brn Brief: Is Ethereum’s Dencun Upgrade the Demise of Ultra-Sound Money?

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The recent weeks have seen some debate around Ethereum's price potential. While the long-term outlook for the world's second-largest cryptocurrency by market capitalization remains promising, a new report by CryptoQuant throws cold water on the popular "ultra-sound money" narrative.

The "Ultra-Sound Money" Thesis

This theory gained momentum after the Merge upgrade, which transitioned Ethereum from a proof-of-work to a proof-of-stake consensus mechanism. A key feature of the Merge was the introduction of a burning mechanism. A portion of transaction fees are "burned," essentially removing them from circulation.

This, in theory, could make Ethereum deflationary over time, similar to Bitcoin's capped supply. A recent CryptoQuant report challenges this narrative. It highlights that the Dencun upgrade, implemented in mid-March 2024, has significantly reduced transaction fees.

This decrease is attributed to improved network efficiency, which is a positive development for scalability. However, it also means less ETH is being burned. To assess the impact of the Dencun upgrade on ETH’s transaction volume and burning rate, we look at the quantity of Ethereum burnt, transaction count and Ethereum net supply.

Table 1 : Ethereum Fees Burnt per Transaction (Mean)

We can see that after Dencun upgrade on March 13, the average fees burnt per transaction fell by a factor of twenty over the course of two months (Table 1).

Table 2: Ethereum Transaction Count

Table 2 shows the daily transaction count. We can see that the number of transactions remained fairly stable. It means that the demand for transactions on ETH is not elastic in the short term (a decline in price will not lead instantly to an increase in the number of transactions).

Table 3: Ethereum Net New Supply

In Table 3, showing Ethereum net supply, we can see that the merge (September 2022) brought the daily net issuance from 16K to a neutral and even deflationary state during high-intensity periods. However, since the Dencun upgrade (13 March), the daily net issuance is slightly higher than 2,000 leading to a 0.6% yearly dilution of the market cap

Long-Term Potential Beyond "Ultra-Sound Money"

While the ultra-sound money narrative might need some revision, Ethereum's long-term potential as a foundational layer for Web3 remains strong. Its robust developer ecosystem, ability to run smart contracts, and position as a leading platform for decentralized applications (dApps) suggest continued network growth.

However, for a more complete picture, investors should monitor factors like gas fees, the number of active dApp users, and the overall health of the DeFi (decentralized finance) ecosystem. These factors will provide insights into user adoption and the overall utility of the Ethereum network

This upgrade enhances Ethereum's cost-effectiveness and operational efficiency. However, the reduction in fees may dampen the demand for the token and subsequently decrease the total amount of ETH burnt.

Should this upgrade fail to catalyse a substantial uptick in Ethereum blockchain usage, compensating for the reduced fees, it could exert downward pressure on Ethereum's price. Monitoring the impact of this upgrade in terms of transaction volume and the quantity of ETH burnt over the coming months will be crucial.

brn's ETH Take

It's important to recognize that the effects of such changes are not immediate, as demand for this product is not perfectly elastic. Should the demand for ETH fail to offset the reduction in fees, there are only two potential solutions to maintain Ethereum's deflationary trajectory: artificially boosting ETH fees or reducing the number of tokens rewarded to stakers.

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