Ethereum's Dencun Upgrade Raises Questions About Network's Deflationary Trajectory

Ethereum's recent upgrade, Dencun, may have compromised its "ultrasound money" status. According to analysts, the fee burn rate has plummeted since Dencun, leading to a net increase in ETH supply. This is attributed to the dominance of layer-2 solutions and the upgrade's inclusion of EIP-4844, which reduces layer-2 transaction fees. As a result, Ethereum's deflationary trend may be unsustainable, and the concept of "ultrasound money" may no longer be applicable.

Ethereum's Dencun Upgrade: Implications for the Network's Monetary Properties

Introduction

Ethereum's much-anticipated Dencun upgrade, implemented in mid-March, has sparked concerns regarding its potential impact on the network's monetary characteristics. Analysts suggest that the upgrade may have inadvertently eroded Ethereum's status as "ultrasound money," a concept central to the asset's long-term value proposition.

Defining "Ultrasound Money"

"Ultrasound money" is a term coined by Nick Szabo, a renowned cryptographer and early advocate of Bitcoin. It refers to an asset that possesses stable purchasing power while simultaneously experiencing gradual price appreciation over time. Unlike "sound money" assets like gold or Bitcoin, which have fixed total supplies, "ultrasound money" has a deflationary supply mechanism, leading to a decrease in the total circulating supply over time.

Ethereum's Monetary Properties Prior to Dencun

Prior to the Dencun upgrade, Ethereum was widely regarded as "ultrasound money." The Ethereum Improvement Proposal (EIP) 1559, implemented in August 2021, introduced a fee-burning mechanism that destroyed a portion of transaction fees, effectively reducing the total supply of ETH in circulation. This mechanism contributed to Ethereum's deflationary nature, aligning it with the "ultrasound money" paradigm.

Dencun's Impact on Ethereum's Deflationary Trend

However, analysts from CryptoQuant argue that the Dencun upgrade has significantly reduced Ethereum's fee burn rate, pushing it to one of its lowest levels since the Merge, Ethereum's transition from a Proof-of-Work (PoW) to a Proof-of-Stake (PoS) consensus mechanism. This decline in fee burn has resulted in a reversal of Ethereum's deflationary trend.

According to data from ultrasound.money, the global ETH supply has increased by nearly 35,000 ETH, worth approximately $106 million at current prices, over the past 30 days. This inflationary trend stands in stark contrast to Ethereum's pre-Dencun deflationary trajectory.

The Role of Layer-2 Scaling Solutions

The Dencun upgrade introduced several improvements, including EIP-4844. This proposal introduced a new block structure called "blobs" designed to significantly reduce transaction fees on layer-2 scaling solutions. These layer-2 solutions, such as Polygon and Arbitrum, offload transactions from the main Ethereum chain, reducing congestion and lowering gas fees.

While layer-2 solutions provide scalability benefits, they may also contribute to Ethereum's inflationary trend. By reducing transaction fees on layer-2 networks, the demand for Ethereum's base layer may decline, leading to a lower fee burn rate and a less deflationary supply dynamic.

The Controversial Pectra Hard Fork

Ethereum is poised for the Pectra hard fork, the next major network upgrade. However, the Pectra hard fork has been met with mixed reactions due to concerns surrounding EIP-3074, a proposal aimed at enhancing wallet management and transaction security.

EIP-3074: Potential Security Risks

Critics of EIP-3074 raise concerns about its potential security vulnerabilities. The proposal introduces a new "Invoker" stage, responsible for processing and packaging transaction authorizations. Without rigorous audits and testing, there is a risk that malicious actors could exploit vulnerabilities in the Invoker stage to gain unauthorized access to user funds.

Itamar Lesuisse, co-founder of the Argent wallet, has expressed concerns that EIP-3074 could allow scammers to drain entire wallets with just one off-chain authentication. "It should allow a scammer to drain your entire wallet with a single off-chain signature. I expect this will be a major use case," Lesuisse remarked.

EIP-7251: Streamlining ETH Staking

In contrast to the controversy surrounding EIP-3074, the Pectra hard fork also includes EIP-7251, which aims to increase the ETH staking limit and streamline the validator setup process for operators. This proposal has received more positive feedback, as it is expected to improve the efficiency and accessibility of ETH staking.

Conclusion

The Dencun upgrade has brought forth a fundamental shift in Ethereum's monetary properties. The reduction in fee burning and the rise of layer-2 scaling solutions have reversed Ethereum's previous deflationary trend, raising concerns about its long-term value proposition as "ultrasound money." While the Pectra hard fork introduces new proposals aimed at addressing wallet security and scalability, the controversy surrounding EIP-3074 highlights the need for careful consideration and rigorous testing before implementing such changes. As Ethereum continues to evolve, it remains to be seen how these developments will ultimately impact its monetary trajectory and the overall value of the network.