Ethereum could be a better inflationary hedge than bitcoin, a new study suggests, just as cryptocurrencies start to gain acceptance as an alternative long-term digital store of value with similar anti-inflationary characteristics to gold.
Australian researchers who did the study say recent innovations on the ethereum blockchain have shown that it is possible for cryptocurrencies to become deflationary.
That occurs specifically through the destruction of transaction fees, says the study by Ester Félez-Viñas of the University of Technology Sydney, Sean Foley of Macquarie University, Jonathan Karlsen of University of Western Australia and Jiri Svec of the University of Sydney.
“With up to half of the networks’ blocks destroying more ethereum than is created, the notion that bitcoin offers the best inflationary hedge among the cryptocurrencies is increasingly coming under threat,” they wrote.
The authors say the Ethereum Improvement Proposal update known as EIP 1559 curtails the growth rate in ethereum supply and reduces the risk that token issuance eventually outpaces demand, rendering the token worthless.
Such protocol improvements could pave the way for more cryptocurrencies to improve their anti-inflationary characteristics, becoming better stores of value than bitcoin, the researchers suggest.
The supply of bitcoins grows deterministically, halving after every 210,000 mined blocks – approximately every four years – with supply ultimately capped at 21 million bitcoins.
These limits to bitcoin supply provide a potential hedge against inflation and explain the increased adoption of bitcoin in countries with a history of hyperinflation such as Argentina and Venezuela, the authors say.
The anti-inflationary properties of gold have for decades offered investors a stable long-term store of value and the limited issuance and hard supply cap of bitcoin are seen as similar attributes.
Bitcoin returns are positively correlated with future inflation expectations, which was a particularly acute issue during the Covid-19 crisis period.
Impending Inflation Risk
Last year, hedge fund investor Paul Tudor Jones warned of an impending inflation risk. “We are witnessing the ‘great monetary inflation’ – an unprecedented expansion of every form of money unlike anything the developed world has ever seen,” he wrote.
“High debt accommodated by money printing is difficult to banish. Inflation expectations could one day respond to this reality.”
The study authors say that following the recent change in its transactions protocol, the digital currency ethereum displays a significantly lower net issuance rate of tokens than bitcoin, achieved by destroying the fees associated with each transaction.
In many cases the amount of ethereum burned outpaces the networks creation of new tokens, resulting in ethereum potentially becoming the world’s first deflationary currency.
“We argue that this provides better inflationary hedging properties than bitcoin, and ether may therefore offer a superior long-term value storage than bitcoin,” the authors wrote.
• George Russell