Ethereum Inflation: Introduction

The past thirty days have seen a prolonged debate on an important matter: Ethereum’s Issuance. But be it an important matter or not – few of us seem to understand what’s going on. To be fair, this issue has complexities that has brought indecision to even the best minds of this space. So, it’s not surprising that many of us have decided to glaze over the issue. However, as a community, we owe it to ourselves to understand at least the basics of this issue. In this post, I will break down the Ethereum Issuance debate as simply as possible. This will be an easy read – and by the end of the post you will have a firm understanding of what is going on.

​​​​Ethereum Issuance & Inflation Rate

Ethereum is “inflationary”. You hear it all the time. But many don’t seem to understand how the inflation is caused. It’s rather simple. Ethereum miners get rewarded for mining new blocks. These miners get rewarded/paid in Ether. But this isn’t “existing” Ethereum; this is Ether that is freshly minted/created.

Essentially, miners are rewarded by issuing freshly minted Ether into the system. This “inflates” the existing supply in the market. Hence the term “Inflation Rate”

Ethereum Inflation Rate vs Issuance Rate

The Ethereum inflation rate and issuance rate are pretty much the same thing – for the most part. There’s a tiny ‘difference’ that is worth discussing. Let’s think about this for a second. There are two factors that will affect Ethereum’s inflation rate: The speed at which fresh Ether is given out The AMOUNT of Ether given out each time

Analogy

I can give you one piece of candy every minute; OR give you ten pieces of candy every ten minutes. Either way, over time I inflate your candy supply at the same rate. You’ll have 100 candy pieces in 100 minutes.

Speed of Ether Issuance

Currently, the speed at which Ether is issued out is pretty stable. Ether is issued to miners as a reward each time a new block is created/validated. As things stand, the time taken to create a block is relatively stable at ~14 seconds . However, if Ethereum increases the difficulty of “block creation”, then it will take longer to create each block. This is what people are referring to when they mention the “difficulty bomb”. If it takes longer to create create blocks, then less Ether will be rewarded over a period of time

Analogy

I stop giving you 10 pieces of candy every 10 minutes, and instead give you 10 pieces of candy every 15 minutes. After 100 minutes, you’ll have only 66 pieces of candy (instead of 100)

Ethereum Block Time vs Ethereum Block Reward

Amount of Ether Issuance

The amount of Ether issued for each reward is the next driving factor for Ethereum’s inflation rate. And this is the most debated factor at the moment. Ethereum is currently issuing roughly 5.5 Ether per block (as rewards) If Ethereum decides to reduce the amount of Ether given out per reward, then the inflation rate will drop regardless of the difficulty bomb.

Analogy

I keep giving you candy every 10 minutes. However, I give you only 6 pieces of candy each time – instead of 10. You’ll have only 60 pieces of candy after 100 minutes.

The Problem

Reducing the Ether issued will cut into miner profits. But not reducing Ether issuance will anger the rest of the community (more on why later)

What is the Debate About?

The Background

The current inflation rate is around 7.3% annually. The Ethereum community was promised somewhere around 2% - 4% with the release of Casper. (In fact, Vitalik once quoted ~0.5% as a feasible number – leading to even more expectations)

Casper Delay

So, the community has been patiently waiting on a reduction in Ethereum’s inflation rate. This was supposed to happen with the release of Ethereum’s Proof Of Stake: Casper. If you’re keeping updated, you know about the delay on the Casper release . ​Casper was also supposed to include a “difficulty bomb” that would increase the time it takes to find a block. This would decrease the ethereum inflation rate

Community Side

However, since Casper has been delayed, the community wants the matter of issuance being addressed right away. If Ethereum has to delay the difficulty bomb, then the other course of action is to reduce the amount of Ether being issued per block. Many community members are advocating for a reduction of issuance that would align inflation rate to ~2%. This would align the inflation rate to what it would be if Proof Of Stake was not delayed.

Miners Side

However the Ethereum Miners don’t like that idea – since it would cut directly into their profits. It’s important to note that Ethereum is still using Proof Of Work – which consumes a lot more power per block than Proof Of Stake would. Many miners claim that they would be forced off the network since the rewards would not be enough to cover their costs.

Why do we care about Miners?

Miners do more than just process/validate our transactions. Each miner contributes to the security of the network via their hashpower. If overall hashpower drops, the network is easier to attack. (I touch on this in a YouTube video on 1% Shard Attack ) Essentially, the more miners we have, the more security we have. If miners drop off the network, security will begin to drop – and we’re more vulnerable to attacks. As you may now be noticing, this issue does not have an easy solution. But we can get a better idea of which direction to take. First, let’s quickly go over where we currently stand.

Ethereum Issuance: Blocks & Uncles

What is the Ethereum Issuance currently?

The current Ether that is being issued is roughly 5.5 Ether per block. It’s important to note that unlike Bitcoin, the reward issuance is not straightforward. Here is a simplified breakdown of the rewards distributed: Block Reward: 3 Ether

Uncle Rewards: ~2.4 Ether





Total Ether issued per block: ~5.4 Ether (Issuance reduction will decrease this)

No. of blocks per day: ~6000 Blocks (difficulty bomb will decrease this)

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Current Annual Increase: ~7.3% (issuance reduction and/or difficulty bomb will reduce this)

Uncle Rewards...What the..?

(If you know what are Uncle Rewards , then you can skip this section) Unlike Bitcoin, Ethereum rewards miners that find blocks that don’t make it into the longest chain . These blocks that are considered “stale” in Bitcoin, and are orphaned. In Ethereum these are called Uncles and are rewarded for their work. This is primarily because Ethereum has a much lower block-time (the average time required to find a block). This “small window” may result in smaller miners unfairly losing out on potential rewards due to network latency etc. As such, miners are rewarded for their work. Of course, we cannot predict the exact number of Uncles – but we’re estimating that around 2.4 Ether will be given out to Uncles on average. Uncle Rewards are important because they:



a) Incentivise decentralization (small miners are less likely to join pools)

b) Increase the security of the chain. (more on this in another post)

Cool.. So What is Being Proposed?

Alright, now the fun part. There are three proposals – Ethereum Improvement Proposals (EIPs) to be specific. Here’s a list and summary of each of them:

EIP-858: Reduce block reward to 1 ETH

This would be a significant decrease from 3 ETH to 1 ETH. It would probably put several small/mid-size miners in the negative profitability. Many miners may drop off the network. However, this would probably benefit miners who have access to cheap electricity since they will be able to accrue more rewards for themselves. Larger miners may probably benefit for the same reasons.

EIP-1294: Keep block reward at 3 ETH. Reduce Uncle Rewards to ~0.56 ETH.

This will be a significant reduction to the Uncle Rewards – from ~2.4 ETH to ~0.56 ETH. Ouch. This will affect small miners the most since they rely on the Uncle Rewards. Furthermore, this reduces the incentive for them to remain independent; and may lead to larger shift of small miners to joining pools. Of course, larger miners who aren’t affected by network latency issues do not get affected by this reduction. They benefit the most from this since the issuance will be maintained.

EIP-1234 Reduce block reward to 2 ETH

This EIP seems to be receiving the most favour from the community. It serves as a good middle ground. it will still eat into profits of miners, but not as significantly as the reduction that EIP 858 proposes. EIP-1234 does seem to have an air of “compromise”. It will offer developers enough time to develop & release Casper while keeping both sides of the community at bay. Is compromise the best way to go? -shrug-

So..What Has Been Decided?