As Ethereum prices rise, gas fees are falling sharply. Why is this?

Author: Tim Craig Source: DLNews Translation: Shan Ouba, Golden Finance

When Ethereum’s Ether (ETH) reached a record $3,800 in May 2021, increased on-chain activity caused transaction fees to soar and users flocked in. It cost up to $100 to trade tokens, but many didn’t care because they could make a profit from it.

Fast forward to 2024, and Ethereum has revisited these high prices for the first time in more than two years. But this time is different. Despite the recent price surge caused by the policy shift of Ethereum spot ETFs, transaction fees on the top smart contract network remain low—only slightly higher than at the worst of the 2022 crypto winter.

This suggests that transaction demand on Ethereum is no longer as strong as it once was. So what is the reason?

Improved transaction efficiency, coupled with activity moving to Ethereum's low-cost second-layer networks (such as Base and Arbitrum), has helped to curb demand and make Ethereum cheaper to use. While this is good for Ethereum users, there are some negative effects.

As Ethereum mainnet transaction fees fall, the number of tokens destroyed (destroyed in crypto terms) by the network is not enough to make the supply of Ether deflationary. The point is that if fees remain low, it could destabilize the network’s economic model.

Is Ethereum Becoming Too Efficient?

When the Ethereum network destroys more tokens from transaction fees than it rewards validators for processing those transactions, the total supply of ether shrinks and becomes deflationary. This situation is good for the network because it rewards those who help run the network without increasing the supply of ether.

But if users don’t spend enough ether on transactions, the ether supply will inflate indefinitely, undermining the network’s economic model. Continued inflation, while unlikely, would devalue ether, making it less attractive for users to lock up in validators to secure the network. After all, an asset that’s constantly printing units is better for spending than storing.

So far, the supply of ether has generally decreased since the Ethereum merge upgrade in September 2022 that reduced the issuance of ether. But that’s changing. Over the past month, the network has added more than 50,000 ether, worth $190 million, due to a lack of activity on Ethereum.

If activity and transaction fees on Ethereum don't pick up, the supply of ether will swell by 0.5%, or $2.2 billion, over the next year.

Where did the fees go?

In recent years, many Ethereum users have turned to so-called second-layer networks. Second-layer networks like Arbitrum, Optimism, and Base offer Ethereum compatibility, faster transaction speeds, and lower costs while still relying on the security of the Ethereum mainnet.

Activity Explodes. Since the beginning of 2024, activity and transaction volume on second-layer networks have soared to all-time highs. These second-layer networks still pay transaction fees on the Ethereum mainnet, but only account for a small fraction of the fees that all users would have to pay to send transactions directly on the Ethereum mainnet.

In addition, Ethereum's Dencun upgrade in March further reduced the cost of publishing second-layer transaction data, further reducing the mainnet demand.

On the other hand, developers are improving the factors that affect Ethereum transaction costs, resulting in lower gas fees and users paying less for the same type of transactions.

With Ethereum's unprecedented efficiency and the thriving second-layer ecosystem, how can the network avoid economic turmoil?