Caution against Monetary Experiments

Economics
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Hi all. I’m new here, and this is my first thread. I hope this is the right place for a discussion of such.
This piece was originally intended as a response to the MEV burn thread, but I opt to make it a top-level one to have a broader and purer discussion about economic/monetary policies of the network, independent of other more technical topics such as ePBS.

Let me start by saying that EIP-1559 was an amazing invention. It is an elegantly designed solution that address the problem of requiring inflationary ETH emission to secure the network, and offset it with the burning of base fees, which is deflationary.

I’m sure we all understand why inflationary currencies are bad or why bitcoin is created in the first place. Fiat regimes throughout the history have engaged in reckless monetary expansions that decimated savers and eventually destroy their currencies. And many of us are here because we found ourselves in the middle, if not near the end, of this unprecedented monetary experiment.

In light of the recent success of the EIP-1559, it is only natural to desire to further embrace ETH burn policies to make ETH even more ‘ultra-sound’. Many on social media has been gloating about ETH’s record burn. Proposals like MEV burn, which could triple the current burn rate have been generally viewed favorably. I do not, however, share this sentiment, and argue that we should examine the cost and benefit more carefully before venture deeper on this path toward more burns. Here are some of my reasonings:

  1. Data has been clear that we already more than offset all the inflationary pressure from ETH emission for network security, ETH supply is already on a slightly deflationary path while we are still in the middle of a bear market.

  2. Additional burn (the like that could come from potential future implementation of MEV burn) are not designed to address any existing monetary concerns. With EIP-1559 in place, the monetary system of ETH is already sound. It is not broken, and therefore, does not require fixing.

  3. Further burn is often justified as it making ETH more valuable to ETH holders, or in other words, make ETH holder richer, in fiat terms. I have several issues with that:

  • So far there is no real-world evidence that suggests the more ETH is burned the more ETH value in fiat goes up. While I would agree that, in theory, over the long run the statement should be true. But ‘long run’ can be arbitrarily and excessively long. I’m sure many of the so-called ‘goldbugs’ foresaw USD to hyperinflate in the ‘long run’. (I should know, because I’m one of them). For many, it’s been more than two decades, and USD is still the world reserve currency. The ‘long-run’ effect of further burn may be meaningful for many ETH holders.

  • So far there is also no evidence that suggest the more ETH we burn, the more we outperform competitors such as bitcoin (let along meme tokens like PEPE). In shorter term, fiat market liquidity or speculative pressures, rather than token burns, are by far the dominant drivers of the price performance of any tokens.

  • As I recall, one of the criticisms from the POW coin camp against Ethereum’s POS system is that it is a system that makes the rich richer, suggesting that ETH stakers get more ETH without doing anything. I obviously don’t agree with that. ETH stakers, at least the solo stakers, operate nodes, take on risk of slashing and illiquidity to help secure the network in exchange for staking rewards. However, one could argue that getting richer from ETH burn is actually somewhat like getting richer for doing absolutely nothing, and the more ETH one has, the more one stand to benefit from doing nothing. I think this might be controversial, but I personally think it is not the network’s job to make ETH holder richer by just holding ETH. We are not PEPE.

  • One thing I love about the ETH core dev calls is that they keep it professional and never talk about ETH price in fiat. When it comes to issues related to the monetary policy, I also find it to be short-sighted to appeal to the greedy nature of token holders. Fiats should eventually destroy themself, as history suggests, independent of of how much we burn. We should instead, focus on the impact of such policies on all economic actors in the system, including those who do not yet own any ETH, but will eventually join the ecosystem.

  1. There are ample literatures that studies the benefits and costs of an inflationary vs. deflationary systems. I would not have much to add on top. But what I do want to argue is that: inflationary or deflationary, there is always wealth transfer from one group to another, whether it’s the savers, the borrowers, those who have, or those who don’t. Why can’t we be satisfied with a neither inflationary nor deflationary monetary system, which should hurt no one?

  2. In a recent Bankless podcast regarding MEV burn, @JustinDrake suggests that ‘with MEV burn enabled, ETH burn could triple the current rate and ETH supply could eventually reach an equilibrium between 50 million to 100 million over the next century’. From over 120 million to potentially 50 million, now that is quite a dramatic decrease. While I don’t pretend to understand how this equilibrium range is estimated, I do know that there has not been any monetary system in the history of mankind that has been this deflationary. The potential long-term effect of such a system is entirely unknown. This to me, feels ‘experimental’.

  3. Inflationary monetary experiments conducted by central planners of fiat regimes are something we are all too familiar with. They cut rates too low, make money virtually free, do too much QE, and then inflation shoots up. In response, they had to turn around, and raise rates too high, and do QT too fast and then crash the economy. The constant theme is: conduct experiment in one direction, go too far; stop and turn around and go the opposite way until they go too far again, rinse and repeat. I’d argue that excessive deflationary policies could be the same monetary experiment, but in the opposite direction. Everything will be fine for a while, then one day, the network as whole may wake up and realize we have gone too far, at which point we’d either risk some death spiral or we’d have no choice but to change monetary policies back to be inflationary. It might work out in the end, but I would not be surprised if ETH’s monetary policy is going to be viewed as subjective and controlled in the hands of a small group of folks that are acting like reckless central bankers. I’d rather this not happen.

In summary, with EIP-1559 in place, ETH already has a sound monetary policy. There is no existing monetary issue that requires the introduction of further deflationary monetary policies. ETH’s monetary policies should be carefully examined and rigorously debated with all current and future stakeholders in mind, independent of fiat price, and decoupled from discussion of technical issues.
Monetary experiments, in either direction, are dangerous. Caution is advised

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The issue with this is that pre-existing ETH holders have very little to gain from deflation in and of itself. The value of ETH will be determined by the demand or adoption. All that monetary policy should do is ensure that there are clear expectations around the amount of ETH in the future. If it is seen that a more Bitcoin-like policy would encourage adoption then do it. Basically, no one should think in terms of limiting supply to up the value of ETH. They should think in terms of promoting adoption, if that is deflationary, then so be it. If the MEV burn gives more confidence to those who might adopt ETH, then do it. All that matters is clear expectations.

I do love the topic though, and I love comparisons to past inflation and deflation.

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When we talk about ‘value of ETH’, we are often talking about ETH price in fiat, or value relative to competitors, such as the ETHBTC ratio. I understand this is how most current and future participants see it (i.e. ETH as an asset, and buying ETH as an investment decision). And ETH price/ratio is indeed an important and useful metric of how successful ETH is. However, I can’t help but feel like we are forgetting our original mission here. Aside from ‘world computer’, aren’t we also supposed to create a better monetary system to replace the existing broken one?

I obviously agree with you on

no one should think in terms of limiting supply to up the value of ETH

But I will go a step further, and argue that the policies should not even be set to drive ‘adoption’, after all what largely drives adoption if not the short-term expectation that the price will go up in the future? We only need to look at what drove the rapid adoption of PEPE, XEN, and swarms of other meme tokens. And I have not forgotten BTC’s “having fun staying poor” meme which suggests either adopt now or remain poor holding fiat or shitcoins

Macro monetary parameters have enormous impact on economic activities and wellbeing of participants in the economic system. I think we should have all learned the lessons from what the central bankers has been doing all over the world. They all had ‘good reasons’ too: to save the collapsing banking system; to assist the failing housing sector; to help grow the economy and promote full employment; to fight inflation they themselves caused in the first place, etc. And these ‘good intensions’, even if genuine to begin with, often leads to horrible results.

Whether it’s the interest rates, total supply, or any other macro-variables, I’m generally against any form of “central authority” manipulating them ‘for the benefit’ of the systems. In that regard, even BTC’s hard cap, in my view, can be seen as arbitrarily set by central planners, which I’ not in favor of.

What I would advocate is leave those monetary parameters set by the free market. It is the most decentralized way. Regarding supply, with EIP-1559 enabled, this is already possible. The supply can expand and shrink depending how much emission to stakers and how much base fees are burned.

As mentioned in my original post: Nothing is broken, there is no need to engage in further experimental deflationary monetary experiment. Further, we also refrain from making a habit of making top-down policy changes.

Finally, for economic policies like the proposed fee burn, which in my opinion could have substantial and long lasting economic impact, how much rigorous public debate has occurred? As far as I can see, the debate in this forum on this topic is mostly just implementation design now, as if implementing MEV burn is already a foregone conclusion. How many people this policy impacts would have been completely unaware that this debate is even happening. If adopted through the EIP process, and implemented in the code base of all the clients, how much say does validators and node operators really have if they don’t agree? Don’t upgrade and get forked out?

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So I agree with most of what you said. And most definatly agree that the path that is least top-down should be taken.

I guess my point is really rather simple, the variation that will explain any deflation relative to fiat, or any crypto for that matter will be 99.9% determined by the demand for ETH. I just don’t see the EVM burn policy have next to any impact on it. Thus, we should take the path that just stabilized ETH the most. And, as mentioned, the one that is the most transparent. I think there are very interesting experiments, OHM the one that I know of, to create an actual programmatic currency that keeps prices perfectly stable. But ETH isn’t that. The reality is as people adopt we will see deflation, there isn’t much we can do about that.

1 Like
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I think you guys think too much. Deflation of ETH is the consequence of it being adopted, and NOT the other way around (i.e. adopting it because it is deflationary as you assumed). And it is being adopted precisely because of its use cases.