryl Morris, wrote in a blog post.

According to Morris, ether’s use as an investment tool shouldn’t be prioritized over its ability to secure and protect the protocol, something he thinks the proposal would do.

Speaking at a developer meeting Friday, Johnson echoed similar points. Because such a limit would, theoretically, cause the value of ether to rise, transactions that burn small amounts of ether would be disincentivized.

“Funding through transaction fees encourages holding and discourages an active ecosystem,” Johnson said. Continuing, Johnson said this would lead to a harmful spiral, where “costs go up because transactions are fewer and that leads to fewer transactions and so forth.”

And the opposition started some time before Buterin’s recent proposal. Zamfir, for example, has spoken out against putting a limit on the issuance of ether in the past. Speaking to CoinDesk in February, Zamfir described the discussion as “bikeshedding.”

He told CoinDesk:

“The entire cryptocurrency HODLer scene is apparently obsessed about issuance policies, even though issuance has very, very, very little to do with a cryptocurrency’s success.”

He further speculated that, should a cap be passed, miners might have reasons to inherently oppose the idea, since a hard cap could limit their future payouts.

“Hodlers and miners have obvious major conflicts of interests which makes it impossible to count on them to care about any notion of public good or even any kind of impartial truth about optimal parameters,” Zamfir said.

Speaking in a blog post, Zamfir continued to state that understanding of the matter is limited, and using scarcity as an investment value-add is “stupid and annoying at best.”

And finally, others have argued that an issuance cap would raise the cost of entry into the network, something that contradict the long-standing value proposition of keeping these costs low so that anyone can participate and in turn, make the network more decentralized.

Speaking to that, one Reddit user wrote: “Great if you want to maximize your personal wealth, but shit if you want to create a decentralized economy.”

The arguments in favor

But from Buterin’s research, none of these things hold true.

In the developer meeting last week, Buterin stressed that transaction fees are not proportional to the price of ether, but rather reflect demand for the ethereum platform. This means that irrespective of a price rise, if the numbers of transactions remain the same, fees on the platform would not increase.

Plus, according to him, it isn’t up to ethereum to provide an affordable entry into cryptocurrency, that instead, new cryptocurrencies will provide that onramp.

“Crypto can avoid being too inegalitarian through [the] emergence of new coins, not through any single coin being super-inflationary,” Buterin tweeted.

While the inflation rate on ethereum is currently quite low, Buterin contended that even small rates of inflation are a “huge deal” in the context of financial market returns.

With an unlimited supply, Buterin warned that ether could even be surpassed in market capitalization by one of the ERC-20 tokens that have been launched on top of ethereum. As tokens can be programmed without inflation, Buterin explained, “basically every ERC-20 token becomes a better store of value than ETH.”

And on the topic of miner payouts, Buterin argued at the meeting that rather than miners being paid with newly-created ether, miners could, in the future, be paid directly by transaction fees.

According to Buterin, that change would be simple to implement, since all the remaining ether could be locked into a smart contract, and dished out to miners via fees over time.

“It would set any rewards to be proportional to the balance remaining inside of the contract,” Buterin said.

And while rewards would decrease as the total ETH supply converges toward its limit – potentially disincentivizing miners – Buterin said that inflation poses a similar risk. “If we have a cryptocurrency which is inflationary then that could lead to its value dropping, which by itself leads to less capital securing the network,” Buterin said.

And though he admits that it’s a complicated thing to measure, Buterin said, “I personally do think that there’s evidence that basically transaction fee levels are capable of providing enough revenue to secure a blockchain.”

He added:

“And in the long run, if they’re not, then there’s the question of well, how valuable is the system that we’re building in the first place.”

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