EIP Update Means Ethereum Is Not Done Rising

Ethereum (CCC:ETH-USD) has rebounded from its recent lows. For the past several months the cryptocurrency has been in a slump, but that may be changing.

A concept image of mining an Ethereum (ETH) token.
Source: Shutterstock

The crypto peaked at $4,178 on May 10 and has been generally falling ever since. But then it recovered a bit after hitting a low of $1,787.51 on July 19. As of Aug. 4, Ethereum had recovered to $2,727, or up 52.55% in the past several weeks.

Actually, ETH is still positive for the year. It ended Dec. 30 at $730.37. So, at $2,727 on Aug. 4, it was actually up 273% year-to-date. This is by far much better performance than most investors have made in the stock market so far this year.

The problem is it doesn’t feel as though Ethereum is winning. It has fallen so far off its peak earlier this year. For example, on May 10, ETH crypto peaked at $4,168.70. So, even though Ethereum is up significantly for the year, it is still down 34.6% from its peak.

But, let’s not get too upset. After all, since the end of Q1 on March 31, when ETH closed at $1,977.28, the crypto is now up 37.9% for investors who have held on to Ethereum during all of Q2 and Q3 through to Aug. 4. But now it appears that Ethereum could have a new leg up.

Where Things Stand

This week there is a major catalyst being implemented for Ethereum with the Ethereum Improvement Proposal (EIP) 1559 update. EIP 1559 will lower “gas” or transaction costs for ETH trades, swaps, NFT (non-fungible tokens) purchases, etc.

Some of these fees will no longer be paid to miners. These base fees will be “burned” or taken out of the total ETH token supply. This introduces a new scarcity effect for Ethereum. Some estimate it at about 20% of the total fees. Others estimate that it will be 4%.

In any case, it will result in a lower number of ETH tokens outstanding. This is similar but not exactly the same as stock buybacks. They reduce stock shares outstanding and push up the stock price. There will be a similar effect on the price of Ethereum, based on the law of supply and demand.

Actually, the lower supply and higher price effect could end up covering the lower fees that Ethereum miners will receive. But it will take time, and the effect may not be obvious at first. The reason is that Ethereum’s total supply is not actually falling with EIP 1559. It is slowing down the rate new ETH tokens are put into circulation.

As Decrypt magazine recently put it, the EIP 1559 effect will be like the “halving” in Bitcoin every four years. That is when miners receive 50% fewer BTC rewards every four years in exchange for processing network transactions. Inevitably, the price of Bitcoin rises after these events.

What to Do With Ethereum

This raises the possibility that the price of Ethereum may already reflect a lot of good news from the EIP 1559 supply “cut.” In other words, the recent rebound in the ETH price, as I discussed above, could already reflect a good portion of the beneficial scarcity effects of EIP 1559. After all, it is up 52.55% in the past several weeks.

That may be the case, but even so, I suspect that there is much more upside to come. For one, Bitcoin (CCC:BTC-USD) has also been climbing. Since July 19, it has risen from a trough price of $29,807 to $39,799, as of Aug. 4. That represents a gain of 33.5% in the past several weeks. This is similar to the 52.55% gain in ETH tokens from the same date.

In other words, much of Ethereum’s gain can be explained by the general rebound in cryptos. I suspect that many investors are waiting to see how the EIP 1559 proposal proceeds. Once it is seen as a success, then I believe that Ethereum has a chance of regaining its former heights.

On the date of publication, Mark R. Hake held a long position in Bitcoin and Ethereum but not any other security mentioned in the article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

Mark Hake writes about personal finance on mrhake.medium.com and runs the Total Yield Value Guide which you can review here.

Article printed from InvestorPlace Media, https://investorplace.com/2021/08/ethereum-crypto-does-not-fully-reflect-the-scarcity-effect-from-eip-1559/.

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