Ethereum: 1000x from Here

Crypto’s biggest winner will replace gold as state-free, global money.

Gold as a Currency

Some people claim that gold has accrued value due its usefulness via jewelry and smartphone manufacturing. However, jewelry is inherently unuseful and the amount of gold used in smartphone production is negligible: $1.82 worth of gold per smartphone, which, at 10bn smartphones, renders $20bn of utility, a far cry from gold’s $8trn market cap. Thus, gold’s success as the world’s store of value can be attributed solely to its scarcity: alchemy has proven impossible, and expensive mining expeditions can only inflate gold’s supply by 1–2% per year. In fact, it is gold’s scarcity that renders its utility in the jewelry business — if there were a more scarce metal, it would likely be more sought after than gold as both a store of value and a watch.

How Cryptocurrencies Change Things

The winning cryptocurrency will be a better currency than gold due to it being significantly more useful and, consequently, programmably more scarce.

Digital Oil → Digital Gold

The most useful cryptocurrency will become the most scarce. The logic follows:

  • Strong network effects among layer-two protocols: as more layer-two protocols are built on top of a blockchain, more layer-two protocols will enter that blockchain to benefit from the capabilities of pre-existing ones, which will then attract more new layer-two protocols, etc.. Layer-two protocol code can be easily copied across blockchains, but the liquidity required for a layer-two protocol’s functionality cannot. Layer-two protocol liquidity is a blockchain’s strongest moat, nearly unforgeable barring extremely low-probability events such as a successful chain attack. Layer-two protocols are the building blocks for applications built on top of blockchains, applications which generate additional network effects.
  • Strong network effects among users: as more consumers use a blockchain, it attracts more merchants, which then attracts more consumers. The same goes for enterprises: as more enterprises use a blockchain, it attracts more enterprises, which then attracts more enterprises. While it is not difficult for users to interact with multiple blockchains, running nodes/validators is non-trivial and neither is moving value between blockchains. Even if interoperability solutions render it extremely easy to move value between blockchains, the cost will still be non-zero.

Accelerating Factors

While this may sound fair and reasonable to you, gold has thousands of years of history, an unprecedented moat in its own right. Even as blockchains underpin the internet and consequently all digital financial transactions and data exchanges, that shouldn’t mean that the most desired physical object in human history should suddenly be replaced.

Ethereum is the Clear Leader

Ethereum is the clear leader to become the most useful blockchain. However, it does face competition from both above and below.

Competition from Above

While Bitcoin currently has a ~7x higher market capitalization than Ethereum, Bitcoin is and, barring significant changes to the Bitcoin community’s culture and roadmap, will continue to be only exceptional at storing and moving only the bitcoin currency. The Bitcoin community acknowledges that this is currently a very small market. They understand that Bitcoin’s long-term security is dependent on bitcoin transactions not becoming a very small market. However, massive consumer behavior changes (from paying in fiat currencies into paying with digital gold) is a low probability outcome, and Bitcoin’s future security is dependent on it: if transaction demand does not increase on Bitcoin, Bitcoin will be forced to raise its price per transaction significantly to pay miners, which will likely further reduce transaction demand, creating a spiral that ultimately leads to Bitcoin collapsing.

Ethereum’s Usefulness

While Bitcoin is only useful for bitcoin transactions, Ethereum’s usefulness is derived from its improved efficiencies over current financial infrastructure: the Ethereum blockchain is in the process of significantly reducing both the time and financial costs needed to conduct all types of transactions in fiat currencies. As Ethereum improves its scalability gradually over the next three years, it will continuously subsume more finance use cases, eventually eclipsing the current financial system in terms of usage. While this may seem like a bold assertion now, those in the rabbit-hole see a clear path for this eventuality. While Ethereum was the first mover of creating ‘Turing-complete’, fully-expressive blockchains, there have since been a new wave of blockchains that are equally expressive, aiming to acquire market share from Ethereum.

Competition from Below

These competing expressive blockchains have made incremental trade-offs/improvements (depending on your perspective) to Ethereum’s design. The greatest benefit that these blockchains have had is, because they have little to no usage, they are able to take riskier decisions than Ethereum can with regards to technical upgrades. However, Ethereum’s usage is a double-edge sword: while it limits the risk it can take with each technical upgrade, it also compounds the growth of its developer community. The growth of its developer community has triggered the network effects mentioned above: Ethereum has by far the best tooling for developers; Ethereum’s layer-two protocols have over an order of magnitude more liquidity than any of its competitors. These advantages continue to compound for Ethereum, as desirable design improvements integrated from scratch by competing chains have been integrated into Ethereum before competing chains could launch them, due to Ethereum’s thriving developer community and despite Ethereum’s inability to quickly innovate at its base layer [2].

Ether, The Asset

While I may have convinced you that the most useful cryptocurrency will become the most scarce cryptocurrency, and while I may have convinced you that the most scarce cryptocurrency will succeed gold, and while I may have convinced you that Ethereum is the clear leader to become the most useful blockchain, you cannot actually buy Ethereum. The asset that underpins the Ethereum network, the asset that will become global, state-free money is Ether. Ether’s numerous use cases will grow the market of state-free, global money significantly beyond gold’s current market cap.

  • Ether will soon be required to be staked by block producers in order to have the right to propose and attest to blocks (earning the transaction fees and inflation rewards associated with these blocks). This renders Ether a capital asset (such as bonds, dividend-producing equities, or real estate). A capital asset is an on-going source of value through income/interest payments. Additionally, the interest paid to Ether miners will very likely be higher than the annual inflation rate of Ether. This renders Ether a store of value asset (such as gold, fine art, and deflationary currencies like the Japanese Yen). Store of value assets are scarce assets, meaning that they either have low inflation or deflation. Nearby upgrades will integrate further deflationary pressures into Ether’s monetary system (through the burning of a certain percentage of transaction fees).
  • Ether is used as collateral for protocols and applications built on top of Ethereum. For example, MakerDAO issues the Dai stablecoin, collateralized primarily by Ether; Synthetix issues synthetic investment products (i.e. Tesla equities), partially collateralized by Ether; Compound, dYdX, and other layer-two protocols built on Ethereum follow the same suit as Maker and Synthetix. While Ether is not the only collateral in these systems, it is the most used one currently, and will likely remain that way, with its greatest competitor being the Dai stablecoin, which, ironically, is also backed by Ether. This is a byproduct of Ether’s store of value property; gold is currently used today by numerous parties as collateral for loans or trades.

From $8trn to $80trn

Gold currently sits at an $8trn market cap, while Ether sits at a $16bn market cap. Isn’t Ether’s growth thus trapped by gold’s current market size (and consequently can’t 1000x, even if everything else I wrote is true)? Just as numerous tech companies have grown the market for their respective industries (Uber for taxis, Airbnb for hospitality, etc.), a significantly better gold will likely significantly increase the market for gold. By how much, we do not know, but we believe there is a strong chance that it is over 2x [5], as Ether’s improvements over gold are significant:

  • Ethereum has already created a market for Ether to be spent (transaction fees to miners), making it a viable unit of account; additionally, because of how Ethereum works, being a widespread unit of account will no longer be a necessary property of any currency [6].
  • Ether can be held without any middleman (making it significantly harder to be confiscated by governments).
  • Ether will bear interest higher than its inflation, making it more scarce than gold, and, due to Ether’s programmability, investors will not need to worry about runaway inflation; the code will tell them the inflation rate for years ahead.

Endnotes

[1] Additionally, copying one blockchain’s virtual machine acknowledges that your competing blockchain was unable to innovate technically enough to merit developers’ switching chains. The one caveat would be an innovative consensus algorithm, although consensus algorithm ‘innovation’ primarily encompasses trade-offs between decentralization, finality, or liveness, not innovation itself. Even if an Ethereum competitor managed to achieve an unforeseen consensus algorithm breakthrough, Ethereum could adopt that consensus algorithm with significantly more ease than thousands of independent developers’ coordinating a chain switch.

Partner at Bizantine Capital