Ethereum is currently experiencing its longest period of inflation in history, and “blobs” of data blocks may be to blame.
Since mid-April, Ethereum’s circulating supply has steadily increased for nearly 72 days, adding almost 50,000 ETH (about $1.687 billion). ETH holders would typically benefit from a decreased supply and increased scarcity. However, the opposite is true due to Ethereum’s base fees being at their lowest point in the past two years. At the same time, the number of transactions on the Ethereum mainnet has increased, and the activity on layer-two networks has exploded.
Since the merge in September 2022, ETH has only been in a state of long-term inflation a few times, with the longest period being 40 days shortly after the merge and 30 days at the end of last year. (There is no unified standard for Ethereum’s inflation period. For the purpose of this article, the definition of an inflation period is a continuous increase in the total ETH supply for three days, and vice versa.)
ETH is in a state of inflation because the base fees used for burning have been significantly reduced. The Dencun update in March reserved space in each block specifically for layer-two networks to settle “blobs” transactions without competing with mainnet users. This, combined with increased data availability through proto-danksharding, has resulted in a significant reduction in competition for block space.
With enough block space for everyone, including layer-two users through blobs, Ethereum’s base fees have plummeted by 90% since Dencun, causing more ETH to be issued per block than destroyed.
In addition to transitioning from proof of work (PoW) to proof of stake (PoS), the merge also allows Ethereum to be in a state of deflation on a per-block basis. The Ethereum base fees that users pay used to be part of the rewards for miners who discovered blocks by consuming electricity.
However, with no electricity costs after the merge, the total block rewards will far exceed expenses. This could potentially distort the supply distribution of the currency in the long run, with validators ultimately accumulating an excessive amount of almost pure-profit ETH.
To make the experience fairer for regular users, developers have chosen to burn the base fees. Validators then receive priority fees, reduced block rewards, and additional MEV income if activated.
Currently, the reward for each Ethereum block is only 2 ETH (approximately $6,800), with fees contributing less than 2.5%. Bitcoin’s proof of work pays nearly 3.3 BTC (approximately $200,000) per block, despite significantly higher costs.
It should be noted that since the merge, Ethereum has burned a large amount of supply, although most of it occurred before the appearance of blobs. Overall, 1.71 million ETH ($58 billion) has been burned, and 1.36 million ETH ($44.6 billion) has been issued, resulting in a reduction of 346,000 ETH ($11.7 billion) in supply.
This translates to an annual deflation rate of 0.161% for ETH.
If Ethereum were still running on proof of work, the supply would increase by 6.76 million ETH ($228.7 billion) annually, with an inflation rate of over 3%. Therefore, despite the recent inflationary trend, holders are still in a much better position, albeit slowly and slightly diluted.
