Ethereum Supply

Ethereum Supply Research Report

Thesis Statement

Ethereum’s supply conditions favor significant price appreciation once demand returns to the market.

Abstract

Supply and demand for ETH are underpinned by structural flows (emissions, fee burn, gas fees). Ethereum’s maximum supply and circulating supply are both shrinking, rapidly increasing scarcity. As ETH becomes more scarce, it will be more prone to price appreciation when demand inevitably returns to the market, making it an attractive target for bear market accumulation.

For those who may not fully understand supply and demand, we will walk through an over-simplified example:

Imagine only 1,000 new bottles of wine are produced each year. No more and no less.

Scenario 1:

1,000 bottles of wine are consumed over the course of the first year.

Supply = Demand

The price of wine should remain fairly constant.

Scenario 2:

Now imagine next year, of the 1,000 bottles of wine produced, only 800 are consumed, leaving an excess of 200 bottles. Demand has decreased.

With an excess of wine in this year, the price of a bottle of wine should drop until all 1,000 bottles of wine produced can be sold.

Scenario 3:

Demand increases and 5,000 bottles of wine are to be consumed this year.

Because there is a higher demand for wine than supply, market participants will pay more for wine, sending prices much higher.

Scenario 4:

This year, demand stays steady at 1,000 bottles of wine, but production drops to only 500 bottles.

Price goes up because demand is greater than supply.

Scenario 5:

Demand increases to 5,000 bottles of wine and supply decreases to 500.

Price goes parabolic and wine becomes both coveted and scarce.

Scenario 6:

Demand decreases to 500 bottles. Production decreases to 500 bottles.

Price remains stable as both supply and demand have decreased at the same pace.

Supply

EIP-1559 was introduced to the Ethereum network in August of 2021. The change made it so a portion of all Ethereum transaction fees are permanently burned, removing ETH from the total supply. This deflationary mechanism acts as a constant positive pressure on the price of ETH as it reduces the supply.

The Ethereum Merge took place in September of 2022 and shifted Ethereum’s consensus model from proof-of-work to proof-of-stake. In doing so, a few things happened:

• The network’s energy overhead was removed. Instead of costing billions of dollars per year in energy costs to run Ethereum miners, proof-of-stake nodes can be run with very little energy. This is a big deal because Ethereum miners had to sell the majority of their ETH rewards to cover energy costs, which greatly hinders price.
• Since the energy costs dramatically dropped, it made sense to simultaneously reduce overall ETH emissions. Instead of paying miners ~13,000 ETH per day (most of which was sold to cover energy costs), daily issuance dropped to ~1,700 ETH per day (88% lower).

The combination of EIP-1559 and the Merge has resulted in the total supply of Ethereum becoming deflationary:

The supply of ETH on centralized exchanges has been plummeting since mid-2020. This means that people have been buying ETH and withdrawing it from exchanges.

As the liquid supply of ETH on exchanges decreases, price becomes more sensitive to increases in demand.

Potential Supply/Demand Catalysts

The Shanghai fork currently scheduled for April of 2023, will allow staked ETH to be withdrawn. Up until this point in time, any ETH staked to secure Ethereum’s proof-of-stake network has been un-withdrawable. Some are worried that with over 17 million ETH currently staked, many will withdraw and sell, putting downwards pressure on price.

This is a legitimate concern, though it should also be noted that many who would like to stake their ETH have not had the confidence to do so because of the indefinite lock-up period. The Shanghai fork will likely attract additional ETH to be staked. In fact, ETH has the lowest % of supply staked of the largest PoS cryptocurrencies, by a lot.

While many are worried about a large wave of unstaking and selling, we expect to see this ratio normalize towards the average of 50%+ in the months following the Shanghai fork.

The normalization of this ratio would greatly reduce the liquid supply of Ethereum, which again would make it more sensitive to demand and price appreciation.

The Mt. Gox Distribution refers to the distribution of roughly 142,000 BTC to creditors who lost their Bitcoin in the infamous Mt. Gox exchange hack of 2014. AS of March 8, distributions may proceed until the deadline on September 30, 2023. There is fear that many creditors who receive BTC will sell it, leading to downward pressure on BTC price, and therefore the overall market (including Ethereum).

However, there is a chance that a large portion of this BTC finds its way into ETH and other altcoins, as it is returning to the hands of crypto early adopters who are familiar with market cycles and altcoins.

BTC Halving Analysis

Each Bitcoin halving reduces BTC emissions by 50% every ~4 years.

In 2012 the block emissions were reduced from 50 BTC per block to 25 BTC.

That 25 BTC reduction per block at the ~$13 price of BTC at the time equated to a daily reduction of emissions of ~$45k.

Compared to its market cap of $128M, this was quite large. A 2844:1 ratio.

The 2016 halving reduced BTC emissions from 25 BTC per block to 12.5.

The daily reduction in emissions at a BTC price of $650 was $1.17M. With a the market cap of BTC at $10B, this was a 8547:1 ratio (weaker than the previous cycle).

The 2020 halving has a 20311:1 market cap to emission reduction ratio, which again was weaker.

With the ETH merge and EIP-1559 fee burn, emissions were reduced by ~$19,500,000 per day using a $1500 per ETH price point. This equates to a 9287:1 market cap to emission reduction ratio, quite similar to the 2016 Bitcoin halving.

In 2016 Bitcoin proceeded to run from $650 to $19.7k, and the supply side emission reductions no doubt played a major role.

Likewise, we anticipate the supply side emission reduction ETH has undergone to play a major role in its price action once demand returns.