Ultrasound Money πŸ¦‡πŸ”Š ETH Supply Equilibrium & Burn Rate for Non-Stakers

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πŸ’¬ Question: If you’re visiting the great ultrasound.money website, you may have stumbled over the term “burn rate for non-stakers”. What does it mean exactly?

In this article, you’ll learn all about it!

Before I give you a concise definition, let’s recap some key terms for learning and ease of understanding.

What Is Token Burning?

Token burning is the process of permanently reducing the supply of tokens, e.g., from a crypto asset like Ethereum. Since the EIP-1559 hard fork of the Ethereum Blockchain, a fraction of transaction fees are automatically “burned”, i.e., permanently removed from the token supply.

You can think of token burning as a “dilution” of somebody else’s stake in the Ethereum blockchain to the benefit of your own stake. If you own 0.0001% of the ETH network and half of all ETH tokens (that are not yours) got burned, you now own 0.0002% of the network.

For example, say you run a business with a business associate. Each of you owns 50% of the company. Suddenly, your partner decides to transfer their equity of 50% of the company to your name. He “burned” his stake in the business asset. You now own 100% of the company. Easy.

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What Is The Benefit of Token Burning?

If the Ethereum blockchain burns tokens, the supply of tokens is reduced. This means that all ETH token holders that are not affected by the “burn” now have a larger percentage or “stake” in the overall network. Their net worth has increased as a result.

For example, suppose the Ethereum blockchain starts with 120 million ETH units. The total market capitalization of the Ethereum blockchain may be 120 billion USD (for simplicity of math).

πŸ‘‰ So each ETH token is valued at 120 billion USD / 120 million ETH = 1,000 USD/ETH.

Now, let’s assume the Ethereum protocol burns half of all tokens over a period of time. So, the ETH token supply goes from 120 million ETH to 60 million ETH.

πŸ‘‰ As a result, each ETH token is now valued at 120 billion USD / 60 million ETH = 2,000 USD/ETH.

If you manage to be unaffected by the burn, your ETH assets would double, all other things being equal.

Whose Tokens Get Burned?

If you’ve read so far, you may wonder whose tokens get burned? Who would give up their stake in the network for the benefit of all other stakeholders?

The protocol update EIP-1559 has brought an important change to the Ethereum ecosystem:

πŸ’‘ “With EIP-1559, there will be a discrete β€œbase fee” for transactions to be included in the next block. For users or applications that want to prioritize their transaction, they can add a β€œtip,” which is called a β€œpriority fee” to pay a miner for faster inclusion.”Β Consensys.net

So, whose tokens get burned?

If you issue an ETH transaction, you pay a portion of your transaction volume to the protocol. This portion gets burned by the protocol. In a way, you can think of Ethereum ownership moving from the active to the inactive network participants.

Token burn is a fee paid for a service, and the fee goes to all owners of the Ethereum blockchain, i.e., the ETH holders.

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Is Ethereum Deflationary?

Talking about all that token burns may make you wonder whether Ethereum will always be deflationary.

The answer is not necessarily. The reason is that the Ethereum blockchain has an inflationary force as well: it pays a certain percentage of the total ETH token supply to its “stakers”, i.e., ETH token holders that use their tokens to provide security to the network.

In this example snapshot shown on the Ultrasound Money website, the stakers would earn a 4.4% yield on their staked ETH:

For example, if there are 100 million ETH tokens in supply, the Ethereum blockchain would distribute 4.4 million ETH tokens to the stakers (pro-rata, i.e., the more you stake, the more you get).

To summarize, there are two forces at play concerning the tokenomics of the Ethereum protocol:

  • A deflationary force burns a fraction of the transaction fees to continuously reduce the token supply.
  • An inflationary force adds more tokens to pay the stakers that provide network security.

If the deflationary force is stronger than the inflationary force, i.e., more ETH tokens are burned than paid to stakers, the protocol becomes deflationary.

If the inflationary force is stronger than the deflationary force, i.e., more ETH tokens are burned than paid to stakers, the protocol becomes inflationary.

What Is the Burn Rate for Non-Stakers?

This leads us to the last question: what is the burn rate for non-stakers?

The burn rate for non-stakers is the percentage of ETH tokens that are paid to the network as transaction fees and burned by the protocol in a given year. It is the strength of the deflationary force of the protocol put into a simple percentage number.

For example, if there are 100 million ETH in supply and 5 million ETH got burned in a given year, the “burn rate for non-stakers” would be 5% per year.

Note that “stakers” have their ETH locked into the protocol so they cannot issue any transaction and, thereby, not pay any transaction fee to the network.

πŸ”₯ Consequently, the “burn rate for non-stakers” means exactly the same as the term “burn rate of the Ethereum protocol”.

Let’s examine two extreme cases to see how it interplays with the protocol.

Case 1: Assume 0% burn rate for non-stakers

If you assume there is a 0% burn rate for non-stakers, you assume that nobody is issuing any transaction. In that case, the protocol will still produce blocks because it’ll pay the validators that stake their ETH out of its inflationary token supply.

🧠 Remember: the Ethereum protocol can produce tokens forever, there is no fixed supply cap.

In that case, the protocol will become inflationary. If this scenario would persist forever, there will eventually be infinite ETH. That’s why the “Supply Equilibrium” shows the infinity symbol.

Case 2: Assume 4% burn rate for non-stakers

If you assume there’s a 4% burn rate for non-stakers, you’re assuming that 4% of the ETH supply held by non-stakers is paid as transaction fees and burned by the protocol.

In the previous example, it is assumed that there are more non-stakers than stakers so even if we pay 4.4% of staked ETH supply to the stakers, a 4% burn rate for non-stakers would result in a deflationary protocol. The steady state of this scenario, i.e., the same rate projected out to infinity woul yield a supply equilibrium of 29.9M ETH.

What Is The Ultrasound Money Barrier?

The ultrasound money barrier πŸ¦‡πŸ”ŠπŸš§ symbol below the “Burn Rate for non-stakers” slider depicts the percentage of ETH that would have to be burned on average by the protocol so that the supply equilibrium doesn’t change compared to the present day.

The protocol is neither inflationary nor deflationary at the ultrasound money barrier.

  • If you move the burn rate for non-stakers up, i.e., more transaction revenue is burned, the protocol becomes deflationary.
  • If you move the burn rate for non-stakers down, i.e., less transaction revenue is burned, the protocol becomes inflationary.

Why “Ultrasound” Money?

Well, you know the drill. An inflationary asset tends to lose value over time (assuming constant demand) whereas a deflationary asset tends to gain value over time (assuming constant demand).

You want to put your money into deflationary assets and not inflationary assets.

The hope is that by providing a deflationary money-like asset that you can move with the speed of light without asking anybody for permission, Ethereum sucks in more and more people and becomes the dominant world currency of the metaverse.

Or whatever. πŸ˜‰

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