Franklin Feringa - 19 August 2021

Why ETH balances on exchanges keep declining

Ether balances on exchanges have been declining for some time. The question is whether this will continue in the future and what it means for the price of Ether. 

Exchange balances

Since last year, the price of Ether has made a significant run during which we have also seen the total supply of Ether located on centralized exchanges in a steady downtrend. This downtrend started in the summer of 2020 after seeing an uptrend since March 2018, shortly after Ether reached its then all time high. 

The strong declining balance of Ether on exchanges coincides with the increase of Ether locked in smart contracts, something that should not come as a surprise to anyone that is active in crypto. 

DeFi on the rise

The entire DeFi market took off in the summer of 2020 and has been growing ever since as innovation has only been increasing due to the massive growth and potential seen in this new industry. The DeFi revolution started on Ethereum and remains the largest on that blockchain. 

Automated Market Making Decentralized Exchanges like Uniswap and lending protocols like Aave have drawn a lot of attention as a way to generate additional yield for investors. A lot of them use Ether for these protocols. So a large portion of the value locked in smart contracts comes from Ether itself. 

The DeFi market has seen a massive surge in size in a short period of time. However, this is just the tip of the iceberg as the global financial services market is worth $22 trln which DeFi is looking to make more efficient and accessible by cutting out middlemen and automating processes. One example is banking the un(der)banked of the world which stood at 1.7 bln adults worldwide in 2017. 

By now institutions are also looking to get into DeFi which will be made possible by permissioned solutions on Aave and Compound, for example. A lot of institutions also look to get direct exposure to Ether as highlighted by Coinshares’ report which states that they have AUM worth $10.6 bln in Ether already. 

ETH 2.0

Ethereum is currently in the process of moving from a Proof of Work consensus mechanism to a Proof of Stake consensus mechanism. There is already a separate chain, the Beacon Chain, that has this mechanism which is currently separate from the Ethereum blockchain. Once these two merge, something which is expected to happen next year, Ethereum will receive its long-awaited upgrade which will bring PoS and increased scalability.

The Beacon Chain was launched last year. Validators had to deposit their Ether in the ETH 2.0 smart contract to start validating blocks and earning rewards on the Beacon Chain. By now, over 6.8 mln has been staked in the smart contract. 

Once ETH 2.0 launches, this will increase tremendously which would likely draw away more Ether from exchanges as well. 

Conclusion

So the declining Ether balances of centralized exchanges comes mostly due to the rise of DeFi which has allowed for alternatives to CEXs as well as new ways to interact with the cryptocurrency ecosystem such as lending and yield farming in general. The DeFi market may have grown a lot, but is still miniscule compared to the potential that it has. As it gets bigger, more Ethereum will stay within the Ether ecosystem instead of on centralized exchanges. 

Furthermore, the launch of ETH 2.0 next year will further increase the utility of Ether by implementing PoS, further incentivizing people to withdraw from exchanges. 

All of this is bullish for Ether as its utility increases, increasing buyers while becoming more scarce.