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Ethereum (ETH 1.05%), the world's second most valuable cryptocurrency by market cap, is in a unique position. Since the start of the year it is up more than 50%, and yet it is still down more than 60% from its all-time high of almost $4,900.

Because of its hot start in 2023, it can be difficult to gauge whether Ethereum is a buy or a sell today. To get an answer to this question we need to do a little digging to find data from Ethereum's network that provides some historical context on its current position in the market.

One of the most important developments to come out of the cryptocurrency industry recently was The Merge, an upgrade that switched Ethereum from the clunky and energy-consuming proof-of-work method of verifying transactions to the more robust and energy-efficient proof-of-stakemethod.

However, although The Merge dominated headlines, there is a lesser-known upgrade that is likely more meaningful for Ethereum's price than it is given credit for.

Known as the London hard fork, this upgrade was introduced in August 2021 and included a new pricing mechanism with a fixed base fee to be burned, or permanently destroyed. Essentially, the more transactions that occur on the network, the greater the number of ether tokens that could be removed from the supply. Because the fixed base fee is permanently removed from circulation, under some circumstances the total number of ether in circulation can actually decrease.

Because of the London hard fork Ethereum has effectively become a deflationary asset, as the chart above shows. It can be a little difficult to see, but around the end of 2022 the line showing the total supply of ether starts to bend. It was around this time that the number of transactions on the network started to increase, causing the burn mechanism to truly start to become evident.

Thanks to this new feature, Ethereum's price is now highly correlated to the dynamics of supply and demand. Before the London hard fork, Ethereum had a relatively high inflation rate, but now this has all changed and it could mean great things for Ethereum's price, especially if a bull market is on the horizon.

There is another metric we can look at to get a better idea of Ethereum's current valuation versus its potential future price. It's relatively simple, but evaluation of the number of active addresses on the Ethereum blockchain can provide a useful glimpse at activity on the network. Active addresses are the number of unique addresses that have either sent or received a transaction on the blockchain during a certain period, and the thinking goes that the greater the number of active addresses, the more demand for the cryptocurrency.

When taking a look at these addresses, it becomes clear that while there has been a downtrend since the market peak in 2021, there has been substantial growth in recent months. It suggests that more people are using the blockchain for various purposes, such as making payments, creating decentralized applications, and executing smart contracts. As the number of users on the Ethereum network increases, so does the amount of ether burned, thus adding more deflationary pressure.

Due to the newness of the burn mechanism and recent trends in active addresses, it's more than likely that Ethereum's price has yet to realize the full potential of this combination. As such, Ethereum seems to be in a position that could benefit users for years to come.

When considering Ethereum was able to hit an all-time high of almost $4,900 without any burn mechanism and while still operating on the former proof-of-work methodology, it's difficult to imagine what could be in store for its price as it begins to reap the rewards of its new deflationary features.

RJ Fulton has positions in Ethereum. The Motley Fool has positions in and recommends Ethereum. The Motley Fool has a disclosure policy.

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Ethereum in 2 Charts: Is It Time to Sell? - The Motley Fool