Four major reasons promote Ethereum will eventually win the battle for store of value!
Author: Michael McGuiness
Editor: South Wind
Thanks to Justin Drake for inspiring many of the ideas in this article and for reading the draft of this article.
For many years, I have always believed that Bitcoin has the most asymmetric risk return in our lives. Its unique attributes make it the best store of value in the world. It is difficult to replicate network effects that other encryption another currency is unlikely to replace it.
As of September 2020, Bitcoin is the only cryptocurrency I hold. Its TAM (total effective market) as a store of value was once so huge that it made no sense to allocate capital anywhere else. The broad store of value market may be as high as 400 trillion U.S. dollars, and what once shocked me is that Bitcoin is very likely to obtain a large percentage of the “currency premium” from the following aspects:
- Gold ($10 trillion)
- Bonds ($100 trillion)
- Stock ($30 trillion)
- Real estate ($200 trillion)
- Broad money ($100 trillion)
- Art, wine, collectibles ($20 trillion)
I used to think, what can compete with this advantage? In addition, most other cryptocurrencies are scams, and a few legitimate projects seem to have not found a product suitable for the product market.
Then, at the urging of a friend, I reluctantly started buying some ETH. Don’t get me wrong, smart contracts and decentralized applications (Dapps) are cool. But in my opinion at the time, Bitcoin will win the use case of value storage. This is the expected result and the ultimate reward. I was not sure how Ethereum’s native assets (ETH) would increase in value at the time.
A few months ago, this view of mine began to change. Almost everyone in the encryption field can attest that once you have something, you will pay more attention to it. (Ethereum) Two developments have caught my attention: 1) Ethereum is turning to proof of stake (PoS); 2) Changes in the monetary policy of the agreement . I quickly realized that these changes will have a huge impact on the currency properties of ETH, and may even make it a comparableBTC A better way to store value.
Of course, I was skeptical at first. After all, Bitcoin already has such a huge lead. It is a household name, and it is the safest in terms of network computing power . Large institutions like Tesla, MicroStrategy, and MassMutual have begun to adopt it as a reserve asset. Can Ethereum really catch up?
But the more I read and think, the more I think ETH is more likely to be a store of value. I quickly converted most of my BTC to ETH and decided to write this article to clarify my thoughts.
In my opinion, Ethereum will win the value store battle for four main reasons:
- More scarce
- Organic demand
- Actual income
I realize that such advice might be considered a blasphemy against Bitcoin maximalists. I support these maximalists in many ways, such as the need for a brand new asset that allows people to preserve their wealth over time. However, I am not so arbitrary about how to achieve this goal. I will eventually support what I think is the most likely asset. To borrow the words of Paul Tudor Jones, Ethereum now looks like the fastest horse.
01. More scarce
1. Store of Value
In my previous article “Why Bitcoin Makes Sense”, I wrote a lot about what is a good store of value, so I won’t spend too much time discussing the definition here. .
The basic premise is that money is just a technology that allows our wealth today to be consumed tomorrow. Therefore, over time, the “best” currency will give holders the most purchasing power. There are several factors that affect the applicability of currency commodities as a store of value, but the most important factor is supply growth or scarcity.
Have you ever wondered why gold is the most important store of value in human history? Why not silver, copper or one of the other 118 elements? The main reason is scarcity . The annual growth rate of gold supply has been hovering around 2% in history. Only the annual growth rate of silver can reach 5-10%, and currently it has reached about 20%. The extremely low growth rate of supply allows gold to maintain its purchasing power better than anything else over time, and the world eventually recognizes that gold is a store of value.
For thousands of years, gold is the best (store of value) we can use because it is a currency commodity with a limited supply that can maintain its value over time. However, the invention of Bitcoin created the first truly scarce form of currency in history. Bitcoin has a precise supply of 21 million Bitcoins, and anyone can use their home computer to audit this. Bitcoin robbed gold of something better than anything else, and improved it by orders of magnitude. However, Ethereum may also do the same with Bitcoin, namely by moving to Proof of Stake (PoS), and will soon change its Gas management.
2. Ethereum’s monetary policy & EIP-1559
The current annual network issuance (ie inflation rate) of Ethereum is about 4.5%, 2 ETH per block, and an extra 1.75 ETH for each uncle block (plus fees) to miners. Ethereum does not have a fixed supply , because a fixed supply also means a fixed network security budget. Rather than arbitrarily fixing the security of Ethereum, Ethereum’s monetary policy is best described as ” minimum issuance to ensure network security .”
Bitcoiners (Bitcoin supporters) hate this ambiguity because they believe that the bottom layer of the financial system should be stable. The development of Bitcoin is deliberately cautious and slow, and the total amount of Bitcoin issued will not exceed 21 million.
But the Ethereum community believes that this sacrifices short-term (issuance) stability for long-term network security, and the fact is that Ethereum does have a history of reducing issuance to the lowest estimated level. In addition, moving to PoS will significantly reduce the issuance of ETH while maintaining the same level of network security . I will elaborate on this later, butVitalik There is a good article on his blog  explaining how PoS can provide more security at the same cost.
According to the current Eth 2.0 specification, as a part of PoS, the issuance rate of Ethereum will be greatly reduced. New ETH issuance will be issued by validators who have pledged ETH by processing transactions and reaching a consensus on the state of the network , rather than being handed over to miners, and there will be a floating ratio between the total amount of ETH pledged and the annual interest rate of the pledger . The current specification will produce the following annual interest rates and inflation rates based on the total amount of network ETH pledge :
Basically, we can predict that after the PoS transformation, the annual network issuance (ie inflation rate) will drop from today’s ~4.5% to less than 1% . The chart below highlights this huge decline:
But this (inflation rate) is still higher than Bitcoin, which has an upper limit of 21 million Bitcoins and a long-term inflation rate of 0%. So, how exactly will Ethereum become more scarce? Well, there is more. With the release of the Ethereum improvement proposal EIP-1559 , Ethereum has begun to address many concerns about its monetary policy. The proposal is called ” Ethereum’s Scarcity Engine ” or ” ETH’s Burning Mechanism “.
EIP-1559 will be implemented in July this year as the upcoming London hard drive for Ethereum.Bifurcationa part of. Digging into the details of the proposal is beyond the scope of this article, but the key aspect to note is that in addition to improving the user experience of Ethereum gas fees, EIP-1559 will burn (destroy) a portion of ETH transaction fees . This will permanently remove part of the ETH supply from circulation and reduce the daily net issuance of ETH.
An analysis of online transactions last year showed that EIP-1559 will burn nearly 1 million ETH in 365 days, which is almost equivalent to 1% of the entire network circulation. As the demand for Ethereum transactions grows, many people expect this number to increase over time. Therefore, when this is combined with the lower issuance rate (less than 1%) brought about by PoS, Ethereum will actually have a deflationary monetary policy .
This led to the recent emergence of a new meme (meme) called ” ultrasound money ” in the Ethereum community , which was created by Ethereum researcher Justin Drake. This term is a bit silly, but Drake’s point is that if Bitcoin is a “sound currency” because its supply cap is 21 million, then a cryptocurrency with a declining total supply should be better, so there is “ultrasound money”. “The word.
In the long run, Ethereum will be a scarcer asset. However, I may be more optimistic about the short-term. along withPoWWith the removal of ETH, the issuance of ETH will drop by approximately 90%. It is estimated that the impact of this on (Ethereum) miners’ selling pressure is equivalent to three Bitcoin “halvings”.
3. Inventory-to-flow ratio & migration to PoS
To quantify the scarcity of Bitcoin and use it to model the value of Bitcoin, the best attempt is from PlanB’s stock-to-flow model (stock-to-flow model) . Essentially, PlanB believes that scarcity (defined as supply growth rate) directly drives value, and the scarcer an asset (that is, the lower the supply growth rate), the more valuable it is. Here is the chart he created to prove his point (where “SF” stands for “stock-to-flow”, and the calculation method is the opposite of the supply growth rate):
Note: SF = Stock (stock) / Flow (flow); Supply Growth (supply growth rate) = Flow (flow) / Stock (stock). The stock of an asset refers to the total amount of the asset currently circulating in the market; flow refers to the amount of new circulation of the asset each year.
What is shocking is that this SF model has been maintained very well in the two years after his publication. In the chart below, the white line is the predicted BTC price, and the multi-colored dots represent the price performance of Bitcoin as of May 2021.
As we have seen, based on this model, the value of Bitcoin will have a big jump every four years . This is because the block rewards paid to Bitcoin miners are halved every 210,000 blocks (approximately every 4 years. Since block rewards are the only way to mint new Bitcoins, the supply of Bitcoins grows It will be reduced by half every four years .
As PlanB clarified (and quantified) in his article, the decline in bitcoin supply growth (ie, halving) is highly correlated with the surge in bitcoin prices. This may be because the halving directly reduced the selling pressure of miners by half . Because Bitcoin uses a resource-intensive PoW consensus mechanism, miners must sell Bitcoin to pay for their hardware and electricity costs . Therefore, when Bitcoin’s block reward is halved from 12.5 BTC per block to 6.25 BTC in May 2020, the selling pressure of miners will drop from 1,800 BTC per day to 900 BTC per day . This means that the annual reduction of BTC sold by miners is equivalent to about 1.6% of the market value of Bitcoin (approximately $18 billion at today’s price). Under such a huge supply shock (decline), we will naturally see the price of BTC skyrocket until a new equilibrium level is achieved based on this reduced inflation rate.
Ethereum is currently using the PoW consensus mechanism. But when it fully transitions to PoS, the current annual ETH issuance of about 4.5% will drop to less than 1%. This is equivalent to the annual reduction of ETH miners sold by about 3.5% (more than 15 billion U.S. dollars at today’s price) of the market value of ETH. In addition, I expect that the selling pressure will be smaller because the block reward will be distributed to those pledgers (validators) who do not need to be forced to sell (ETH) because of the very low cost of hardware and electricity. However, to be fair, most pledgers will still have to sell some ETH to pay the income tax on the rewards, so the new ETH market supply will not become zero .
Of course, besides scarcity , there are many other factors that drive the value of an asset. The degree of acceptance by others is one of the factors. However, scarcity (at least for the time being) seems to be the most important factor affecting the monetary value of a commodity, as it affects commodity sales over time. On the other hand, safety is also a crucial factor. Just like gold does not rot, corrode, or undergo other types of deterioration, cryptocurrencies must be designed with appropriate incentives to last. After all, an asset that no longer exists after decades cannot become a store of value.
02. More secure
With gold, you don’t have to worry about safety. From unforgeability to unforgeability, the laws of physics apply to it. However, as far as cryptocurrency is concerned, you must continue to pay costs (i.e. block rewards paid to miners/validators) to ensure network security.
In the case of the Bitcoin network, a new block is created every 10 minutes. Each block contains the newly minted BTC (the ” block subsidy “, currently 6.25 BTC per block) and transaction fees , which together constitute the ” block reward “. According to Bitcoin’s hard-coded monetary policy, the number of newly minted BTC in each block will decrease over time (halving every 4 years), and eventually reach 0% in 2140. When this happens, that is, when no new bitcoins are issued, the only compensation to miners will be transaction fees.
Many Bitcoiners (Bitcoin supporters) believe that this will not be a problem, because when the block subsidy is exhausted, the dollar value of the transaction fee will be high, so the security expenditure (of the Bitcoin network) will be sufficient to ensure network security. Bitcoin supporter Dan Held wrote in his article “Bitcoin’s Security is Fine” (Bitcoin’s Security is Fine) :
“I guess that based on the current value of U.S. dollars, hundreds of billions of dollars should be a sufficient security budget, because it is difficult for a government to waste so much money just to attack the Bitcoin blockchain to prove such behavior. Reasonable. They must also publicly respond to such attacks, because their citizens (taxpayers), businesses and banks will all invest in Bitcoin.”
In the article, he then responded to the concerns that people often raise about relying solely on transaction fees to achieve (Bitcoin) network security. I agree with many of Held’s points and understandSatoshi NakamotoWhy is Bitcoin designed this way. Due to the use of the PoW mechanism, there is always a trade-off between inflation (block subsidy) and security. Bitcoin has made specific trade-offs. It will continue to pay less and less fees to its consensus engine (i.e. lower block subsidies) to maintain scarcity and limit the number of Bitcoins to 21 million.
However, I disagree with Held’s view that this kind of dollar-denominated security spending is important, and support Vitalik Buterin’s recent reddit post :
“The security needs of a thing must be proportional to its size, because as a thing becomes larger, its enemies will become larger and motivated. If BTC (the market value) is 100 times what it is today , Then the value (cost) used to destroy it will increase 100 times, and those who want to destroy it will be bigger and more terrifying. This is why the military scale of all countries accounts for the same proportion of their GDP. Therefore, In fact, the attack cost divided by the market value is the correct data to measure . In the long run, PoW that (eventually) will not issue (new currency) does not look so good.”
So let’s take a look at Held’s most optimistic assumption that Bitcoin “survives, thrives, and continues to grow exponentially in market share, just as it has done in the past 10 years.” In this hypothetical scenario, the market value of Bitcoin in 2140 is 100 trillion U.S. dollars, and (users) transaction demand for Bitcoin block space brings miners an annual transaction fee income of 365 billion U.S. dollars (this is Security expenditures of the Bitcoin network at that time). See below:
Is the $365 billion security spending really enough to protect the Bitcoin network from attacks? Perhaps. I’m really not sure, and I don’t know what the world will look like in 2140. But I’m pretty sure we can do better . In the above hypothetical situation, Bitcoin’s PoW consensus mechanism will make Bitcoin’s value-to-security ratio (that is, the ratio of Bitcoin’s market value to annual security expenditures) approximately 273 to 1 . And under the Ethereum based on the PoS consensus mechanism, we can get the value to security ratio of about 10 to 1 . If the market value of Ethereum is the same as the Bitcoin market value predicted by Held, the cost of launching a 51% attack on the Ethereum network will be equivalent to about 10 trillion U.S. dollars, which is more than $365 billion higher than the Bitcoin cost predicted by Held. 27 times . And the only assumption is that about 10% of the ETH is pledged, which seems reasonable; at the same time, Held’s prediction assumes a 500% increase in the size of Bitcoin blocks, a 40% increase in efficiency, and users’ Block space has huge transaction demand.
In addition to the much lower value/safety ratio (note: the lower the value/safety ratio, the higher the attack cost), Ethereum has a major advantage in how to respond to attacks . After the 51% attack, the only option for the Bitcoin network is to migrate from the current Double SHA-256 ASICs to a new PoW system. This new system will have to be based on commercial mining hardware, such as GPUs or CPUs, because there is not enough time to manufacture hardware for another ASIC PoW system. Then the attacker can only perform the same 51% attack on ordinary hardware. Vitalik called it a ” nest attack ” (spawn camping attack), that is a 51% attack launched miners alliance will continuously attack, so this chain useless. As far as the PoW system is concerned, there is no way to destroy (or punish) the attacker’s mining ability .
Ethereum (and PoS more broadly) is less susceptible to such attacks. This is because the Ethereum network can “punish” or punish attackers . If an attacker does something bad, the network will punish the attacker by confiscation of their pledged ETH. This is equivalent to letting Bitcoin destroy the attacker’s mining equipment, but this is obviously not possible with the protocol.
Ethereum actually has two penalties and forfeiture mechanisms . The first one can be called “Layer 1” penalty, that is, if you (the verifier) do something obviously wrong in the agreement (such as submitting two conflicting proofs), it will be triggered. In this case , The Ethereum network will automatically confiscate at least one third of your ETH pledge amount . This will deal with most potential attacks and redistribute ETH from dishonest nodes to honest nodes, thereby making the system vulnerable to fragility to some extent . If you look at it from the point of view of the so-called “iterated game” in game theory, the Ethereum system becomes stronger every time it is attacked .
Suppose the attacker wants to attack again. He must get more ETH, attack again, and then be fined again. After each attack, the amount of ETH in circulation will decrease, so there is actually an upper limit on the number of times the system can be attacked . For example, there are currently a total of 100 million ETH, of which 10% are pledged. For each attack, the attacker will have to buy at least 10 million ETH, and every time he is confiscated, he will have to regain another 10 million ETH. In the worst case, the attacker can only attack the system 9 times. In addition, the cost of each attack will get higher and higher , because the price of ETH on the open market is likely to rise as the supply drops.
Similarly, this resistance to fragility also exists at the level of a single game. If you want to attack the Ethereum network, you must obtain 10 million ETH (using the simplified number in the example above). Due to the simple supply and demand situation, the more ETH you have to buy, the more expensive the price of ETH will become as the available-for-sale ETH decreases, resulting in diseconomies of scale, such as your second The cost of buying 1% of the ETH supply is more expensive than the first time, because after you buy the 1% ETH supply for the first time, there is less ETH available for sale.
In order to alleviate the fear of miners or mining pools obtaining 51% of the computing power, a common argument (hypothesis) is: even if they obtain 51% of the computing power, why should they attack? After all, attacking the network will destroy the “golden goose laying eggs”, which is not in their interests. But in reality, we cannot make such assumptions . This argument not only assumes rationality, but also assumes that there are no outside incentives. The whole point of having a high security level is to prevent attackers with external incentives from breaking this chain . This is why Vitalik’s approach to PoS security is “if they (attackers) have X billion U.S. dollars, how many times can they break the chain before all their funds are confiscated?” This is not a rational assumption. It just assumes that the financial resources of malicious actors are limited .
Perhaps the best argument for PoW security that I have heard is that its property driven by physical hardware (mining machine) increases resistance to attackers with sufficient capital: you need to wait a year for these hardware To be manufactured, this process inevitably involves many people, and you are at a high risk of being discovered in this process (note: in the process of gradually increasing your computing power). This is the real advantage of PoW. That being said, physical hardware also has a key disadvantage: it is difficult to conduct large-scale mining without being detected, and PoS is more censorship-resistant.
In terms of security, participating in Ethereum pledge will not bring any “footprint”, which is a huge advantage: to become an Ethereum validator, all you need is ETH, a Raspberry Pi, an SSD and the Internet connection. This is in sharp contrast with Bitcoin. In Bitcoin mining, becoming a miner will bring a lot of “footprint”: miners need to consume huge energy and use huge warehouses to store mining equipment. Such a “footprint” makes it relatively easy for the government to detect and shut down mining activities. As far as Ethereum is concerned, you (the verifier) can be anywhere in the world (perhaps after passing through the Tor network, you can even hide your IP address). Even if a country can find and confiscate your physical devices for verifying Ethereum, these devices do not store your pledged ETH: ETH only exists in the Crypto world and can only be confiscated by asking the owner to surrender their private key.
People sometimes forget that when Satoshi Nakamoto created Bitcoin more than a decade ago, this was the world’s first successful attempt to create Crypto scarcity and incentive design for a PoW consensus system. Although the pseudonym “Satoshi Nakamoto” is very clever, this person (or team) is actually a person, and it is impossible to reasonably anticipate all potential problems arising from Bitcoin’s incentive design. Since then, the blockchain field has conducted more than 12 years of research and development in terms of network security and scalability.
In my opinion, in the long run, Ethereum seems to be a more secure network.
03. Organic demand
In 1944, the Bretton Woods Agreement laid the foundation for a near-global lock-in of the international monetary system by the United States. However, only ten years later, the Bretton Woods system began to disintegrate. The United States began to have a huge fiscal deficit, and inflation levels rose moderately, first with domestic projects in the late 1960s (the United States vigorously developed its own economy after World War II), and then the Vietnam War. Soon, the U.S. gold reserves began to decrease, because other countries began to doubt the support of the U.S. dollar and exchange the U.S. dollar for gold. The continued decline in gold reserves eventually forced Richard Nixon to end the dollar peg to gold in 1971.
After the collapse of the Bretton Woods system, every currency is legal tender. This is the first time in human history that all currencies in the world have been converted into banknotes without any support. These currencies have no value in themselves. They are valuable because the government declares them to be valuable and enforces them as a medium of transaction and a unit of account. The method is to allow all taxes to be paid only in this currency, or by enacting other laws. Increase barriers to the use of other trading media and accounting units (or completely prohibit them in some cases).
However, outside the United States, foreign companies and governments still have little reason to accept (US dollar) banknotes, because these banknotes can be printed endlessly without solid support. But facts have proved that through the petro-dollar system , the United States has created a continuous international demand for the U.S. dollar, which has forced the world to adopt the U.S. dollar.
In 1974, the United States and Saudi Arabia reached an agreement. Saudi Arabia (and other OPEC members) will only sell oil in U.S. dollars in exchange for U.S. protection and cooperation. For example, even if Germany wants to buy oil from Saudi Arabia, they can only buy it in U.S. dollars. Since then, any country that wants oil has to use U.S. dollars to pay. As a result, non-oil-producing countries began to sell many of their export products in U.S. dollars so that they could get the U.S. dollars they needed to buy oil from oil-producing countries. All these countries use surplus dollars as foreign exchange reserves.
Over time, this system has continued to strengthen. As Lyn Alden wrote in her wonderful article “The Fraying of The US Global Currency Reserve System”:
“In the beginning, countries needed U.S. dollars to obtain oil. Decades later, with so much international financing conducted in U.S. dollars, countries now need U.S. dollars to repay U.S. dollar debts. Therefore, U.S. dollars are composed of oil and U.S. dollar debts. support , which is a very powerful self-reinforcing network effects. importantly, most of these debts are not owed to the United States (although denominated in US dollars), but less in other countries . For example, China has provided to developing countries Many U.S. dollar-based loans are the same in Europe and Japan.”
It is this “self-reinforcing network effect” that causes everyone in the world to accept waste paper issued by the US government in exchange for tangible goods and services. This is definitely the fundamental reason why the U.S. dollar has become a global reserve asset. Why is this important? I think a similar system – and a virtuous circle – is emerging around the Ethereum network .
In the past decade, the demand side of most crypto networks has been dominated by speculation . This is understandable. Speculation provides funding for the construction of the supply side (infrastructure, applications, etc.) of these networks. But this situation is changing . You need to use ETH to do things on the Ethereum network, and people are doing a lot of things in this network: they buy domain names, trade tokens, borrow loans, issue bonds, use prediction markets, make payments, buy insurance, buy art, games , Purchase virtual land, horse racing, etc. in the Metaverse. All these things require the use of ETH to pay transaction fees .
As applications built on Ethereum become more complex and intuitive to users over time, the demand for Ethereum will grow. 94 of the top 100 crypto projects are built on Ethereum, and more than 3000 Dapps and 200,000 ERC-20 tokens are running on Ethereum. The total transaction volume on Ethereum reaches a record high every day, and the average transaction value on Ethereum is more than twice that of Bitcoin.
Some of these figures are indeed shocking. (At the time of writing) More than $80 billion of ETH is locked in DeFi applications, up from $16 billion in January. In the past 12 months, likeUniswap with SushiswapThe transaction volume of such decentralized exchanges ( DEX ) on Ethereum reached 432 billion US dollars, because these automatic market makers (AMM) make token trading easier than ever. The supply of stablecoins on Ethereum has increased from $19.5 billion in January to over $48 billion today.
Above: The growth of various stablecoins supplied on Ethereum.
Ethereum is not only the settlement layer of almost all leading Dapps, but also the settlement layer of almost the entire Crypto dollar (that is, a stablecoin anchored to the dollar) ecosystem. Even traditional financial services companies like Visa will allow use on EthereumUSDCThe settlement of transactions shows that stablecoins are now far beyond the use cases of traditional cryptocurrencies . Just a few weeks ago, the European Union’s investment sector used Ethereum to issue a two-year Crypto note worth 100 million euros (121 million US dollars) for the first time.
In addition, the sales of NFTs (non-homogeneous tokens) on Ethereum have exceeded 600 million U.S. dollars, of which 13 NFTs are sold for more than 1 million U.S. dollars. The use cases of NFT are exploding .
Similarly, if you want to interact with the Ethereum network in any of the above use cases, you must pay a fee to the miner/validator who processes your transaction. Ethereum is essentially a decentralized computer, and computing power requires money. These costs are called “Gas” (natural gas), and the similarities to oil are incredible.
The more useful applications built on Ethereum are, the greater the demand for ETH . It is estimated that the TAM (total effective market) of DeFi reaches US$2.7 trillion per year (accounting for 2%-3% of global GDP ) using only cumulative revenue as an indicator . Knowing this, it is easy to see how a petro-dollar-like system will develop around the Ethereum network . Let’s quote the words of Lyn Alden above and modify it a bit:
At first, everyone needed ETH so they could use this global decentralized computer . Decades later, with so much international financing conducted in ETH , people now need ETH to pay off debts denominated in ETH . Therefore, ETH is supported by both computing needs and ETH-denominated debt, which is a very powerful self-reinforcing network effect.
Comparing the demand for ETH with the demand for oil seems far-fetched, but if the world’s financial infrastructure is all on Ethereum, would it be far-fetched? In my opinion, it seems that ETH is increasingly likely to benefit from such self-reinforcing network effects that make the US dollar a global reserve currency.
In general, Ethereum imitates Bitcoin in many ways, but by creating a virtual decentralized computer, it greatly expands the potential use cases and provides a substantial improvement. These use cases provide an organic, sustainable and growing demand for Ethereum block space . As these use cases flourish and become more widely adopted, the demand will only increase.
Since the “best” currency will give holders the most purchasing power, this organic demand further increases the probability of ETH winning the value store battle .
04. Actual benefits
Wall Street financial giant George Soros (George Soros) may become the greatest foreign exchange trader in history. In his book “The Alchemy of Finance” (The Alchemy of Finance), he revealed a lot of his decision-making process. The third chapter is “Reflexivity in the Currency Market” (Reflexivity in the Currency Market), which describes the vicious circle and the virtuous circle of the currency market. In this chapter, Soros believes that there are some complementary factors in the traditional currency market that create cycles characterized by large fluctuations in exchange rates, interest rates, inflation, and/or levels of economic activity. This section is very technical content, but let’s focus on speculative capital key driver of (speculative capital): The rising exchange rate (exchange rate) and interest rates .
The reason why we focus on speculative capital is that it is one of the three major driving forces (fundamentals) of exchange rate changes. The other two driving forces are trade and non-speculative capital flows. In fact, the “fundamentals” (the “scarce” and “organic demand” discussed in the previous chapter are also the fundamentals of ETH) are also affected by market participants’ expectations of future exchange rate movements (note: that is, the two interact with each other). influences). This is just an example of Soros’s “reflexive” concept, which is easy to see in Ethereum: speculation drives many investors and developers to invest their time and money to build network infrastructure and applications on top of it . In fact, speculative capital is crucial to fundamentals.
“Speculative capital is to seek the highest total return. (Impact) There are three factors in total return: interest rate differences, exchange rate differences and capital appreciation of the local currency . Since the third factor varies from situation to situation, we can propose the following general rule: speculative Capital is attracted by rising exchange rates and interest rates . Of these two factors, the exchange rate is the most important . The exchange rate of a currency does not need to fall too much, and the total return will be negative. Similarly, when a currency appreciates When there is also an interest rate advantage, the total return exceeds any expectations of financial asset holders under normal circumstances.”
Let’s analyze it. The exchange rate (exchange rate) is the most important factor. This makes sense. If I pledge ETH at an interest rate of 8.5%, but the price drops by 10%, then I lose money. So until we can be sure that the exchange rate will rise, we really shouldn’t pay attention to interest rates . This is why most altcoins with annual returns of more than 1000% are bad bets, and Bitcoin has been such a great bet in the past 12 years. This is why I will focus on the key factors that drive the price of ETH in the first three sections of this article.
Let us assume that Bitcoin and Ethereum have equally compelling currency attributes, and the market expects the prices of these two assets to appreciate by 100% this year. In this case, rational investors should not have a strong preference for one of these two assets. However, if you let the same investorCoinbaseIf you get a 6% interest rate by staking ETH (or let him run a validator node to get an 8%+ interest rate), the situation will start to change. Although (BTC) 100% expected return rate and (ETH) 106% return rate seems not much different, in the long run, this will make a huge difference . As the speculative nature of cryptocurrencies decreases and the market becomes more efficient, the expected asset appreciation will drop from 100% to a more reasonable level, which is especially true. Over time, this additional 6% pledge income may account for an increasing proportion of ETH’s expected total return .
By staking ETH, you can get an additional risk-free staking income of more than 6%, which will incentivize some investors to transfer funds from Bitcoin to Ethereum . This is how the market works. For example, since 2008, foreign investors’ inflows into the United States have reached approximately US$8.5 trillion, most of which have increased since 2011, because investors sought to obtain higher returns in the form of arbitrage at that time (US Bond yields are higher than zero or negative yields in Europe and Japan). Speculative capital will naturally flow to the asset with the highest expected actual rate of return .
The virtuous circle of Ethereum will become the vicious circle of Bitcoin. As more and more speculative capital flows from Bitcoin to Ethereum in search of higher actual returns, the exchange rate between the two currencies is expected to change. This will not happen overnight, but over time, I expect the market to expect a higher price of Ethereum than Bitcoin will appreciate . When this happens, Bitcoin may be in a bad situation. As Soros wrote:
“The longer the virtuous circle lasts, the more attractive financial assets holding appreciation currencies will be, and the more important the exchange rate will be when calculating total returns. Those who tend to fight the trend will gradually be eliminated, and ultimately only trend followers will be Survive as an active participant. As speculation becomes more and more important, other factors lose their influence. Only the market itself guides speculators, and the market is dominated by trend followers. These considerations explain how the dollar can gain Continue to appreciate in the face of the expanding trade deficit.”
I like Bitcoin and everything it stands for, but this situation seems more and more likely to happen. I want to know what will happen if the market value of Ethereum exceeds that of Bitcoin in a period of time. If Bitcoin is not the most liquid asset among cryptocurrencies, which asset will it be?
Another aspect that I will not spend much time discussing is that for most large ETH holders, staking (using ETH) and income farming in DeFi (liquidity mining) are sufficient to provide passive Daily income . They no longer need or do not want to sell ETH, because they can passively earn 8%+ pledge income and higher liquidity mining income. This will further enhance the scarcity of Ethereum and the expected price increase in the future.
05. Risks & Concerns
In summary, these four factors (more scarcity, safer, organic demand, and actual benefits) are the main reasons why I think Ethereum will eventually win the value store battle. Of course, the conclusions I have drawn above are not deterministic, and if this article does not discuss some of the risks, then this article is incomplete. Because this article is already very long, I will briefly comment on each risk.
1. Expansion challenges
At present, when the (Ethereum) network is busy, the transaction speed will be affected, which makes the user experience of certain types of Dapps very poor. As the network gets busy, the gas price also rises as transaction senders bid against each other. This makes using Ethereum very expensive. A few months ago, the gas price for completing a simple transaction was as high as $100-200, but with the Berlin upgrade, the price dropped, which coincided with the ETH price reaching a new all-time high .
This may be the most critical risk of Ethereum, because it opens up opportunities for competing projects , such asSolanaSome interesting things are being done in this area. But in the end, Ethereum has many options to improve the speed, efficiency, and scalability of the network. Layer 2 solutions and sharding are probably the most notable . But they are not without technical risks, and they are urgently needed.
2. Other Layer 1 solutions
I can’t help but wonder if Ethereum will eventually be replaced by a cryptocurrency that learns from Ethereum’s experiments and improves in some basic aspects. There are many “Ethereum killers” trying to take advantage of the weaknesses of Ethereum to become the boss, includingPolkadot, Solana,Cosmos, Cardano, etc.
As Peter Thiel (billionaire venture capitalist) explained in the Stanford Entrepreneurship Seminar, “People often talk about’first mover advantage’. But focusing on this can be problematic; you may take a step first and then slowly disappear. The latecomer is more important than the first mover. You must have the hold.”
Two years before Amazon (Amazon) was born, there was Book Stacks Unlimited (online bookstore). Four years before Google, Yahoo! (Yahoo) created the first global search engine. Before Facebook, MySpace dominated social media. The list goes on. In the history of science and technology, there are countless examples of this: the first mover became interested in a concept or product, and then the late ones took advantage of the emptiness and made improvements to the existing products.
But Ethereum has strong protection against this risk of being eliminated . It has many of the same network effects as Bitcoin, and the Ethereum community and protocol are innovation-friendly, which may be equally important. “Bitcoin will absorb all innovation” is a meme that has never been realized. In fact, Ethereum has the opportunity to do this, largely because they have “functional escape speed” at the EVM level.
Although I admit, we must constantly adapt to new developments and risks in this field. But Ethereum currently seems to be the best choice.
3. Stability of monetary policy
Bitcoin may be the most unchangeable encryption system in history. Bitcoiners believes that this is the true value of Bitcoin. It is a reliable and neutral system based on code (not humans), and you can rely on it for decades.
Ethereum’s human-managed hard fork and relatively centralized development team bring risks. How do we believe that Ethereum’s monetary policy will not change again? How can we ensure that an unfavorable (agreement) change does not occur? Even if the Ethereum community agrees that it will never change and respect this, it will always be 12 years behind the trust established by Bitcoin.
If Ethereum will become a global store of value, this is an important issue, but as mentioned above, I think Ethereum is sacrificing short-term (currency issuance) stability in exchange for long-term security. Ethereum is already very decentralized, and its relative centralization allows them (the Ethereum development team) to innovate in security, monetary policy, and effectiveness.
4. Increased complexity
Just as it almost always happens in the field of (protocol) design, there are trade-offs in the transition from PoW to PoS. The first is complexity. Bitcoin’s PoW system is very simple, you can write pseudo-code for it with a dozen lines of code. But Ethereum’s PoS is much more complicated. The state transition mechanism of the beacon chain may be written with about 1000 lines of code, so we will see a complexity increase of about 100 times. This is a very real trade-off – complexity leaves room for bugs and may cause other problems such as expansion issues. But the good news is that Ethereum has dealt with this complexity well, proving that it can be overcome by four production-level (client) implementations that are protecting the beacon chain.
5. Fair start
Some people believe that Bitcoin “has a monopoly on fairness” because when it starts, no one knows what it will become. They believe that this is something that can no longer be copied and gives Bitcoin some of the best attributes. Anything that is pre-sold cannot be considered fair. In addition, Bitcoin’s PoW system is an excellent mandatory function for the distribution of BTC , because miners must sell Bitcoin to pay for their hardware and electricity costs. PoS does not have this attribute. Ethereum pledgers will only accumulate more ETH and will not be forced to sell ETH, because PoS is very effective and the hardware and electricity costs are very low. Therefore, Bitcoiners believes that PoS will establish a permanent system of rule by the rich.
However, as mentioned in the previous question, this is a misunderstanding because income tax (about 50% in many jurisdictions) will function as an economic coercion. In addition, Ethereum has been using the PoW system for nearly 6 years, and many Ethereum supporters believe that this has enabled ETH to achieve a good distribution . In addition, do most unethical market participants really care whether the Internet is fair? What I want to say is that most of them are acting out of self-interest, buying whatever assets they think will make them the most money. Also, who can decide what is fair distribution, and what is not?
Editor’s note: This article only represents the original author’s point of view, the translation is slightly deleted, and the original English text can be found at: