Bitcoin Supply Increased by Only 1.8% in 2021, Ethereum EIP-1559 Considered Largely Successful, Coin Metrics Reports

thought-catalog unsplash Bitcoin Ethereum CryptocurrencyKyle Waters and Nate Maddrey from Coin Metrics have noted that after a “transformative” 2021 marked by all-time highs for most of the major digital assets and “key on-chain metrics,” expectations are now quite high for the crypto and blockchain space this year.

In their latest issue of State of the Network, Coin Metrics analyzes some of the “most important trends and stories to watch in the new year.”

The team noted that throughout its history, the key narratives surrounding Bitcoin (BTC) have gone through many changes with an “ever-evolving world.” Although the reasons to own bitcoin (BTC) still vary, “the perception of BTC as an attractive hedge to inflation has accelerated in the last couple of years following the unprecedented fiscal and monetary response to the COVID-19 pandemic across the world.”

Bitcoin’s property as “an untamperable and non-inflatable store of value helped drive institutional interest in 2020 & 2021,” according to an extensive report from Coin Metrics.

In May of 2020, hedge fund manager Paul Tudor Jones declared that “we are witnessing the ‘Great Monetary Inflation’ with the ‘expansion of every form of money’ and made a case for owning bitcoin – what he called the ‘quintessence of scarcity premium’ that is ‘literally the only large tradable asset in the world with a known fixed maximum supply’.”

In October 2021, Jones announced that his portfolio “contained crypto holdings in the “single digits,” the team at Coin Metrics wrote in their report.

They’ve explained that Bitcoin was intentionally designed as “a deflationary currency with a fixed total supply that is programmatically set to max out at 21M BTC.”

The BTC issuance schedule “follows a predetermined set of protocol rules known to all, with the amount of new BTC issued via block rewards cut in half (“halving”) every 210K blocks or roughly every 4 years.”

Over 90% of all BTC that will ever exist has now “been issued.” And in 2021, the BTC supply “increased by just 1.8%.” And the next halving will take place in May 2024, the report added.

The report further noted that in another case study, in August 2020 Microstrategy “adopted bitcoin as its primary treasury reserve asset citing that the ‘decision to invest in bitcoin at this time was driven in part by a confluence of macro factors’ and would ‘provide not only a reasonable hedge against inflation, but also the prospect of earning a higher return than other investments.’

As mentioned in the report from Coin Metrics:

“With inflation in the US recently hitting a 39-year high of 6.8% YoY in November and the Federal Reserve dropping the word “transitory” to describe this latest bout of inflation, these decisions now seem especially prescient. Bitcoin seems poised in 2022 to continue benefiting from its role as an inflation hedge. But there is still some structural and macroeconomic uncertainty.”

First, Bitcoin’s correlation to US equities has been “persistently positive since the marketwide sell-off at the onset of the COVID-19 pandemic.” The current correlation of ~0.2 using a one-year window of BTC and S&P 500 daily returns “is relatively low, but historically BTC’s returns have been more detached from the broader market which is generally an attractive characteristic for portfolio construction,” the report added.

From a structural standpoint, if BTC is moving more “in line with other volatile assets like stocks this might dampen BTC’s narrative as a hedge.”

The report also mentioned that in August 2021, Ethereum core developers “implemented EIP-1559 which changed Ethereum’s fee market mechanism and was one of the most significant upgrades to the protocol since its 2015 genesis.”

With around five months worth of data, EIP-1559 now seems to “have been largely successful in lowering fee market variability and reducing overpayment.”

The report added that as we enter 2022, another significant change is “expected to be on the horizon for Ethereum: “The Merge,” the upcoming event of swapping out Ethereum’s current proof of work (PoW) consensus algorithm for a proof of stake (PoS) consensus mechanism.”

As explained by Coin Metrics:

“Mechanically, The Merge and move to PoS should have minimal impact on applications currently running on Ethereum and nothing will happen to ETH that is held by current users. In fact, the Ethereum EVM will not be deprecated and will remain as the execution layer post-merge.”

They added that after several iterations of the ETH 2.0 vision, “the first set of changes that comprise ETH 2.0 launched in November 2020.”

Called “Phase 0”, the creation of the beacon chain “introduced the PoS consensus mechanism for ETH 2.0 and the ability to register as a validator by depositing a minimum of 32 ETH to the official deposit contract.” More than 8.8M ETH has now been “deposited to the ETH 2.0 staking contract, with around 277K total validators.”

The report added that staking introduces “a way for holders to earn yield on their ETH, and also serves as a supply sink as large amounts of ETH is locked into the deposit contract, effectively lowering free float supply.” Staking rewards are “dependent on the amount of ETH staked, and gradually decrease as more ETH gets deposited,” the report explained.

The report also noted that current estimates “pin the potential timing of The Merge in Q2 or Q3 of this year, however there is still uncertainty about the exact launch date.” The move to PoS will have “several implications for Ethereum, its cryptoeconomics, miner extractable value (MEV), staking derivatives, and more making it one of the most important areas of crypto research in 2022,” according to the Coin Metrics report.

The report added:

“In 2021, as Ethereum transaction fees hit new record highs, some users and investors turned to competing smart contract platforms that could offer lower fees. Solana (SOL), Avalanche (AVAX), Algorand (ALGO) and others experienced record growth in 2021 in the battle to be the next big smart contract layer-1 (L1).”

They also noted:

“Going into 2022 we’re on the cusp of a new scalability war: the battle of the layer-2s (L2s). L2s are built on top of an existing blockchain to improve transaction scalability while maintaining the underlying blockchain’s security. For example, some L2s use rollups to execute transactions off-chain while eventually committing transaction data back to Ethereum’s layer-1. This helps increase transaction speed and allows for lower fees while maintaining Ethereum’s decentralization and security.”

Several major Ethereum L2s went live late last year, including Arbitrum, Optimism, Starknet, and zkSync.

DeFi protocols such as Maker, Uniswap, SushiSwap, and AAVE all “announced L2 integrations.” And applications that help users move funds and trade across L2s “started to launch in 2021.”

The report further revealed that Bitcoin also “started to see the rise of L2s in 2021.”

Lightning Network, a payment channel based L2 solution that enables fast, low-fee transactions, “saw its largest growth ever throughout 2021.” Going into 2022 there’s “over 3.3K BTC held across 86.41K public Lightning channels, up from 1.07K and 38.05K (respectively) since January 1st, 2021.”

The report added:

“L2s still face a lot of challenges, including sometimes complicated UX, and high costs of moving funds to and from an L2. But successful L2 scaling could unleash a new Cambrian explosion of usage and development going into 2022.”

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