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hello friends 👋,
Happy Monday! Sometimes it’s better to be lucky than good.
I was actually planning on writing this article last monday, before matthew brennan contacted me about contributing to shein. while this is *never* investment advice, and you need to do your own research, and you should already know you’ll never listen to me, some of you would have learned about eth, started researching, and decided to invest. It would have been a difficult moment.
Last week, the bitcoin price plunged almost exactly 50%, from a May 10 price of $59,600 to a May 19 momentary low of $30,000.00. eth fell further, falling 60% from a May 12 high of $4,384 to a low of $1,728 yesterday. if you do your own due diligence and decide to invest in eth today, you are doing so at a third less than you would have if you had sent this in last monday. Phew.
On the other hand, I also had a bit of bad luck. smart people posted great content on eth last week, in line with the thesis he was going to write.
patrick o’shaughnessy had justin drake talk about business crises to talk about ethereum. james wang wrote an excellent post on ethereum’s first quarter results. Bloomberg’s Joe Weisenthal wrote a post about financial standards being filled with ethics. In general, a lot of the smartest people I know are very excited about ethereum. writing this week, I’m a little less ahead of the curve.
At first, I was a little bummed out. he had this whole angle ready to write, and it was picked up. but the more i thought about it, the more i realized that the fact that all these people are spreading information about ethereum is part of the analysis itself. is changing the narrative.
before we start, some important things:
Disclosure: I am long eth and plan to go long. This is not investment advice.
Warnings: There are people much smarter than me in all of this. I encourage you to read and listen to his work, much of which I have linked to in this article. this is mostly a bullish case. there are obvious risks, many of which I’ll address, but for the ones I miss, I asked twitter for the downsides. your answers in all their glory:
Also, for the love of god, take a look at what has been happening in the crypto markets in the last few days and do your own research before you buy anything. That being said…
let’s get to it.
“The most optimistic thing for the ether is to understand it.”
ryan sean adams, no bank
What if I told you about a company with strong network effects and 200x year-over-year revenue growth that is preparing to offer a 25% dividend and implement a permanent share buyback program? Is it something that might interest you?
that’s pretty much ethereum. it is one of the most fascinating and compelling assets in the world, but its history is clouded by the complexity and spectrum of cryptocurrencies.
ethereum is so many things at once, all of which feed off each other. ethereum, the blockchain, is a world computer, the backbone of a decentralized internet (web3), and the foundation layer for web3. its cryptocurrency, ether (eth), is also a lot of things:
property of the ethereum network.
the most used token in the great online game.
a reserve of value (sov).
a bet for more activity in the chain, or the future web3.
because ethereum is so much at once, it’s hard to understand. this post is an attempt to help understand ethereum. For a group like ours, people interested in business technology, finance, and strategy, it’s much more fascinating than bitcoin, but there’s a trade-off with that. it is much more difficult to assimilate than bitcoin, and because of that, it has not received the mainstream or institutional attention that bitcoin has.
bitcoin is easy. it’s digital gold. it is a store of value (sov). it just sits there.
That’s your value support. it is immutable and the most decentralized asset in the world. it is the og and the most difficult to attack. At this point, your bitcoin will not disappear overnight (although this post on tether is enlightening regarding the ways in which it can be manipulated, nonetheless, and other cryptocurrencies, including eth). As long as other people believe in its value, it will remain valuable. technically, uppercase-b-bitcoin is the blockchain and lowercase-b-bitcoin is the cryptocurrency, but for all intents and purposes, they are the same. bitcoin exists to make and track bitcoin. he’s very good at what he does.
ethereum is much more than a cryptocurrency. it is a “world computer” and the “value layer” of the internet. It allows people to create apps and products with money built into the code. if you think web3 will continue to grow, you probably think ethereum will eventually become the settlement layer of a new internet. All types of transactions, whether they occur on Ethereum, another blockchain, or even Visa, will turn to Ethereum to exchange funds and keep records secure and immutable. A year ago, I wouldn’t have said that.
Until last year, much of ethereum’s value existed in a theoretical state, in ideas of what might be possible in a decentralized global internet. personally i saw it as kind of a more interesting thing that was kind of like bitcoin but smaller and maybe taller. As a result, after buying eth for fun in the lead up to 2017, I sold my remaining 15 eth in June 2020 once I broke even. lack of understanding = weak hands.
As you know, I’m an idiot. even after the recent drop, those 15 eth are worth over $30,000. I lost ~10x on the upside. not as painful as my $2 million bitcoin mistake, but still silly. however, to be fair, you shouldn’t invest in these things unless you understand, and I didn’t. I’m starting to.
Between then and now, a few things have happened that changed me from moderately curious to very curious and very optimistic:
use case explosion. defi, nfts and daos have emerged as real crypto use cases and have grown dramatically over the last year.
ultrasonic money. with the upcoming implementation of eip 1559, ethereum will likely become deflationary, removing its biggest currency weakness.
eth2. ethereum is currently running a test chain that will merge with the main ethereum chain in about six months. when it does, ethereum will switch from proof of work (pow) to proof of stake (pos), accumulating more value for eth holders.
narrative. the narrative around ethereum is gathering steam and jumping from crypto folks to the mainstream. last week’s releases from patrick o’shaughnessy, james wang and joe weisenthal all came through well. this essay is a little extra push.
Right now, ethereum is at a narrative inflection point, and narrative reflexivity is more important to blockchain than almost any other company or asset.
I am increasingly convinced that eth will be one of the best assets to own over the next five years. here is the bull case in a nutshell:
Owning eth is like owning shares on the internet. eth demand will increase with increased web3 adoption, while upcoming changes will decrease eth supply and allow holders to accumulate more value. It’s like a tech stock, a bond, a ticket to web3, and money all rolled into one.
To make the bull case clear, we need to understand why ethereum will survive and adoption grow, how it actually makes money, and the differences between ethereum and a tech stock. we will cover:
ethereum is the excel of blockchains
how ethereum makes money
legitimacy and lindy
the bullish argument for ethereum
threats, more warnings and a conclusion
For eth to be worth anything, and for the bull case to matter, ethereum needs to survive and grow. It has faced early challenges and competition from purpose-built blockchains, and the past week was terrifying. nothing is guaranteed.
To understand why ethereum is not going to die, let’s start with an analogy.
ethereum is the excel of blockchains
If you are going to be bullish on ethereum, the first thing you need to believe is that it will be around for a long time, and that more and more people will continue to use it, and that other people believe those things to be true, too.
You will be comforted to know, then, that ethereum is the quintessence of blockchains.
That’s not exactly correct. the analogy breaks down in some places. but for our purposes, it’s good enough. start by comparing it to bitcoin.
Bitcoin is like a database. that’s what a blockchain is: a distributed ledger of transactions. The bitcoin blockchain allows people to send bitcoins (btc) to each other and tracks who owns what bitcoin at any given time. You can also reward people for securing the database by giving them BTC for turning electricity into solutions to math problems (Proof of Work or POW). does one thing very well: track ownership of bitcoin.
bitcoin is like a spreadsheet, and a lot of people compare blockchains to spreadsheets, but that’s not what I mean when I say ethereum is like excel. I want to say that the same elements that have powered excel for almost four decades are also present in ethereum.
It starts with flexibility. Ethereum is a complete programmable blockchain that allows anyone to build complete applications using smart contracts. People can build all kinds of decentralized applications (dapps) on top of Ethereum, connecting to the blockchain and surrounding ecosystem to provide everything from security to identity to payments. decentralized finance (defi) applications, nft markets, decentralized autonomous organizations (daos), and virtual games and worlds can be built on top of ethereum, all powered by the native currency, eth.
that flexibility is really hard to achieve.
excel never dies, ben rollert and I wrote about the staying power of excel in a technology landscape where new products typically replace old ones every few years. we write:
If there is one basic product design lesson to learn from Excel, it is that combining usability with flexibility is both incredibly difficult and incredibly rewarding…
A design principle for developers is to make any piece of software really good at a specific thing by deliberately restricting its capabilities to a specific domain. excel is a truly notable exception to this rule: it’s kind of like picking up a phone, and clearly hundreds of millions of people want to compose for it.
you could replace “excel” with “ethereum” and it works perfectly. Ethereum’s early usability challenges are a function of its flexibility. ethereum is kind of like choosing a phone, and clearly millions of people want to compose for it.
Beyond the product philosophy, there are some specific similarities between the two:
full completeness. if something is complete, it means that it can solve any reasonable computational problem. With the introduction of Lambda, which allows users to create their own formulas, Excel became complete. With ethereum, you can write smart contracts that can solve any reasonable problem.
composability. in excel, “you can chain functions together, passing the output of one function as the input to another, allowing for a huge number of potential computational pipelines. Every time Excel adds a function, the power and flexibility of Excel is multiplied, since that new function can be chained to a large number of existing functions.” this is very similar to the idea of composability, or “x laymen”, in ethereum.
Together, completeness and turing composability mean you can create smart contracts to compute anything, and then chain them together to create ever more complex things, faster. it takes time to get the motor up to speed, but it should move quickly once it’s moving.
that is exactly what is happening. after years of building in relative obscurity during the crypto winter, doubting there was any real use for any of this stuff, 2020 and early 2021 saw an explosion of real use cases for the ethereum ecosystem. In ethereum announces Q1 2021 results, james wang included a results table highlighting the year’s progress:
Those are absolutely massive numbers across a wide range of use cases. this is not a thing. It’s not just “the price goes up”. it’s a sign of the momentum and composability of the space, where improvements in one area directly feed improvements in another:
the total value locked, or the amount of eth staked in defi, increased 64 times from $800 million to $52 billion.
Financials aside, nft art sales increased 562-fold, from $700,000 to $396 million.
Ethereum usage spiked in the first quarter, and while nft sales have slowed, partly as a result of high gas fees and partly because the initial euphoria has died down, defi is still going strong:
From May 1 to May 22, only uniswap and sushiswap, the two largest ethereum-based dexes, handled $78 billion in transaction volume. q2 will expel q1 from the water.
Despite the explosion in activity and transaction volume, the question remains: what does that mean for eth?
how ethereum makes money
I have known ethereum for a long time. I first bought (later sold) eth in 2017, but it was speculative and I didn’t get it. the big question mark i had with ethereum was how did i make money. how does more activity other than ethereum translate into a higher price for eth?
In the near future, the answer will be that more transactions mean higher returns for eth holders and a diminishing supply of eth. but that’s not how it works, yet.
Let’s start with how it works today, look at the challenges of the current model, the proposed solutions and what it will look like in the future.
(note: for a more detailed explanation, listen to justin drake on business breakdowns)
Today, when you want to transact on ethereum, you need to use eth. there are currently around 116 million eth, and the price is freely governed by supply and demand. more transactions on ethereum means more demand for eth, which means a higher price, all else being equal.
when you transact, let’s say if you send eth to someone else, a few things happen:
you send 1 eth and the other person receives 1 eth
you pay gas fees, say .01 eth
Your on-chain account balance decreases by 1.01 eth, theirs increases by 1 eth
To keep ethereum running, it uses a proof-of-work consensus mechanism to trustlessly agree on the state of the blockchain. bitcoin also uses proof of work, that’s where ethereum got it, though bitcoin mining can be run on cheaper hardware and has 20 times more miners than ethereum, and is therefore more decentralized.
pow accomplishes the same thing that your bank account balance goes up and someone else’s goes down when they send you money, except instead of a centralized bank, there’s a distributed network of miners who agree that these transactions happened and that all balances are up to date.
To do so, miners around the world are racing to solve increasingly difficult cryptographic problems to create a new block on the blockchain to contain the new transactions. these problems are often difficult to solve, read: they require a lot of energy, but they are easy to verify. when a block is entered into the blockchain, the transactions on it officially become part of the record. miners who successfully create a block are rewarded with 2 newly minted eth (up from 5 at first) and all transaction fees within the block.
Those transaction fees, called gasoline, are what people pay to send transactions to be included in the block. when a user sends someone eth into ethereum, or mints an nft, or does any number of things that need to be validated on chain, he has to pay a gas fee. that gas fee goes to incentivize miners to spend the required money, in the form of hardware and electricity, to solve the puzzle and create the block.
so currently, the price of ethereum is based on a combination of supply and demand, and the price it costs miners to protect the blockchain. to participate, you need eth, and you have to pay for gas. miners receive eth in the form of newly minted supply and their fees. miners pay for hardware, electricity, and taxes, and keep ~5% of their profits. today, most of the value accumulates in gpu manufacturers, electric utility companies and the government, and the mining part is reduced to almost 0.
There are a lot of challenges with this system.
is slow. the ethereum blockchain currently performs around 19 transactions per second. visa, by comparison, makes around 1,700.
it is expensive. the simplest transaction costs about $5 in gas fees, and when I minted the big game online as an nft with jack butcher a couple of weeks ago, it cost me almost $1k to mint and auction it off.
is volatile. gas rates are based on the auction and change all the time based on demand. that makes it difficult to transact with confidence or predictability.
is inflationary. unlike bitcoin, there is no hard limit on the amount of eth that could theoretically be minted, and proof of work requires minting a bunch of new eth, meaning growth leads to dilution for holders of existing eth.
it is not very friendly to the environment. mining means using a lot of electricity.
is inefficient. Most of the money spent on transaction fees leaves the system: miners are forced to sell the eth they earn to pay for electricity, hardware, and taxes.
The fact that ethereum has seen the adoption it has despite all those challenges is impressive, but they are still real challenges. when i tweeted that unfortunate tweet asking for reasons not to buy eth, many of the responses focused on one of the above, most commonly the cost of gas and inflation.
Also, more demand for ethereum-based dapps (more defi, more nfts, more daos, more games) means more transaction fees, but those fees don’t really add up for eth holders. they are filtered out of the system to cover the real-world fiat costs of miners in the proof-of-work process.
so today, the price of eth is based on the demand for more eth, as is bitcoin and the dollar. it’s not tied to revenue, like a business is, but it will be soon.
Proposed solutions: eip 1559 and eth2
One of the things bitcoin maximalists like best about bitcoin is that you can’t really change it. one of the things they don’t like about ethereum is that you can trade it. It is not easy, but it is possible.
Two changes are coming to the ethereum blockchain that aim to address the challenges mentioned above.
eip-1559 is a proposal that changes the way gas rates work by dividing them into two parts: a base rate and a tip. with eip 1559, the base fee is burned on every transaction and the miner (and soon the validator) keeps the tip. sounds boring, but it’s huge, because burning will probably make eth deflationary. furthermore, tipping allows people who value blocking positions better to pay more. that could be important to defi participants trying to run an arbitrage, for example. The proposal was approved in March and will come into force in July (as part of the London hard fork).
eth2is an update to the ethereum blockchain itself that will change consensus from proof-of-work to proof-of-stake and introduce sharding. eth2 is expected to make ethereum more scalable, more secure and more sustainable. the pos chain, or beacon chain, is already active and is expected to merge with the main chain sometime in late 2021 or early 2022.
Proof of Stake is a change in how the network is protected and who earns the rewards. It means that instead of anyone in the world solving math problems to mine blocks, eth holders can validate block transactions according to the amount of eth they own. validators secure the network in exchange for performance in the form of tips and newly minted eth. ethereum claims that pos will be more secure because validators will have eth in play, which can be destroyed if they try to cheat. critics claim that staking puts more power in the hands of people who have more eth, making it less decentralized and therefore less secure.
For scalability, sharding aims to increase throughput, or transactions per second, by 100x by creating 64 shard chains that validate transactions in parallel. each shard will only need to validate a fraction of the total chain, instead of each miner needing to validate the entire chain today.
Furthermore, third-party layer 2 solutions like polygon and optimism are already working to speed up transactions and reduce fees by bundling off-chain transactions and setting them on-chain into one transaction instead of many (there are complexities, but this is close enough). the l2 solutions could increase performance by another 100-fold, and the combination of the eth2 and l2 solutions could lead to a 10,000-fold improvement if the theory is carried out in practice.
Together, eip 1559 and eth2 could be game-changing for eth holders because they improve performance while drastically altering where value is stored in the ethereum ecosystem.
the future: triple point, ultrasonic money
In 2019, David Hoffman wrote an essay called Ether: A New Model for Money. If you want to go deeper, you should read it. In it, he cites a 1997 portfolio management article by Robert Greer, What’s an Asset Class Anyway?, which says there are three superclasses of assets:
Capital assets are productive and generate value or cash flow. examples include stocks, bonds, or leaseable real estate.
Transformable/consumable assets can be consumed once, transformed into another asset, and their consumption produces an economic return. think about energy or raw materials.
value reserve assets are scarce, they cannot be consumed, only transferred, and their value persists in time and space. examples include gold, coins, art, or bitcoin.
hoffman argues that ether, as fully programmable money, can be all three once eip 1559 and eth2 pass, and moreover, it can be all three at the same time. he calls this triple point money, referring to the concept in thermodynamics that at the right temperature and pressure, a substance can exist as a solid, liquid, and gas at the same time.
how they occur simultaneously with the aether is beyond the scope here, what is important to understand are the three phases in which the aether can exist:
store of value. eth is locked as collateral for defi transactions. for example, you can place eth to secure a loan or provide liquidity to a dex. currently almost 10 million eth is locked in defi.
consumable asset. with eip 1559, gas rates will act like gas in a car. every time something happens in ethereum, gas needs to be burned, which decreases the overall supply.
capital asset. Ether acts as a capital asset in several ways. Owning eth represents a part of the ethereum network, like owning shares in a company. once staked, eth grants its owner the right to work for the network by becoming a validator and the right to collect fees generated by the network.
so how does eth make money? where does the value accumulate?
There are many ways to make money from your eth: staking, yield farming, liquidity pools, validation, and more, but let’s look at the simplest, simply owning eth like you own a stock.
once eip-1559 is implemented and the eth2 merge completes, the value accumulates for people who own eth, in several ways:
advice and broadcast. Tips and new issues go to eth holders and are retained in the system (net of taxes) instead of going to miners to pay for hardware and electricity.
burnt gas. burnt gas permanently removes supply from the ecosystem and, at certain transaction rates, actually decreases the overall supply of eth each year.
We will address the implications of those two things in the case of the bull, but before we do, we need to understand why ethereum is defensible. why can’t another l1 come in and steal its volume?
legitimacy and lindy
Because ethereum behaves like a company, with the added benefit of its own currency, we can analyze its strategic position as we would a company. it benefits from the brand and network effects.
In March, ethereum co-founder vitalik buterin wrote a post titled the most important scarce resource is legitimacy, in which he argues that the real value of any crypto asset comes not from owning it, but from legitimacy . he defines legitimacy thus:
legitimacy is a pattern of higher order acceptance. An outcome in some social context is legitimate if the people in that social context widely accept and play their part in enacting that outcome, and each individual person does so because he or she expects everyone else to do the same.
If people believe that other people believe something, it makes more sense for them to believe that too and act accordingly. On the popular Ethereum No Bank podcast, hosts Ryan Sean Adams and David Hoffman call Legitimacy “the theory of everything for cryptocurrencies.” listed a number of questions people often ask about space:
Why is cryptocurrency trading over $2 trillion?
why are nfts valuable?
why can’t you fork your own bitcoin and make it valuable?
why do we trust that ethereum’s monetary policy will only change to lower inflation?
the answer to all of them, according to adams and hoffman, is legitimacy.
In the post, vitalik highlights six ways legitimacy can emerge. two are particularly relevant here:
legitimacy by performance: if the results of a process lead to results that satisfy people, then that process can gain legitimacy (for example, successful dictatorships sometimes are described this way).
legitimacy by continuity: if something was legitimate at time t, it is by default at time t+1.
performance and continuity create the lindy effect, which says that the longer something lasts, the longer it can be expected to last. something that has existed for one year is expected to continue to exist for another year, but something that has existed for 100 years is expected to continue to exist for another 100 years.
This is an observable phenomenon. Amazon is more likely to exist in 30 years than a new company, our children are more likely to listen to the Beatles than Olivia Rodrigo, and our grandchildren’s grandchildren are more likely to read Socrates than Dan Brown.
legitimacy helps explain the lindy effect. the longer something has been around, the more people can expect other people to continue using it. In the excel article, we describe a couple more reasons why something might be lindy:
quality. some things are just better than others, and the quality that has allowed them to survive so far will allow them to continue to survive in the future.
network effects. As people recognize the quality of a thing and it lasts longer, more people use it, so more people build on it. which creates a two-sided platform net effect. more users attract more developers, more developers attract more users, and so on.
for excel, the network effect comes from the fact that developers (people who build models) know that other people use excel, so they build their models there, which means more people need to use excel, which it means that the next person building a model is more likely to use excel.
In the case of ethereum, more dapps on ethereum means more users on ethereum, and more users means it makes sense for more developers to create dapps.
ios is an example of two-sided platform network effects. The more people have iPhones, the more likely developers are to create iPhone apps, and the more iPhone apps there are, the more likely someone is to buy an iPhone. In Apple’s case, this network effect is so strong that it requires a 30% cut of all app store revenue, either through an app purchase or through in-app purchases.
Even though they’ve been doing it for years, that model is starting to show cracks. The maker of Fortnite Epic Games is fighting Apple in the courtroom over fees, and just last week, Twitter was on Twitter over the fact that Apple will earn more from ticketed Twitter slots than Twitter itself. Whether monopolistic or not, Apple’s tariffs feel extractive.
what makes ethereum’s network effect potentially stronger and potentially longer-lasting is that it aligns incentives in a way that traditional software doesn’t.
Both users and developers have eth, it is the most widely used token in the big online game, and they benefit from its appreciation. With eip-1559 and eth2 merging, the more eth used, the more value accrues to its holders. also, the more eth is worth, the more difficult it is to attack.
on ether: a new model for money, hoffman said that fees paid to ethereum validators act like a wall protecting ethereum: “the height of the wall is highly correlated to the total fees produced by the network. the height of the wall is the cost of attacking ethereum.”
ben sparango from solana went a step further when we spoke, explaining that it is in everyone’s best interest that the value of the underlying blockchain exceeds the value of all the dapps built on top of it. if that wasn’t the case, bad actors would be incentivized to spend whatever it takes to attack the blockchain and drain those dapps of their value.
The implication is quite far-fetched: Projects that are based on certain blockchains are actually given financial incentives to support the value of the underlying blockchain in order to secure their project. they don’t pay for aws or security software; hosting and security are provided by the blockchain. Instead, solana-based projects can pay out of their treasury to support the sol price, and ethereum-based projects can pay out of their treasury to support the eth price.
That’s a platform network effect like no other. It’s hard to imagine an app willingly paying to increase Apple’s stock price.
In traditional software, the bill gates phrase, coined by ben thompson, describes what makes something a platform according to gates:
a platform is when the economic value of all those who use it exceeds the value of the company that creates it. then it is a platform.
ethereum has a built in bill gate line. by owning and using eth, and making eth more valuable through use, the value of everyone who uses ethereum exceeds the value of ethereum itself. but they are also incentivized to make ethereum more valuable in the process. it blurs the bill gates line by aligning incentives so closely that the line becomes irrelevant.
More importantly, this wall also explains why narrative is so important and why narrative reflexivity is so powerful in cryptography. more demand for eth not only drives up prices; shifts some of the burden of security from builders to investors, raises the wall, makes the network more secure, increases the attractiveness of building on ethereum, which makes eth more valuable, raises the wall even higher, and so on. it is a narrative-driven flyer.
definitely so most of the value accumulates in layer 1 and those who own the layer 1 tokens. makes being the layer 1 on which everything is built the main place in the chain of worth.
Because of that, and because of ethereum’s shortcomings to date, a handful of l1 competitors have emerged looking to challenge ethereum’s dominance, or at least eliminate some of its use cases.
When I first made the connection between ethereum and excel, I didn’t realize how deep it went. in excel never dies, ben and i wrote that, “excel’s flexibility allows businesses to create all kinds of workflows and processes in the humble spreadsheet. which creates a roadmap of emerging products for the b2b software industry.”
The result is the unbundling of excel, which has created software companies collectively worth half a trillion dollars.
Similarly, a handful of l1/blockchains aim to thrive where ethereum is weak. As an update, ethereum, bitcoin, and other blockchains are layer 1 in the web3 technology stack. for bitcoin almost everything besides the lightning network happens at layer 1. hold btc, send btc, track btc. for ethereum, most of the magic comes from the interaction with layer 2, the application layer.
source: readthedocs.io, my examples
The second layer is where builders create lego blocks of protocols and smart contracts that can be arranged in myriad combinations and formations to do anything from minting art to exchanging cryptocurrencies directly, without the need for a third party. it’s also where l2 scaling solutions like polygon and optimism live.
when i asked twitter for compelling reasons not to buy ethereum other than bitcoin maxis, the most common nonsensical responses came from people making fun of other l1. there are a lot of maxi algos out there, people who think theirs is the only solution, but I subscribe to the idea that every successful l1 or l2 will focus on what they do best and interoperate with others who do something else better. I am a maximalist minimalist.
To be fair, before digging in, I would have also thought that other l1s were the biggest risk to ethereum. but talking to much smarter people in the space and comparing the situation to stand out, I think the most credible l1’s are complementary, and the ones who are trying to compete directly will lose completely.
The main one among direct competitors is cardano ($ada). many people in my answers were cardano shillings. then I looked at the website:
“cardano is a blockchain platform for change makers, innovators and visionaries, with the necessary tools and technologies to create possibilities for the many, as well as the few strong>, and achieve positive global change”. I read and write a lot of words and I have no fucking idea what that means. The whole site has strong quibi vibes, like seasoned execs who heard about the blockchain and tried to make one that kids would wake up to and appreciate. Furthermore, it is trying to compete directly with ethereum through smart contracts and faster speeds, and is somewhat based on peer-reviewed research. ngmi.
others, like avalanche and hedera, seem to be building for the company. it’s an interesting approach, but not much of a threat to ethereum.
There are others, however, that are more interesting and less directly competitive, aimed at use cases that ethereum does not serve well. if ethereum is in the middle of the pareto frontier, these others move up or down the line:
source: sino global capital, h/t @luxetveritasil
compromise to optimize certain features and potentially use ethereum as a settlement layer, where its higher security will give whales more convenience to hold high value accounts and digital items.
Two of the l1’s that take this approach and interest me the most are flow and solana.
When axiom labs released the first nfts, cryptokitties, they swamped ethereum with volume and swamped buyers with transaction fees. in response, the team installed dapper labs and built the flow blockchain.
dapper labs, and their nba topshot, were the darlings of the recent nft boom. They recently raised a round with a valuation of $7.5 billion, led by coatue, to continue developing the stream and expand the ecosystem built on top of it. He’s talked to a few consumer-focused NFT startups in recent weeks that are ramping up the flow with funding from Dapper Labs. it’s win-win: startups get funding and support from the company that has been most successful scaling nfts to non-cryptocurrency users, and dapper gets more usage and flow consumers.
on investing like the best, a16z partner chris dixon explained how flow and ethereum could interoperate:
Imagine a world where you’re playing a game, you have virtual goods, and those virtual goods interact with the flow. but then some of your virtual goods become really valuable. You say, “You know what? I want to put this in the bank.” so it moves them to ethereum, using trustless bridging, which is a way that nfts and cryptocurrencies move across blockchains. and maybe you pay a little higher fee on ethereum, because ethereum does a different set of tradeoffs. you’re trading performance for better security.
as the flow attracts more non-cryptocurrency people to web3, both the flow and ethereum benefit.
The l1 that excites me the most besides ethereum is solana (disclosure: I have some sunshine).
solana is probably the fastest and lowest cost blockchain in operation, capable of 50,000 transactions per second (tps), compared to ethereum’s current 19 tps, at a cost of less than a tenth of a penny this global sinus thread is packed with information on solana for the curious.
I spoke to solana’s founder and CEO, anatoly yakovenko, and he told me that what solana is trying to optimize is instant censorship resistance for very short periods of time to create fair and open access to the data in the market. he wants to build the execution layer for finance, not necessarily competitive with ethereum, but with the new york stock exchange. where those transactions are settled and where people keep their coins, he doesn’t care so much.
Like eth2, solana uses a proof-of-stake consensus mechanism, but unlike eth2 or most other scaling solutions, solana is single shard. everything happens on the same chain. They accomplish this by using something called a proof of history, which is not a consensus mechanism but a source of time, or as anatoly explained it, “time’s arrow implementation in mathematics”. proof of history uses cryptographic timestamps to sequentially order each transaction that occurs in solana to provide a verifiable order without requiring all nodes to agree simultaneously.
which has obvious use cases in finance. Just as Ethereum users may be willing to pay a larger tip to move up the block order, Solana makes money through miner extractable value (or MEV). It sounds evil, but it’s not. it’s like pay per order flow, but open to anyone in the world with the right hardware instead of just hedge funds. it hopes to commodify and democratize what high-frequency traders can do today.
There are also non-financial products that are built on top of solana.
audius, the web3 music streaming platform, is based on ethereum and solana. issues and manages the $audio token on ethereum, but runs upvotes and likes, things that need high speed and low cost to run, as well as a web2 counterpart, on solana, powered by the same engine used by some of the most sophisticated financial professionals in the world.
That’s one of the coolest things about blockchain technology: the ability to build a super-high-performance machine that anyone in the world can plug in and use, even if they might never otherwise be able to afford it.
here too, something I first thought was competitive with ethereum is actually a plugin. By optimizing for a high-speed trading use case not currently possible on Ethereum, Solana is bringing more financial activity to the chain. By enabling microtransactions like votes and likes, on-chain, and by improving the user experience for products that also run on Ethereum, Solana is improving the Web3 experience and onboarding more users.
in addition, solana is building support for ethereum that would allow it to behave like an ethereum l2, but with the functionality of an l1, including the ability to directly deposit usd at minuscule fees. more on-ramps is a net positive for the ecosystem as a whole, and ethereum is at the core of the ecosystem. this thread captures the argument well.
If you come to the king, you better not get lost. Just as nothing has killed excel’s core use case, but many multi-million dollar companies have built businesses by focusing on specific use cases, none of the eth killers are going to kill eth. on the contrary, given the nature of web3 and how early the ecosystem is, more plugins bringing more demand is a positive thing.
the bull case for ethereum
more demand and less supply leads to higher prices. more fees accrue in fewer coins.
I’ve written a lot of words here, but the ethereum argument is that simple if you believe some things.
web3 will continue to grow. I make. I have written about it many times. there are too many smart people building too many crazy things that wouldn’t be possible without this technology for me not to do it.
eip 1559 and eth2 will work fine. This is definitely a risk, but people seem optimistic.
ethereum will remain the main l1 for web3. at this point, ethereum’s network effects are too strong to overcome. developers, users, and even other l1’s are building or supporting ethereum.
if you believe in all those things, then here is the case of the bull.
demand will increase
Between Q1 2020 and Q1 2021, there was a massive increase in demand across all categories from defi to nfts to virtual worlds. transaction fees increased 200x.
All of this happened while usability was difficult and fees were exorbitant. as explained by my friend jon wu (who you should follow to get smarter in all this):
last year was as bad as it will get for ethereum. it’s only going to get better from here, for a few reasons.
first, assuming all goes according to plan with eip 1559 and the eth2 merger, transaction speeds will increase and gas rates will be lower and more predictable.it will be easier and cheaper to transact. Lower transaction fees and faster transaction times should lead to more transactions.
Second, even if what we just experienced was a bubble, short-term bubbles are helpful in the long term! they attract money and talent into the space, and the money and talent will be mixed to create new products that attract new users and more demand. In the last few months alone, I’ve seen dozens of launches from strong teams ditching traditional startups to build web3 products, many on ethereum. more products and better experiences will attract more users. eth is an indexed bet on that growth rather than a bet on the success of any project.
strong trends, lower prices, better experiences and new products = growing demand.
For many eth bulls, this is the crux of the argument: eip 1559 means eth goes deflationary.
Bitcoin issuance is capped at 21 million. this has been the strongest bullish case for btc. you can’t just print more, like evil central banks, it’s math and capped. it’s solid money.
The knock against ethereum is that there is no limit. in theory, enough ethereum users could decide to keep printing eth and inflating the supply. if you’re going to have an inflationary asset, why not just use fiat 🤮 amiright?
but eip 1559 and eth2 change that. With eth2, new issuance to reward validators is expected to drop dramatically compared to proof-of-work rewards. with eip 1559, burning eth on every transaction, assuming a conservative amount of daily transaction fees and that 70% of the gas fee is burned and 30% sent as a tip, then more eth will be burned than is emitted every day. together, eth supply will actually start to decline after eip 1559 and the eth2 merge.
is better than solid money. it is ultra solid money. 🦇 🔊
To understand the numbers, check out the models justin drake built on the maximum eth supply and the path to 100 million eth.
The implications here are huge.
Directly, it means lower supply meeting a growing or accelerating demand, which should lead to higher prices.
even wilder, if people and institutions hold btc due to its use as a non-inflationary store of value, could they switch to ethereum instead if the ultrasonic money thesis plays out? could ethereum make bitcoin the most valuable cryptocurrency?
but it doesn’t end there, because eth is not just a store of value.
value accumulates for eth holders
Ethical ownership also grants the right to work for the ethereum network as a validator and earn a portion of the fees.
As proof of work, miners must sell the eth they earn to cover costs. today, that creates a daily selling pressure of 22.3k eth, according to another model by justin drake. that means that every day, 22.3k newly created eth, worth about $50 million, are dumped on the market. with proof of stake, the only costs are taxes, which drake assumes to be 50%, and new issuance falls from 13.5k eth to 2.1k eth. that leads to a reduction in net selling pressure, from 22.3k eth per day to 2.6k eth per day. that’s the equivalent of approximately $40 million per day in new demand.
Also, instead of being filtered out of the system, the value is accumulated in the validators. another drake model estimates that people who stake their eth (meaning blocking it to secure the network) can earn 25% apr including new issues and tips.
ethereum has strong network effects and will remain at the core of the web3 ecosystem as it continues to grow, creating more transactions and more fees
eth will become a deflationary asset as demand increases
eth will become a capital asset earning holders a high annual interest rate
I don’t even know how you price that, but of course justin drake tried, putting his best estimate somewhere between $13-51k.
risks, more warnings and a conclusion
As long as you’re not reading boring, you should remember a couple of things:
I’m incredibly optimistic and excited about technology
I have a higher risk tolerance than most
Part of the reason I’m so bullish on eth, the asset, is that the potential of ethereum, the technology, excites me. eth is a ticket to web3, but it’s also an excuse to keep going deeper and deeper down the rabbit hole. what I’m looking for in an investment (yield + participation + education + fun) may be completely different from what you’re looking for.
Last weekend showed how volatile crypto can be and how tied everything still is to bitcoin. if i was on eth for a quick trade this weekend could have been nauseating. if you participate because you want to learn and explore web3, it was a great opportunity to buy more tokens to play at half price.
despite my general optimism, there are real risks to ethereum, both macro and specific.
on the macro side, what happens if tether explodes? what if governments crack down on cryptocurrencies in general? what if rates rise earlier than expected and risky assets stall? what if elon musk tweets again One of the scariest things about last weekend’s sell-off is that there was no clear and obvious catalyst. crypto markets can be wild.
Somewhere between the micro and the macro, there is a question: what if people outside of the early adopter group just don’t care about decentralization? what if the solutions more centralized ones like binance smart chain, which comes with a built-in user base of millions of people who trade on binance, are they decentralized enough and more efficient?
On the micro side, ethereum faces some real challenges. what if eip 1559 doesn’t work as planned? what if the eth2 merge is delayed? what if sharding doesn’t work as planned and creates more problems than improvements? one very real possibility is that sharding will make legos built on ethereum less composable, undermining one of the most exciting aspects of the network.
Perhaps the biggest problem facing eth is the adoption of fragmented layer 2 scaling solutions. while l2 solutions have the potential to dramatically improve performance, they present two main challenges, one for ethereum and one for eth:
- of the transaction. Ideally, one or two L2 solutions emerge victorious, but a world in which there are multiple L2s can strengthen Ethereum’s network effect and weaken the product experience.
eth. layer 2 solutions are called summaries because they accumulate a bunch of transactions into a transaction that is set to layer 1. maybe 100 transactions occur on l2, and the whole group appears on l1 as a transaction. that would reduce transaction fees by 100x, unless l2’s better performance and lower prices lead to a 100x increase in transactions or l2 handles transactions that represent new demand because they are not possible at the speed and prices current prices.
It’s true that I don’t know enough to have a strong opinion on the subject. this is an area for further exploration, and perhaps a future post.
At the very least, I hope this article has changed the way you think about ethereum and makes you want to continue exploring for yourself. that’s the fun here.
the rules are getting filled with ethics, the narrative is changing and the most optimistic thing for the ether is to understand it.
Thanks to anatoly yakovenko, ben sparango, jon wu, and ryan sean adams for their input, and to brother dan for editing!
what did you think that this week was not boring? your feedback helps me make this great.
loved | great | good | good | bad
thanks for reading and see you on Thursday,