Can Decline in Inflation Affect ETH in February?

Dur­ing Jan­u­ary, the cryp­tocur­ren­cy mar­ket wit­nessed a sig­nif­i­cant surge, and Ethereum (ETH) was among the ben­e­fi­cia­ries. The lead­ing alt­coin in the blockchain are­na record­ed a 31% increase in mar­ket cap­i­tal­iza­tion last month, dri­ven by fac­tors such as height­ened antic­i­pa­tion among the ETH community.

It is impor­tant to note that the infla­tion rate plays a cru­cial role in main­tain­ing the sta­bil­i­ty of a cryp­tocur­ren­cy’s val­ue over time. A low­er infla­tion rate sig­ni­fies a scarcer sup­ply of cryp­to, which results in increased demand and, in turn, increased val­ue. Con­verse­ly, a high infla­tion rate may result in reduced demand, lead­ing to a decrease in the asset’s value.

Addi­tion­al­ly, cer­tain cryp­tocur­ren­cies, such as Bit­coin (BTC), have been engi­neered with a fixed max­i­mum sup­ply and a min­ing process that decreas­es the sup­ply over time. This con­trolled infla­tion is a cor­ner­stone of the flag­ship cryp­tocur­ren­cy. Although not ini­tial­ly designed as a defla­tion­ary coin, Ethereum is mov­ing toward a state of scarcity.

Fall in Ethereum inflation

In June 2021, the Ethereum net­work took a step toward defla­tion with the EIP-1559 upgrade. This upgrade intro­duced a fee for each trans­ac­tion on the ETH blockchain, effec­tive­ly reduc­ing the sup­ply of the cir­cu­lat­ing cryp­tocur­ren­cy and address­ing exces­sive trans­fer demand.

How­ev­er, this was not suf­fi­cient to make Ethereum a defla­tion­ary asset as a greater amount of the cryp­tocur­ren­cy con­tin­ued to enter cir­cu­la­tion, even as some of it was being burned. The turn­ing point came in Sep­tem­ber 2022 with the arrival of The Merge.

The most eager­ly await­ed update in the past year, The Merge, trans­formed Ethereum’s con­sen­sus mod­el from proof of work (PoW) to proof of stake (PoS), result­ing in improved effi­cien­cy and reduced block min­ing needs. This has caused the sup­ply of ETH to grow at a slow­er pace, poten­tial­ly lead­ing to defla­tion in the long term.

There is good news for cryp­tocur­ren­cy hold­ers, as data from Ultra Sound Mon­ey reveals that Ethereum has burned more tokens than it has issued since the start of the year. As of this writ­ing, Ethereum’s annu­al infla­tion rate is ‑0.18%, com­pared to Bit­coin’s cur­rent infla­tion rate of 1.8%.

Could this be good for Ethereum in February?

A low infla­tion rate is gen­er­al­ly seen as pos­i­tive, but it can also have some draw­backs. One such draw­back is the lack of incen­tive to spend the cryp­tocur­ren­cy, which can lead to a decline in inno­va­tion and even a poten­tial defla­tion spiral.

Despite this poten­tial issue, it is unlike­ly to affect Ethereum’s net­work, as it is the most wide­ly used in key areas of the blockchain indus­try, such as sta­ble­coins, decen­tral­ized finance (DeFi), non-fun­gi­ble tokens (NFTs) and oth­er smart con­tract-linked features.

It is unlike­ly that Feb­ru­ary will be the month that Ethereum expe­ri­ences growth due to its defla­tion. The cryp­tocur­ren­cy needs to demon­strate its abil­i­ty to over­come infla­tion over a longer peri­od before any sig­nif­i­cant impact can be seen. Fur­ther­more, prepa­ra­tions for the Shang­hai event in March may divert atten­tion away from Ethereum’s defla­tion­ary momentum.

How­ev­er, in the long term, a suc­cess­ful defla­tion­ary trend could be great to attract more investors and strength­en ETH, just as Bit­coin’s trend has helped to bol­ster the cryp­tocur­ren­cy. It remains to be seen whether Ethereum can suc­cess­ful­ly main­tain its defla­tion­ary trend in the com­ing months and years.