Inflation Or Fees?

By dalz | dalz blog | 20 Jan 2021


Just want to share some thoughts on the topic of inflation and fees.

Some of the trends that are starting to pop up more and more is rewarding users/stakeholders without inflation. Then how to do this? Well the usual way is trough some income generating mechanics.

Fees are bad and everyone hates them, except for the ones that receive them 😊. In a decentralized world it doesn’t mean that only corporates will get those fees but there is a chance for anyone to participate, big or small.

The same question applies for the big boys of crypto Bitcoin and Ethereum.

Not to forget miners on Bitcoin and Ethereum receive inflation but at the same time they receive fees from the transactions.

Bitcoin has a limited supply. For miners to keep going, it will better be that Bitcoin is very valuable in the future so even those small amounts of Bitcoin are worth putting in a large numbers of computers to secure the network and confirm transactions. The other source of revenue for miners will be the fees. At some point fees will be the only source of income for Bitcoin miners. Their better be worth it, otherwise the whole network will be under threat at that point.

Ethereum is also rewarding miners with inflation and fees. Ethereum fees are now even higher than Bitcoin. Unlike Bitcoin, Ethereum does not have a limited supply and have around 5% yearly inflation. Ethereum has a fixed amount of reward per blocks, so as the supply grows, the inflation in terms of % is going down. Also, there was a few adjustments of the ETH per blocks rewards in the past.
At this moment there is a proposal in place called EIP 1559 which aims to burn the fees rewards. In this way the Ethereum inflation will be lowered or maybe even reduce the overall supply. IMO if Ethereum wants a lower inflation and supply, the right approach will be to just lower down the inflation, the rewards per block then burning fees. In the long run fees are actually a better bet than the inflation.

DeFi tokens and the whole defi movement is also having projects that explore the idea of generating revenue/rewards to the token holder’s trough fees only. There is a token named Beefi on the BSC chain that reward the token holder’s trough the fees generated on the platform.

There are other protocols like this on the Ethereum network as well. No inflation rewards only through fees.

IMO inflation is not a bad thing when it is used for growth. A new project needs high inflation to grow. Without a high inflation and great rewards, the adoption can be slowly. Of course this is just one piece of the picture and there are more elements for a successful project, then just the tokenomics and inflation or the fees. But when it comes to inflation the overall picture seems to be this one. In the first years even, Bitcoin had double digits inflation. Then the halving’s came and we are now under 2% yearly inflation per year. Ethereum also had a higher inflation at first.

Looking only from an inflation point of view the “right” way for a project to go around this is high inflation, high rewards at first and lowering it in time, maybe even have a cap of the supply. At some point stop the inflation and generate rewards only from fees in the system.

The thing is depending only on fees in the system can be risky as this is the only way to reward participants and stakeholders. If there is not enough activity/volume, or it is going down so will the rewards. Once the rewards start to go down this can be a downward spiral that lower the activity/volume in the system further lowering the rewards causing less and less activity.

Having the above in mind, some baseline low inflation maybe is a good thing to ensure there will be rewards for the participants. A 1% per year inflation or 0.5% would not change much for the whole tokenomics and will keep the incentives in place.

Bitcoin

The Bitcoin cap of the religious 21 million has its bad side as well. Although far in the future 100+ year, even today Bitcoin has a low inflation that keeps going down every four years. After the next halving in 2024 the Bitcoin inflation will be under 1%.

This requires high Bitcoin price for the miners to keep securing the network and the capital in it, or high fees. At this moment 18.6M out of the 21M are mined (88.5%) leaving it only 2.4M Bitcoin to be mined. At todays price of 36k USD per Bitcoin this is “only” 86 billion left for securing the network.

As times progress and there is less, and less bitcoin rewarded to miners from inflation, high bitcoin price is needed or high fees. At some point if the rewards from the mining inflation are not enough and there is a large capital in the network at risk, Bitcoin might need to increase its fees artificially to secure the network. This will happen for sure when the 21M total supply is hit, but it can happen even earlier. If Bitcoin is around in the next decade 😊, this might be already a requirement. The trend for Bitcoin fees will go only one way …. UP.

What is your opinion?

All the best
@dalz

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