Ethereum’s supply is shrinking again. Here’s why

The Ethereum network has entered its longest period of token deflation since the “merger.”

A New Ethereum Gas Guzzler

The ETH supply is shrinking again.

Ethereum gas fees increased over the weekend following the launch of a new token airdrop. The top smart contract network’s users have been rushing to create XEN – the token of a newly launched crypto project – straight to their wallets for free. The catch is that it costs a small amount of gas to do so.

XEN Crypto distributed its contracts to Ethereum on Sunday, marking the launch of the project and the start of token mining. The project was developed by early Google engineer and serial entrepreneur Jack Levin. According to their website, XEN is based on the first principles initiated by Satoshi Nakamoto in the Bitcoin Whitepaper. The protocol is permissionless, completely on-chain and decentralized. There was no pre-mint or token sale, meaning that the market forces and game theory surrounding the project alone will dictate the price of XEN going forward.

The reason XEN mining consumes large amounts of gas on Ethereum is that every address on the network has the right to mint XEN. The amount of tokens each user receives is based on a complex formula that takes into account the number of people who interacted with the smart contract before them and how long a user is willing to wait to receive tokens. As more time passes from launch and more people produce, it becomes increasingly difficult to create XEN, with longer waiting periods needed to receive a full allocation of tokens.

The XEN project also makes no effort to prevent users from attacking Sybil, where opportunists create multiple addresses and claim tokens on each one. Since there is an incentive to mint XEN early in order to sell the tokens immediately or receive a larger amount by locking them up, the airdrop has created a “gold rush” scenario where XEN is the gold, and ETH is the hack needed to mine it .

Ethereum is feeling the burn

In the last 24 hours, XEN token minting has consumed 1,470 ETH in gas fees – roughly 40% of the total gas spend on the Ethereum network, per Etherscan data. As a result, the average Ethereum transaction fee has consistently ranged between 15 and 32 gwei, which is enough to push the amount of ETH burned through transactions above that issued to validators on the network. When more ETH is burned than is rewarded to stakers, it causes the total ETH supply to shrink.

According to ultrasound.money data, the circulating ETH supply has dropped from 120,534,186 to 120,531,045 since XEN Crypto launched. During today’s gas use, the total Ethereum supply is going to shrink by 0.45% a year, or by about 1.25 million ETH tokens. However, it is unlikely that XEN mining will be able to sustain this demand for Ethereum usage in the long term. As those who mint XEN will aim to sell their tokens for more than the price of the gas it took to mint them, higher gas prices hinder minting.

Nevertheless, as XEN inflation decreases with time and the number of addresses minted, over a long enough time frame, it can become profitable to mint XEN when gas prices are low. The project will likely need to provide use cases for XEN to keep Ethereum users interested and maintain demand for the token.

When Ethereum switched to Proof-of-Stake on September 15th, it adopted a significant ETH supply reduction. Before the merger, the Ethereum network paid out around 13,000 ETH daily to miners as block rewards for processing transactions and securing the network. Now using Ethereum Proof-of-Stake, the rewards distributed to validators are equivalent to approximately 1600 ETH per day – a decrease of almost 90% in emission. As the base fee for processing Ethereum transactions is burned, the network can become deflationary during periods of high usage.

Disclosure: At the time of writing this piece, the author owned ETH and several other cryptocurrencies.