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As Ethereum rises, its fees are plummeting. Here’s why this is a problem – DL News
- Ethereum mainnet usage no longer increases with the price of Ether as it did in the past.
- Over the past month, the network has created more tokens than it has burned in transaction fees.
When Ethereum’s Ether token hit an all-time high of $3,800 in May 2021, increased activity on the chain caused transaction fees to soar as users piled in.
They have become accustomed to spending more than $100 just to trade tokens onchain. But many didn’t care: there was money to be made.
Fast forward to 2024, Ethereum is revisiting those heady prices for the first time in over two years. But this time it’s different.
Ether surged above $3,800 hours after Bloomberg analysts revised the probability of an Ethereum ETF spot approval from 25% to 75%.
Despite prices rising compared to recent times Ethereum spot ETF reverses positionTransaction fees on the major smart contract network remain low, only slightly higher than they were during the depths of 2022’s crypto winter.
It’s a sign that demand for Ethereum transactions isn’t what it once was.
So, what happens?
Increased transaction efficiency, along with an exodus of activity to Ethereum’s low-cost Layer 2 networks, such as Base and Arbitrum, have helped moderate demand and make Ethereum cheaper to use.
While this is great for Ethereum users, there are drawbacks.
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As transaction fees on the Ethereum mainnet collapse, the network is unable to burn (in cryptography we talk about destroying) enough tokens to make Ether’s supply deflationary.
Crucially, if tariffs remain low, this could call into question the economic model of the network.
Ethereum becoming too efficient?
When the Ethereum network destroys more tokens from transaction fees than it rewards validators for processing those transactions, the total supply of Ether shrinks and becomes deflationary.
This situation is favorable for the network as it rewards those who help manage the network without inflating the supply of Ether.
But if users don’t spend enough Ether on transactions, the Ether supply will swell indefinitely, breaking the network’s economic model.
Persistent inflation, while unlikely, would devalue Ether and make it less attractive for users to lock themselves away in validators to secure the network. After all, a resource that maintains printing units is better spent than saved.
So far, the Ether supply has worked shrunken in total since Ethereum drastically reduced the issuance of new Ether with its September 2022 Merge update.
But things are changing. Over the past month, the lack of activity on Ethereum has caused the network to add over 50,000 Ether, worth $190 million.
If activity and fees spent on Ethereum do not recover, Ether’s supply will swell by 0.5% – or $2.2 billion – over the next year.
Where are the taxes going?
In recent years, many Ethereum users have moved to so-called Layer 2 networks.
Layer 2s such as Arbitrum, Optimism, and Base offer Ethereum compatibility, faster transactions, and lower costs, while still relying on the Ethereum mainnet for security.
The business exploded. Since the beginning of 2024, activity and trading volume on the 2 levels have risen to all-time highs.
These layer 2s still pay transaction fees on the Ethereum mainnet, but only a fraction of what it would cost if everyone using layer 2s sent transactions on the Ethereum mainnet.
Also, the march of Ethereum Dencún update reduce the already low cost of publishing Layer 2 transaction data, further decreasing demand on the mainnet.
Elsewhere, developers are improving the fees that govern Ethereum transactions. The result is a reduction in gas costs, meaning users pay fewer fees for the same type of transactions.
With Ethereum more efficient than ever and a thriving Layer 2 ecosystem, how will the network avoid economic turbulence?
Tim Craig is DL News’ DeFi correspondent based in Edinburgh. Contact us with suggestions at tim@dlnews.com.