A big draw for many investors when it comes to Bitcoin ( BTC -0.49% ) is the belief that it could be a hedge against inflation, largely because its supply is finite and capped at 21 million tokens. Ethereum ( ETH 0.26% ), the second-largest cryptocurrency, has never really gotten the same attention on this matter. But lately, there has been more talk that Ethereum could be a hedge for inflation, despite the fact that there is no cap on the number of Ether tokens that can be created. Let’s take a look at this new narrative and examine if Ethereum really could be a hedge against inflation.
Why Ethereum is now being viewed as deflationary
For several years now, developers have been hard at work on a huge set of upgrades to the Ethereum network in what is being called Ethereum 2.0. The goal of Ethereum 2.0 is to make the network more sustainable, more secure, and more efficient.
In August, developers completed a big part of this upgrade called Ethereum Improvement Proposal (EIP) 1559, otherwise known as the London Hard Fork, which changed the way transaction, or gas, fees are charged on the network. It’s fairly confusing, but the network essentially sets a more predictable base fee on transactions to try to lower congestion on the network, although it still seems like the network is struggling to reduce gas fees at the moment.
As part of the new setup under the London Hard Fork, this base fee will also be burned after every transaction, so the network will be eliminating Ether from the current 118 million supply. Since the implementation of the London Hard Fork in August more than 1 million Ethereum tokens have been burned. It’s also interesting to note that the supply of Ether really hasn’t increased that much in recent years, all things relative.
Now, the network is still creating Ether tokens, but the burning is shrinking what the supply would be and limiting its growth right now. In fact, longer-term projections show that once the network completes the full transition to Ethereum 2.0, the supply of Ether could decline by 2% annually. And this is where people start to get excited about the idea of Ethereum being more like Bitcoin and acting as a hedge against inflation, because it looks like the Ethereum supply will become more scarce over time.
Is Ethereum a hedge?
I think the jury is still out on whether Bitcoin and Ethereum are hedging against inflation. But an important thing to note about the London Fork and the overall Ethereum 2.0 upgrade is that the goal is not to necessarily make Ethereum more scarce, but really to bring down the gas fees and access to the network. In having each transaction burn the base fee, the network loses control over the supply of Ethereum, so while there may be times when Ethereum looks deflationary, it’s also possible the cryptocurrency’s supply could increase as well.
“We see so much misinformation out there about how Ethereum is deflationary,” Noelle Acheson, head of market insights at Genesis Global Trading, recently told Bloomberg. “Occasionally yes it is, but that’s not the purpose.”
In conclusion, while I cannot say with certainty that Ethereum hedges inflation, this new upgrade has certainly curbed the supply of Ether and should continue to do so based on future projections, which bodes well for Ethereum investors.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.