Is Ethereum Finally Becoming the Deflationary Currency that Memes Promised?

The term Ultra Sound Money is often brought up in relation to Ethereum. Originating in the competition of Bitcoin and Ethereum communities, the two camps have distinct opinions on which properties the perfect currency should have. Some time ago, Ethereum implemented a mechanism, which burns a percentage of gas fee on every transaction occurring on the network. In this article, we will have a look at what stands behind this Ethereum narrative, where it originated, and how exactly Ethereum plans to become a deflationary asset.

Sound Money and Ultra Sound Money

It is quite likely that you have seen some memes referring to Ethereum as “Ultrasound money”. This vision was coined by the Ethereum community in reaction to Bitcoin being positioned as a variant of “Sound money”. In this reaction, the Ethereum community is trying to mock Bitcoin and highlight its own, technologically advanced approach (hence the “Ultra”).

The term Sound money refers to the silver coins that were used all the way back in Ancient Rome. These coins made a distinct metallic sound when dropped, marking their undeniable value and scarcity. Today we use the term in a derived sense to describe money that has intrinsic value, is scarce, and is able to maintain that value for prolonged periods of time.

Why should Ethereum be UltraSound Money?

Now we are getting to the important stuff. The question is why should Ethereum be better money than Bitcoin, counting that Bitcoin was invented for this very reason. The answer has to do with the way how these projects manage their total supply.

In this regard, Bitcoin and Ethereum are very different. Bitcoin went the way of fixed total supply in the amount of 21 million BTC. No more BTC can ever be minted, which gives Bitcoin an undeniable sense of stability and trust. 

Ethereum on the other hand has no amount of maximum supply and the number of ETH in circulation can increase indefinitely (in theory). New ETH is minted each day in order to reward stakers in the network, but here is the catch. Ethereum also has an integrated burn mechanism, which reduces its supply depending on the activity of the network. This could mean that Ethereum has the potential to become a deflationary asset - the Ultra Sound money.

ETH Burning Mechanism

On 5th August 2021, a proposed upgrade of the Ethereum network EIP1559 was implemented. This new feature ensured that a percentage of the gas fee of every transaction on the network will be permanently removed from the supply (burned). 

The theory is such that if a bigger portion of ETH is burned than new ETH minted, then the circulating supply will ultimately decrease. Hand in hand with supply decrease goes also an increasing price per ETH because when there is less ETH in the market, it is becoming more scarce and more valuable. Of course, this works out only if the activity on the Ethereum network is sufficient.

The Current State of Burn

Using the ultrasound.money tool we shall now have a look at how this attempt at deflation is working out so far. In these metrics, it is important to include an event known as the Merge, where Ethereum successfully migrated from PoW to PoS consensus mechanism. The Merge influenced greatly how the circulating supply behaves and new ETH is issued.

From the first chart we can see that implementation of the burning mechanism only began to take effect after the Merge. From that point forward we can see a slow decline of the circulating ETH supply.

Just to imagine the situation on a bigger scale the widget above shows the total amount of burned ETH since implementation of the EIP1559, as well as the current burn rate.

So far the biggest source of burned value includes ETH transfers with over staggering 875 million USD removed from circulation since the EIP1559. In the close second position, we have OpenSea, which is notoriously known for its record NFT minting fees.

ETH as a Deflationary Asset

At the time of writing Ethereum is technically deflationary, which means that the burn rate exceeds the issuance of new ETH. The supply is decreasing and the price per ETH is rising slowly over time. 

However, this deflation depends heavily on whether enough transactions will occur on the network. If the demand for Ethereum is high, more users will transact and more ETH will be removed from circulation. Similarly from the other side, if the user activity is not sufficient, there will be a lower burn rate and Ethereum may become inflationary for a period of time.

The Bottom Line

The whole Sound money vs UltraSound money comes down to the debate on the tokenomic models of Bitcoin and Ethereum. We have gone through the main differences between these two approaches, but a lot of it depends on personal sentiment.

So far it seems that the current tokenomics model of Ethereum including PoS and ETH burns was able to withstand the current harsh market conditions and even managed to earn some yield for its users. 

We could expect that once Ethereum becomes more user-friendly and widely available, the burn rate rises even more, making ETH the Ultra Sound money with inherent value and increasing scarcity. However, we need to keep in mind that there will most likely also be periods of increased inflation for Ethereum.