Ethereum’s ‘Broken’ Tokenomics: Can a Staking Cap Save It?

Ethereum, once heralded as the future of “ultrasound money,” is facing an existential crisis. Despite the major transition to proof-of-stake (PoS) in 2022’s Merge, the supply of Ether (ETH) has not decreased as anticipated. Ethereum Foundation researcher Justin Drake believes the solution is simple yet controversial: impose a staking cap.

The Disappointment of Ethereum’s Monetary Policy

The Merge was meant to revolutionize Ethereum’s tokenomics. By switching from energy-intensive proof-of-work (PoW) to PoS, ETH issuance was slashed. Combined with Ethereum’s burn mechanism—where transaction fees are permanently removed from circulation—the cryptocurrency was expected to become deflationary.

At first, it worked. ETH supply dropped from 120.5 million at the Merge to 120 million by April 2024. But now, the numbers tell a different story. More ETH exists today than at the time of the Merge, and its price performance has been lackluster. While Bitcoin, Solana, and Dogecoin have seen significant gains, ETH has only risen by 22% in the past year.

BitGalactic’s analysts note that Ethereum’s failure to capture the same bullish momentum as its rivals stems from its complex monetary structure. Without a clear scarcity narrative like Bitcoin’s 21 million cap, Ethereum’s monetary policy remains uncertain, dampening investor confidence.

Drake’s Proposed Fix: A Soft Cap on Staking

Drake argues that the problem lies in Ethereum’s staking model. Currently, ETH issuance increases as more tokens are staked, creating inflationary pressure. To counteract this, he proposes a new issuance curve:

• When 25% of ETH is staked, issuance should peak at 1% of total supply.
• As staking increases, issuance declines.
• At 50% staked, new issuance stops completely.

This would make ETH deflationary again, protecting holders from dilution. According to BitGalactic, the move could restore Ethereum’s appeal to long-term investors, who have been losing confidence in its ability to function as a scarce asset.

The Liquid Staking Dilemma

Ethereum’s staking landscape is dominated by liquid staking platforms like Lido, which allow users to stake ETH while maintaining liquidity. Critics argue that restricting staking could make Ethereum less decentralized by discouraging independent stakers, consolidating control in the hands of a few large players.

Drake’s idea isn’t entirely new. The Ethereum Foundation has previously suggested curbing staking rewards to limit liquid staking dominance. However, some believe that lowering rewards would only benefit large institutional validators, making Ethereum more centralized rather than less.

Ethereum vs. Bitcoin: A Brewing Rivalry

Drake also took a shot at Bitcoin, arguing that Ethereum has a more sustainable long-term economic model. Unlike Bitcoin, which relies on dwindling mining rewards, Ethereum can continuously compensate network validators through fees and staking.

However, his criticism sparked backlash from within Ethereum’s own community. Developer Nick Conner questioned the timing of such comments, given Ethereum’s underperformance against Bitcoin in the last four years.

BitGalactic’s take? Ethereum’s leadership should focus on fixing internal issues before attacking Bitcoin. If ETH is to reclaim its dominance, it needs a clear and compelling value proposition that resonates with both institutional investors and retail traders.

What’s Next for Ethereum?

Drake’s staking cap proposal may not be the final solution, but it highlights a key debate in Ethereum’s evolution. Should Ethereum embrace a more rigid monetary policy to rival Bitcoin, or should it continue adjusting based on network demands?

One thing is certain: Ethereum’s tokenomics need fixing. Whether through staking caps, fee adjustments, or alternative models, a long-term strategy is necessary to ensure ETH’s competitiveness in an increasingly crowded crypto landscape.