Fee Burning Makes Weakness in Ethereum a Buying Opportunity

Ethereum (CCC:ETH-USD) has been tumbling for the past several months. From a recent peak of Nov. 10 from $4,843.91 per ETH token to a low around $3,035.22 on Jan. 10, its decline is pretty severe. That represents a drop of 37.3% from peak to trough in just two months.

The ethereum logo on coins

Source: shutterstock

Even at its Jan. 18 price of $3,161.48, Ethereum is still not out of the woods. First of all, from $3,800.75 at the end of December, ETH is down 16.8% year-to-date (YTD).

But do not despair — this kind of drop can easily be made up over a short period of time, given its huge volatility. For example, at the end of Q3 2021, Ethereum was at $2,807.30. That is still 11% lower than the price yesterday. That seems to imply ETH could still have more to fall if it were to retrace its previous lows.

However, consider this: Since the end of Q3, Ethereum shot up to $4,843.91 on Nov. 10, then immediately plummeted again to its lows today. So, over the past three and a half months, it’s only risen from $2,807.30 to $3,161.48, or about 12.6%.

That does not seem like a very good performance. But if you annualize that increase, it works out to 50.5% (even without compounding.) It just seems like a paltry gain, especially given its huge volatility. As a result, Ethereum is actually a good buy here, even if it were to continue to fall.

Where Things Stand With Ethereum

It has become apparent that the EIP 1559 upgrade from the summer of 2021 has been a success. EIP 1559 was an “Ethereum Improvement Proposal,” also known as a hard fork, that introduced ETH fee burning into the Ethereum validation process.

As a result, the total number of Ethereum tokens has begun to decline. This is known as a deflationary supply system and is akin to a public company buying back its own shares in the market. As a result of a reduced supply, all things being equal, the price of the asset should rise over the long term.

I wrote about EIP 1559 several times last summer. One such article references a piece in Decrypt magazine indicating the hard fork will begin to remove ETH tokens from circulation.

EIP 1559 changes how transaction fees work with Ethereum. The Decrypt article described the details, which are quite complicated.

In essence, “… the upshot is that anyone who makes a transaction on the network will now pay a base fee that will be burned instead of going to Ethereum miners.” The “burning” referred to here is sending an amount of Ethereum tokens to an address which no one has a key to unlock.

However, the article also makes it clear that the actual supply of Ethereum is not being reduced, per se. It is reducing the rate at which ETH tokens are being put into circulation. This is akin to the Bitcoin halving, a quadrennial event that reduces the amount of Bitcoin that can be mined by 50%.

Where This Leaves Investors in ETH

An article in Eight published last September wrote about the effect of the EIP 1559 hard fork. It showed that as Ethereum transactions increase or are in high demand, more ETH tokens are burnt. It points out that in these periods, the actual supply of Ethereum can decline due to the high amount of tokens burnt.

Investors should take comfort, then, that ETH is now in a position where its supply will not infinitely expand as transactions increase due to its popularity.

On the date of publication, Mark R. Hake did not hold any position (either directly or indirectly) in the securities mentioned in this 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/2022/01/fee-burning-makes-ethereum-weakness-a-buying-opportunity/.

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