How Cancun Upgrades Affect Ethereum’s Token Policy

summary

• The Dencun upgrade on Ethereum introduces new data storage capacity aimed at reducing the cost of fees for its Layer 2 scaling solution.

• The upgrade also implements fixed limits on incoming validators to manage the growth of the validator set and maintain efficient node communication.

• This change could affect Ethereum’s token policy by reducing the rate of new issuance of Ethereum. This could result in a reduction in the supply of Ethereum.

Reduce the cost of scaling solutions

On Wednesday, March 13, Ethereum underwent another major update. The Cancun-Deneb (Dencun) upgrade made significant changes to Ethereum’s Rollup infrastructure. The upgrade also made some modifications to Ethereum’s staking pools to improve node communication and network stability.

In recent years, various solutions have emerged to help the Ethereum network handle more transactions. Roll-up is a blockchain that utilizes a separate execution environment to execute transactions outside the Ethereum blockchain. They aggregate batches of transactions that occur during the Rollup and anchor them into a single transaction, which is then submitted to and verified by the Ethereum blockchain.

Roll-up solutions have become increasingly popular over the past two years, with Arbitrum and Optimism, two major scaling solutions, increasing their usage by 150,000 and 100,000 daily active addresses, respectively. Meanwhile, Ethereum Mainnet still has the most active addresses, with over 400,000 daily active addresses.

The main feature of the Dencun upgrade is the creation of additional data storage capacity on the Ethereum network. It introduces a new type of transaction capable of carrying large data packets, called blobs.

Blobs are temporarily stored at the consensus layer instead of the execution layer, which reduces the cost of the Ethereum network and Rollup itself. As shown in the table below, transaction costs have dropped significantly after the upgrade, and the transaction fees of Optimism and StarkNet are even less than 1 cent.

Normalizing to USD allows us to see how roll-ups perform differently relative to mainnet fees. Since their launch, roll-ups have offered cheaper, less volatile fees, with Arbitrum and Optimism charging between $0.10 and $0.30 per transaction. In comparison, Ethereum mainchain fees have ranged from $2 to $7 over the same period.

During periods of high activity, when demand for Ethereum block space surges, fees can rise to over $30. Prior to Dencun, Rollup fees were somewhat dependent on mainchain fees, and in similar circumstances, their fees increased to as much as $2.50.

The shared reliance of accumulated fees on the high volatility of the Ethereum fee market tends to result in an overall more expensive and challenging user experience. These Layer 2 solutions also impact the Ethereum fee market by adding new sources of demand for block space. According to a report by Fidelity, transaction fees paid by various Layer 2 chains typically account for around 10% of the total fees paid on the Ethereum mainnet.

Source: Fidelity Digital Assets

Separating Layer 2 anchor transactions into blobs through the Dencun upgrade is largely in line with improving user experience, reducing fees, and is consistent with the Ethereum Foundation's Rollup-centric roadmap. It is hoped that lower transaction fees will encourage more users to switch to Rollup, thereby increasing the total transaction throughput based on Ethereum. This strategy aims to improve scalability without compromising the decentralization and security of the main chain.

Shortly after Ethereum launched its first set of scaling solutions, we observed an increase in average transaction throughput to 105 transactions per second (TPS) in mid-2021. Of this, roll-ups accounted for approximately 46 TPS, or 44% of the total.

This provides an initial sign of success for Rollup-centric roadmaps and similar Layer 2 scaling solutions. However, there is still a significant difference compared to Ethereum’s largest competitor Solana (averaging ~2.6k TPS), which is largely a function of modular (e.g. Ethereum) vs. monolithic (e.g. Solana) design architecture.

Staking Pool Adjustment

The Dencun upgrade also introduces new technical changes that impact stakers on Ethereum, primarily aimed at improving the user experience:

• Permanently valid signature exits enhance the user experience for delegated staking participants, such as liquidity staking pools. Currently, the signature keys required to authorize users to exit from staking pools are held by validator operators. This arrangement makes stakeholders rely on the goodwill of validator operators when they want to exit their positions. After the Dencun upgrade, validator operators can pre-sign voluntary exits, allowing stakeholders to unilaterally exit their stake.

• Increasing the attestation window extends the time validators have to vote on block correctness from 6.4 minutes to 12.8 minutes. This allows more attestations to be collected, which can speed up the block confirmation process. Currently, the number of attestations is about 759,000 attestations per day.

A fixed limit on new validators has also been added to slow down the growth of the validator set. Currently, the churn limit specifies how many new validators can enter or exit the staking pool each day. This limit increases by one step with a defined increment in the total number of active validators.

After the Shanghai upgrade, the number of active validators increased significantly, with an average of +1347 new validators added per day. However, as the number of validators increased, people noticed that the side effect was a slowdown in node communication.

The Dencun upgrade has now introduced a limit of 8 new validators per ~6.4 minute period to replace the churn limit feature.

The slowdown in the growth of the validator set and effective staked balance has a secondary impact on Ethereum’s token policy. Currently, the issuance rate of ETH depends on the number of active validators, and since fewer people can now enter the staking pool, it may slow down the issuance of new ETH.

Since the Shanghai upgrade, issuance has increased from ETH 1183/day to ETH 2554/day as the validator set has grown. Although it’s still early, we saw the third drop in issuance rate shortly after the Dencun upgrade.

A possible slowdown in issuance could also result in a net decrease in Ethereum supply, as more ETH is burned through transaction fees than is newly issued. Since the merger, we have observed a net decrease in the total circulating supply of ETH of 410,000 ETH.

The combined impact of the Dencun upgrade on ETH supply remains to be seen, as there are a number of interacting changes:

• Layer 2 anchor transactions have now been moved to the blob data structure, eliminating about 10% of the fee congestion pressure. This may lead to a slight reduction in ETH destruction.

• Lower Layer 2 fees could attract more people to the Ethereum mainchain and scaling solutions, which could increase fee pressure.

• The issuance growth rate is likely to decrease due to a decrease in the number of new validators able to enter the staking pool.

Throughout its history, Ethereum has undergone six major updates, but not all of them directly target changes in ETH supply. However, it is clear from the last four upgrades that the growth of ETH supply has slowed down. After the merger, it even turned slightly negative. The following chart shows these different upgrade events and the relative changes in ETH circulating supply.

Summarize

The Dencun upgrade significantly enhances the Ethereum network by creating additional data storage capacity through Blob transactions. This upgrade effectively reduces the cost of various scaling solutions, thereby improving the user experience and potentially increasing total transaction throughput by encouraging the use of Rollups.

The upgrade may also affect Ethereum's token policy by limiting the entry of new validators, which will slow the growth of the validator set and thus the rate of new ETH issuance. While the reduction in issuance means that the supply may be reduced, the new blob structure may also lead to fewer transactions at the execution layer, thereby reducing the destruction of ETH and potentially mitigating the impact of the reduction in issuance.

All in all, this development continues Ethereum’s trend of slowing its supply growth and executing a Rollup-centric roadmap. As can be seen, the last four upgrades have led to a slowdown or even a small reduction in ETH supply since the merger.