Thread by @SquishChaos

Lots of new followers so...

🧵On Misunderstood Supply Dynamics

I'm seeing a lot of $ETH commentary that doesn't account for key differences between staked and unstaked Ether w/ EIP1559.

This is a crucial mistake.

As I've said before... All of the $ETH will be staked. 👇

Simple Model: Assume 40% ETH is staked, 10% staking yield, and net 0 issuance (neither deflationary nor inflationary)

In this model, I'll pretend there are 100,000 total ETH in supply for easier numbers.

So 40,000 staked. Staking issuance is 10% on that, so 4,000 new issuance. I assumed net 0% inflation, so 4,000 ETH is also burned.

What happens next?

Stakers have to pay taxes on that issuance, but they're also the most long-term oriented $ETH investors. What % of their issuance would they restake?

I'll assume they re-stake 25% of issuance, aka 50% of after-tax issuance.

This leaves 75% of staking earnings for expenses.

Year 1: 100,000 ETH = 40,000 staked + 60,000 unstaked.

Year 2: 100,000 ETH = 41,000 staked + 59,000 unstaked.

Even *without overall supply deflation*, EIP1559/PoS deflates the supply of unstaked ETH.

Ok - why do I care?

All of the demand for DeFi, all of the fee burn, it's all funneled through the small vanishing unstaked ETH pool.

The more DeFi is used, the faster that pool shrinks.

If you value $ETH via DeFi, that's a valuation for the scarce supply of unstaked $ETH. Not total $ETH.

Valuing $ETH for its use in DeFi (the fee burn) and then dividing by the total staked+unstaked supply is like valuing oil based on its consumption and then dividing by the total amount of oil that exists underground.

squish.substack.com/p/ethereum-mov…

Per the oil analogy, the obvious crucial question is what forward "unstaked ETH production" will be.

At the limit (staking yield = ~0 (limits of profitable arbitrage)) we'll see a reversal as 0% of ETH is restaked and the % unstaked ETH increases.

This "produces ETH."

The % staked at that 0% staking yield point will be a huge determinant of the value of $ETH.

Where this point is depends entirely on DeFi transaction volumes.

More volume➡️ more fees ➡️ more yields ➡️more staked ➡️ more scarcity.

The primary determinant of $ETH's long term value comes down to the scarcity of unstaked $ETH.

In other words, the primary determinant of $ETH's value comes down to a bet on #DeFi.

It always has.