Is Ethereum ready to return to deflation?

In recent weeks, as more and more Ethereum validators voluntarily leave, the growth of the Ethereum validator population has begun to slow down, which has also reduced the mining rate of Ethereum. Due to the increasing activity in the Ethereum network, the amount of Ethereum burned through the EIP-1559 protocol has also increased, which has caused the supply of Ethereum to fall into deflation again.

summary

• The trend change of Ethereum staking is becoming more and more significant. Since October, the number of validators withdrawing has been increasing. This change is closely related to the bullish trend of the digital asset market.

• The increase in validator exits has led to a decrease in the daily mining of Ethereum, and this change is closely related to the amount of active Ethereum in the staking pool.

• At the same time, due to the renewed interest in various digital assets and stablecoins, it is not difficult to see an increase in current Ethereum network activity. This is reflected in the fact that the increase in gas fees burned through EIP-1559 has triggered deflation in the ETH supply.

Without a doubt, the most important headline of the past week was the resignation of Binance CEO CZ. In the previous lawsuit, Binance reached a final settlement amount of $4.3 billion with the authorities, and many people regarded this key event as a sign of the end of the wild growth era of the digital asset industry.

Following the announcement, BNB’s price fell by 9.1%. However, this market reaction was relatively mild compared to previous price declines – BNB saw a 24% drop earlier this year when the SEC announced that they were charging Binance.

Figure 1: BNB price trend

Withdrawals from Binance’s main assets increased following the announcement. The total balance of a range of DeFi “blue chips” fell 6.7% in the previous 24 hours, while Bitcoin, Ethereum, and stablecoin balances fell 4.4%, 4.9%, and 2.2%, respectively.

However, within six days of CZ’s resignation, Binance’s balances showed signs of recovery — outflows slowed across all four digital asset classes, and even resumed net inflows. In many ways, this is a sign of how much trust users have in the Binance platform. Some believe that user confidence in the exchange may even be revived, given that Binance should be able to reach a settlement with U.S. regulators overseeing it for the next three years.

Figure 2: Recent balance changes of mainstream assets on Binance

Validator Exit

Although it has not made the same headlines as Binance, the Ethereum staking pool has been experiencing noticeable changes since October this year. Now, more and more validators are exiting staking.

With the official launch of the upgraded "staking withdrawal" mechanism in Shanghai, the number of users who have withdrawn from staking and cashed out their earnings has increased significantly. At the same time, the staking providers and their equipment have also ushered in an increasingly fierce reshuffle. During this period, an average of 319 validators withdrew from staking every day.

Since the beginning of October, we can see that this exit behavior is still increasing, even reaching a peak of 1,018 validators exiting on average every day. This upward trend is consistent with the recent upward trend in the spot price of the digital asset market.

Figure 3: Ethereum validator traffic

As a result, the total effective staked balance of Ethereum, which represents active participation in the proof-of-stake consensus, has slowed down, with the metric currently experiencing its first decline since the Shanghai upgrade.

The growth gradient of the total effective balance in the staking pool has flattened since mid-October, with an average daily growth rate of 0.1% to 1%, which is more than half the growth rate since May.

Figure 5: Change in the net percentage of total effective Ethereum balance

We carefully considered the circumstances of these exiting validators and found that most of them "voluntarily exited" in the past eight weeks. "Voluntary exit" means that the validator voluntarily chooses to withdraw from staking, which is different from being "removed" from the staking pool - the latter is a penalty for validators who violate the protocol rules.

During the same period, the network saw only two “slashing” events, one of which was a large one involving 100 new validators who were punished for signing two different blocks at the same time.

Figure 6: Comparison of voluntary exit events and “deletion” events in the Ethereum network

These exiting validators can be further categorized based on the type of staker they belong to. This categorization reveals some interesting phenomena:

• Since October, centralized exchanges (CEX) have been the main battlefield for staking withdrawals, with Kraken and Coinbase seeing the largest outflows.

• Withdrawn stakes also saw a small uptick, with Lido still the largest player in the space.

There are several factors that may drive these investor behaviors:

1. Perhaps driven by continued regulatory pressure, investors are choosing to change their staking configurations, such as transferring staked Ethereum from CEX to staking providers with higher liquidity.

2. Since the interest rates of safer assets such as U.S. Treasuries offer higher returns than the current Ethereum staking, investors with access to the U.S. capital markets will be more inclined to invest their funds in the former rather than the latter.

3. Investors may also seek greater liquidity for their Ethereum holdings to take advantage of upcoming market uptrends rather than continuing to hold these less liquid Ethereums.

We noticed that among the CEXs with staking withdrawals, Kraken and Coinbase were in the leading position, while the highest high-liquidity staking provider exit rate came from Lido. However, we must point out that these entities represented by Lido are also the main recipients of Ethereum staking, which shows the good investor stickiness of these large institutions and their superior position in the market.

Figure 7: Ethereum staking: inflows and outflows

On a net change basis, Lido’s dominance has become more solid, with its total staked balance increasing by 468,000 ETH. Among CEXs, Coinbase and Binance’s staked balances continued to increase, while Kraken’s staked balance decreased by 19,400 ETH. Among staking providers, HTX and Staked.us saw the most significant decreases in staked balances, both decreasing by more than 44,000 ETH.

Figure 8: Ethereum Staking: Net Flow

In line with the decrease in effective balance we observe, there has been a corresponding decrease in the amount of ETH mined - since the amount of ETH mined per day depends on the number of active validators, or the total effective balance within the staking pool.

As the growth rate of validators slows down or even declines, the daily Ethereum mining volume has also declined accordingly. In the past 7 days, the growth rate of Ethereum mining has dropped by 0.5% per day. It is worth noting that this is the first time that the growth rate of mining volume has declined in recent times.

Figure 9: Daily Ethereum mining since the merger

With Ethereum’s mining rate declining, we can now turn our attention to another aspect that can serve as a complementary study - the burn rate. With the fee burning mechanism enabled by the EIP-1559 protocol starting with the 2021 London hard fork, which involves transaction fees for the Ethereum fuel portion, it lays the theoretical foundation for the phenomenon of Ethereum supply deflation as network usage increases.

Considering the recent increase in gas fees means that the demand for transactions on the Ethereum network is growing, it is obvious that the daily consumption of fees has also increased. Throughout October, the network burned 899 Ethereum per day. In the past month, a total of 5,368 Ethereum has been burned as fuel in transactions across the entire network.

Figure 10: Ethereum: Gas Fees and Burn Rate

In addition to this, we can evaluate detailed accounts of gas usage for various transaction types. These metrics allow us to identify those actions that primarily lead to supply consumption.

By studying the two areas that have historically driven the most adoption of the Ethereum network, NFT and DeFi, we can clearly see that transaction activity in these two areas has been relatively low in the past four months, down 3% and 57% respectively from the previous period. Our conclusion is that the binding strength of these two areas to the Ethereum network is weakening, and they have contributed little to the recent surge in on-chain activity.

Figure 11: Ethereum: Gas fees in NFT and DeFi transactions

The recent surge in Ethereum network activity should be attributed mainly to the trading of digital assets and stablecoins. In the past three months, the gas volume of these digital assets has increased by 8.2%, while the gas volume of stablecoins has increased by 19%. This shows that as confidence in the market increases, capital may shift to long-tail assets.

Figure 12: Ethereum: Gas fees for other digital asset transactions and stablecoin transactions

Since the London hard fork, Ethereum has transitioned from net inflation to equilibrium to outright deflation. Notably, it experienced a brief period of net inflation between August and October due to a drop in Ethereum network activity.

In recent weeks, Ethereum’s total supply has again seen net deflation due to a declining issuance rate and increasing supply.

Figure 13: Ethereum: Total Market Supply after Consolidation

Summarize

Ethereum staking dynamics have changed significantly in recent weeks as the number of validators exiting the staking pool has begun to increase. This has led to a slowdown in the current growth rate of Ethereum mining and the first decrease in staking balances since the Shanghai upgrade.

In addition, the recent surge in Ethereum network activity, especially driven by other digital asset transfers and stablecoin transactions, has led to an increase in transaction demand. This in turn has put upward pressure on gas prices, leading to an increase in daily Ethereum fees burned through the EIP-1559 protocol.

In this context, we can see more clearly that Ethereum's network conditions and market supply interact with external factors including the trading conditions of other digital assets, as well as the activities of fields such as DeFi and NFT that are deeply dependent on the Ethereum network. It can be seen that Ethereum's deflation is actually the natural result of the superposition of the above factors.