Ethereum’s Creator Mulls Limiting Supply In Novel Ways

While the ICO craze has got out of control in 2017, the two leading cryptocurrencies – Bitcoin and Ethereum – have gone from strength to strength. We’ve seen frequent gut-wrenching (for bulls) drawdowns, wallet freezings (Ethereum several days ago – see here), exchange closures (China) and high-profile criticism from speakers engaging forked-tongues (Jamie Dimon’s famous fraud comments, etc).  Nonetheless, like fledglings learning to leave the nest, a broad swathe of opinion senses that there is progress. Like the early days of the internet, investors will suffer losses on those ICOs which were poorly planned and/or poorly executed – which might be most of them. As this process unfolds, however, the better cryptocurrencies will be tweaked, refined and sometimes “forked” to make them better suited to a range of decentralised applications which are, themselves in state of flux.

Talking of tweaks, the co-founder of Ethereum, Vitalik Buterin, is mulling one for Ethereum which might happen before the end of 2017. Watching the firehose of ICOs, Buterin has been asking himself whether, with Ethereum (ether), he’s creating too much of a good thing. According to Bloomberg.

The 23-year-old helped sell one of the first digital currencies in 2014 when he introduced ether to the public. Three years later he’s witnessed scads of other digital currencies raise more than $3 billion in 2017 via so-called initial coin offerings. The sheer number of coins now being created has made him ponder the previously imponderable: limiting the supply of ether.

“I’m concerned a lot of these token models aren’t going to be sustainable,” Buterin said in a rare interview last week at the Ethereum Developers Conference in Cancun, Mexico. So what’s the problem? There’s a hard limit — 21 million coins — on the supply of bitcoin, the first successful cryptocurrency, that helps underpin its value. Buterin isn’t mulling a cap like that, but he’s intrigued by the idea of imposing fees on applications built atop ethereum. Those fees would destroy — or burn, in Buterin’s parlance — ether tokens over time.

Finite supply is hardly a new concept, but it’s certainly entered the consciousness of Bitcoin investors. There’s been much debate on Ethereum supply and while there isn’t a hard limit, the inflation in Ethereum supply is set to decline exponentially, with the maximum amount somewhere in the region of 100 million. There is a quote on Reddit that is attributed to Buterin on this subject.

During the interview at the Ethereum conference, Buterin pondered – at times in slightly less than coherent fashion – the need to limit Ethereum supply in order to differentiate it from fiat currencies.

“If the token is being burned, then you have an economic model that says the value of the token is the net present value of basically all future burnings,” he said.

Otherwise, “it’s just a currency that goes up and down. It feels kind of like voodoo economics and the price of the token isn’t really backed by anything,” Buterin added.

“That’s a very spooky thing.” Reminded that he created such a coin himself, he said going forward that could change. “It’s a fact that’s definitely informing a lot of design choices,” Buterin said. “Introducing some kind of sinks into ethereum is definitely something we’re looking at,” he said. “By sinks, I mean fees that lead to the token actually being destroyed.”

If he decides against “burning”, another possibility is essentially warehousing some of the supply, eliminating it from circulation.

Another way to limit supply, at least temporarily, is through locking up some of the ether currently in circulation. That’s the plan as ethereum moves to a new way of verifying transactions on its network. Known as proof-of-stake, it requires users who want to be rewarded for validating transactions to deposit ether for a set amount of time. The more ether they set aside, the bigger the reward for verifying the network. Buterin said the ethereum community may transition to proof-of-stake as early as the end of the year.

While Bloomberg notes that Ethereum’s abundance has obviously not adversely affected its price this year, our question is what impact would limiting supply have on Ethereum? Especially when  cryptocurrency prices are so sensitive to newsflow, even when it’s ill-informed, in Dimon’s case, for example. Talking of limiting supply, Buterin had some cautionary words on the ICO boom although, given the nature of financial market regulation, nothing will be done until something really bad happens, which is sadly inevitable.

Buterin said ICOs had both good and bad attributes. The way they’re currently structured skews the incentives of the startups that have raised over $3 billion this year. In nearly all ICOs, groups have pitched tokens to fund projects still in development, leaving open the question of what happens if they fail to deliver on promises. “The token models we have right now are lopsided and give skewed incentives,” Buterin said. “The worst part is the front-loading. Basically getting $140 million before you have a product. The right way to do that is to come up with a mechanism that either splits the ICO up across rounds or has a mechanism where if it doesn’t go well people can get refunds or anything similar.” ICOs have solved a key problem, making it easier for developers to raise money to fund their work, he said. But that doesn’t mean that every project should start with an offering, Buterin said. “It’s definitely a complicated balance,” he said.

The ICO boom is definitely not balanced.