ETH 2.0 will create an economic shift? Here are 7 reasons

Editor’s Note: The original title is “Seven Reasons Why ETH 2.0 Will Create Economic Transformation”

Preface: This article mentions 7 reasons why ETH2.0 drives ETH changes. This article describes the prospects of ETH development in an optimistic way, and does not fully consider various potential risks and market factors, so everyone needs to make their own judgments. This article mentions how large rent-seeking investors and retail investors who are afraid of missing out will react with the arrival of the ETH2.0 staking economic mechanism? What are the reasons behind these reactions? Welcome to discuss together. The author of this article is Adam Cochran, translated by "SIEN" from the "Blue Fox Notes" community.

With ETH2.0 only a few months away from launching, it has the potential to prove to be a major economic shift. Here are seven reasons why. (Blue Fox Note: It would be more accurate to say that it is the launch of Phase 0 of ETH2.0, which is mainly based on the beacon chain)

• Reason 1: Rent Seekers

Due to the size of their principal, large investors focus on stable returns of around 3%-5%, which is why traditional investments have shifted below these rates (as the big players stop pumping money into sub-3% yields).

When ETH turns to staking, large investors may put their money into staking lock-up until they reach a 3%-5% return range. ETH2.0 may not be lower than this range because the Ethereum network still has technical risks that are not present in the traditional market, so rent seekers want higher returns to bear the risks.

To get down to this level, it means that about 10-30 million ETH will be locked in ETH2.0 validators. In the early stages of ETH2.0, these ETH cannot be withdrawn. Therefore, at the beginning of the launch, we may see lower investment and higher interest rates.

But this means that about 10%-30% of all circulating ETH will need to be locked up before the network falls below the return rate expected by large rent-seeking whales. What happens when 30% of supply is suddenly removed from the supply market? You will experience a supply shock.

Every major trader, investor, and miner knows they can become rent seekers, so those who normally provide liquidity to the market will be reluctant to sell. This is likely to hit lending pools and DeFi liquidity first. (Blue Fox Note: The two are in a competitive relationship and will eventually reach a balance)

Supply shocks usually create a sharp increase in commodity prices. This is what we have seen with the disruption of supply chains in COVID, so the lockdown alone creates shortages, which causes prices to spike.

• Reason 2: Second round entry

The price surge caused by the supply shock means that rent seekers get a 3%-5% return on their ETH investment, but in fact, if they use the fiat currency principal on their books, they will get a much higher return, which may be more than 2-4 times higher. Therefore, they will enter a second round of purchases and pledges until their expected return on investment returns to 3-5%.

It’s a chain reaction with diminishing returns, with each round having a smaller and smaller impact on the price. While it won’t have the full impact of the initial purchase, all of these chain reactions combined could be as much as two-thirds of the first impact, depending on how the price moves.

• Reason 3: FOMO of retail investors

So now, we have rent seekers, creating a supply shock. At the same time, we also have a secondary knock-on effect. This means that the market does start to move upward. This creates FOMO (fear of missing out) among retail investors, who tend to move later than any stimulus to invest. They tend to buy when the market is rising and sell when the market is falling. Retail investors, especially those who enter FOMO mode, tend to react violently. They rush into the market to buy and make sure they don't miss out.

These retail investors don’t care about P/E ratios or RSI, and they don’t pay attention to market depth. They just want to get in. When they start buying in, the market will be flooded. In the 2017 bull run, the biggest obstacle was that it took time for users to go through KYC/AML on exchanges. At that time, Coinbase only had 5 million users, and it was not possible to buy cryptocurrencies with fiat currency like on exchanges like Biannce.

All it takes is one crazy MSNBC headline about Ethereum growth to remind them of their accounts and retail investors go wild. However, as we know, 10-30 million ETH is locked up when ETH2.0 is launched, so there is a supply shock with a reduced supply.

However, now we have a demand shock where everyone wants a piece of the asset. When we have a supply shock and a demand shock at the same time in a short period of time, it can really ignite FOMO and can drive a short-term, one-off price spike.

Now, when we look at the lock-in for the ETH2.0 launch, that’s only the third reason for a short-term price surge. But what about the long-term? There are a lot of factors that will establish a strong “base growth rate”.

• Reason 4: Practical needs

The best reason for this growth is actual demand for the asset, namely for use as gas fees in decentralized computing, something only ETH2.0 can truly claim.

With the release of ETH2.0 (and other improvements), we will see ETH greatly increase its tx/s, thereby improving its commercial and consumer capabilities. Transaction congestion, high transaction costs, and long waiting times for dApps are gone. This means that all teams built on Ethereum can now deliver commercial and consumer-scale products, and there are more projects joining. The use of Metcalfe's Law drives value growth. (Blue Fox Note: A little optimistic here. ETH2.0 has a long completion time. First, it takes time to achieve high performance. Second, the sharding of eth2.0 also has cross-sharding problems)

In short, the more actual demand there is to use the Ethereum system, the more upward momentum there is in its price. This is because the real value foundation is created by users.

The best part about an open system like this is that every transaction has a different value for everyone. You could value one 200,000 gas transaction at $0.10 and another at $5. This means everyone in the market has a different price, and that’s not even taking into account that we could eventually decide to change what we pay for gas.

• Reason 5: Whales buy in cycles

What happens as actual usage drives the price up? Those rent-seeking whales come back. The price goes up a lot, and their ROI goes up again. So they can put more money into staking.

However, the more capital they put in, the more nodes they have. More nodes = proportionally lower rewards. This means that every additional node a whale adds dilutes the potential gains of all other rent seekers. If these rent seekers want to continue to earn the same rate of return, then, they also need to put in more capital.

This creates a competitive condition. Rent seekers must buy more to maintain their yield. However, this in turn creates scarcity, which drives up the price, which in turn causes more whales to buy in for staking. The whale buying cycle continues. However, users cannot stake fractional ETH, not even 1 ETH, and must be allocated in 32ETH quantities, which brings us to the next reason for market growth.

• Reason 6: Gathering 32 ETH

You have to count how many zeros there are. As ETH is used as gas, as the price of ETH goes up, it will use decimals. You don't care if it's 0.00001ETH or 0.0000001ETH, as long as the transaction is cheap in fiat currency.

Suppose a whale finds that they have made a profit of 20 ETH from their node, and they cannot simply re-stake the money. They need to collect 32 ETH. This means that they must obtain 12 additional ETH funds from outside to make a new stake.

This is the minimum stake per node, and since every node has the same stake, people cannot recycle their profits. Even whales who make money from the market must bring new funds into the market to essentially “pro-rata” their staked amounts as the network grows.

This is one of the most effective components of the new ETH design, because whales will inject new money into the market to make up the amount of ETH they can stake.

Why? It’s because of opportunity cost.

Idle money loses 2% of its income every year. In this case, idle ETH may earn x% of its income every year, but staking ETH can earn (X%+Y%) of its income, where Y is the staking income. The value of Y is almost irrelevant, because X+Y always exceeds X.

As long as it has a return of about 2%, it is more profitable to invest money to get the ETH staked just right, rather than losing 2% every year due to inflation. Under ETH2.0, if more than 100 million ETH are locked, the ETH issuance rate will not exceed 1.81%. However, under the demand/supply shock, this will be crazy, which will cause the price to soar.

• Reason 7: Fee destruction in EIP-1559

EIP-1559 changes the way fees are calculated on the Ethereum blockchain. First, it means more efficient payments and no miners voting on fees.

But, most importantly for us, it means we can expect BASEFEE to be burned, with early estimates of at least 10,000 ETH per year, and growing as usage increases.

Right now, this is only 0.01% of the total annual supply, but this is proportional to actual usage and could become a significant driver. The short-term goal here is to eventually offset the amount of new ETH issued each year.

In the long run, if Ethereum is the world computer, then we can expect the annual destruction of ETH to exceed the annual new issuance and begin to reduce the total amount of ETH.

Right now, we estimate there are about 1.2 million active Ethereum users, many of whom only use 1-2 services, but this will change as larger services begin to adopt and deploy on Ethereum.

Considering that there are rumors that Reddit will release its own token based on the Ethereum blockchain and appears to be pushing an Ethereum wallet in its app.

This means that their 330 million monthly active users will have Ethereum wallets and a reason to interact with ETH every week to claim their tokens. If 10% of these users become monthly active ETH users, then 10k ETH burned per year could quickly turn into 250k ETH burned per year just for the blockchain integration of one major service.

Ultimately, in the long run, the supply of ETH will decrease, which is a good thing for everyone.

In ETH, we only need to count zeros. Someone using ETH as gas fee doesn’t care if it costs 0.001ETH or 0.00000001ETH, as long as its transaction fee is $0.001 in both cases.

Since gas doesn't have to count zeros (unlike painfully reading payments denominated in BTC), the price point doesn't matter, as long as the price rises slowly enough, it will make no difference between buying ETH and spending ETH. However, this is good for investors, because the supply is decreasing and the value of ETH is rising. Therefore, they will gradually release their staked ETH to the open market, creating a smooth base growth rate.

Perhaps many of you may know that the economic design of ETH2.0 is smart, but perhaps you have not considered how smart it is.

Although the amount of ETH locked in DeFi is not large, this also drives its price. (Blue Fox Note: Currently, there are 2.7 million ETH locked in DeFi) The amount of ETH locked in staking will be more than 10 times its locked amount. It is a perfect combination of instant rise, repetitive buying cycles, competitive conditions driving short-term prices, and just the right base growth rate.

In Vitalik's words, ETH's economic policy is the minimum necessary issuance to ensure network security. Ethereum will eventually reach a balance, and supply and demand will drive prices to maintain a good and steady growth rate, thus ensuring that the Ethereum network is always economically viable.

However, for the reasons we mentioned, this equilibrium will likely be reached at a much higher price than we have now, greatly rewarding early adopters/investors.

In turn, it will create one of the largest economic growth events in our modern society, and it is now acceptable to be a part of it, and you don't need to be a big bank to participate.

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Risk Warning: All articles in Blue Fox Notes cannot be used as investment advice or recommendations. Investment involves risks. Investment should consider personal risk tolerance. It is recommended to conduct in-depth research on the project and make your own investment decisions carefully.