The looming fear: Will Ethereum's market value surpass Bitcoin's?

The author of this article is Arthur Hayes, the founder of BitMEX, and it has been compiled by Echo and Hu Tao.

There is an increasing number of voices in the crypto industry suggesting that the possibility of Ethereum's market capitalization surpassing Bitcoin is rising.

One of them is Arthur Hayes, the founder of BitMEX, who previously wrote that the price of Ethereum is likely to reach $10,000 (Chain Catcher has translated this article, click “How to Value the Future of Ethereum?” to read the full text). Today, he wrote again that Ethereum's market capitalization could potentially surpass Bitcoin, providing several arguments, which is also the most feared scenario for many Bitcoin believers.

Arthur Hayes believes that as investors, we need to confront our fears, discard dogmatic thinking, and reassess the narrative logic of the crypto industry.

“I will not fear. Fear is the mind-killer; Fear is the little-death that brings total obliteration. I will face my fear. I will permit it to pass over me and through me. And when it has gone past, I will turn the inner eye to see its path. Where the fear has gone there will be nothing. Only I will remain.”
-- Paul Atreides, “Dune”

I love science fiction. At any given time, I am reading at least one science fiction novel. Frank Herbert's “Dune” is the best science fiction novel of all time. The best science fiction series is Liu Cixin's “The Three-Body Problem” trilogy, which is so good that I wish my Chinese were better so I could read the original text instead of through English translations.

American traders and investors are simple creatures driven by fear and greed. Greed can drive humans to do many incredible things, but the fear of loss outweighs everything. Economist Daniel Kahneman has a wealth of work describing why human decision-making is not as rational as classical economists believe.

In particular, monetary losses often inflict greater psychological harm than monetary gains. As we delve deeper into this epic crypto bull market, assessing panic is crucial, as one or more of these narratives can replace traders' desire to BTFD (Buy the Fuck Dip, a jest among traders meaning to overcome human weaknesses and buy on dips).

1. The Great Reversal

A few weeks ago, I suddenly received a message from Su Zhu (founder of Three Arrows Capital). He asked me how likely it was that Ethereum's market capitalization would surpass Bitcoin in this bull market.

I replied 0, then asked for his opinion. He responded with a 50% probability. Shortly thereafter, Raoul Pal's “Global Macro Investor” was published, which included a lengthy report by Nikhil Shamapant arguing why Ethereum could reach $150,000 before January 2023. After reading the report, I sent another message to Su Zhu, raising the possibility of surpassing to 30%.

There is a segment of the Bitcoin community that is sleepless with worry that Ethereum will one day surpass Bitcoin. Bitcoin maximalists believe that Bitcoin is the true god of currency in the crypto space, and everything else is at best auxiliary and at worst purely evil.

On the other hand, mETH proponents believe that Ethereum can be both the most reliable form of cryptocurrency and the best decentralized computing network in the world. For them, once ETH 2.0 launches and completes the transition from POW to POS (currently scheduled for later this year), Ethereum's market capitalization will quickly surpass Bitcoin.

I strive to eliminate my dogmatic thinking to avoid being tethered to a mindset that becomes outdated over time. Like everyone else, I will fail in this effort, but I hope to mitigate future losses by reminding myself of the potential consequences and taking appropriate actions.

The dogmas surrounding Bitcoin and Ethereum must be simplified to the actual fundamental concepts of each cryptocurrency. Then we can build a retrospective of the current situation and assess whether the narratives are fundamentally meaningful.

2. The Great Reversal

The best form of currency has no industrial use. Fiat currencies are very useful for commerce because they are essentially worthless. The demand for a specific fiat currency depends entirely on the utility of its network. In this case, the network is the number of domestic and international trade counterparts who will accept a specific fiat currency in exchange for goods and labor.

The reason commodity forms of currency are unsuitable for everyday use is that their value is tied to certain real-world use cases. A barrel of oil is a poor currency; compared to labor and goods, oil will have two sources of demand affecting its price: one is the demand from energy consumers, and the other is the demand as a medium of exchange.

How do you measure the price of labor with a barrel of oil? The value must be calculated based on oil's usefulness for everyday energy needs, while others believe its value lies in the goods or services they trade. As the number of economic participants increases, the supply of oil and the velocity of currency circulation contain interdependent vectors, complicating this issue.

Ethereum's primary task is to power the world's largest decentralized computing network. Ethereum is valuable because the Ethereum network is the most widely used smart contract protocol. It has the most developers, DApps, and the largest total value locked (TVL). Ethereum is the commodity used to pay for Gas, allowing you to use the Ethereum decentralized network.

My belief is in the market. Over the past five years, Ethereum's market capitalization has been 30 times that of ETC, and the market value focus is that Ethereum is the best smart contract protocol and is trying to become the most reliable cryptocurrency collateral.

3. Ethereum's Inflation Timeline

If the EIP-1559 proposal is approved, it will significantly change Ethereum's inflation timeline. Essentially, Ethereum will not transfer value from users to miners in the form of gas fees, but will instead burn the base fee and provide miners with tips. It is understood that up to 70% of gas in a transaction may be burned. In my previous article, I discussed how if DeFi could replace a small portion of CeFi, there would be significant room for growth in Ethereum's gas fees.

If the amount of gas grows exponentially with usage and these fees are burned, then the inflation timeline will quickly turn into deflation. As the platform becomes increasingly useful, the supply of ETH will decrease. If we underestimate the impact of DeFi on human economic interactions, there will not be enough ETH in the future to make the system function.

The counterargument is that the extremely high price of ETH solves the supply issue. But this is not the case; if marginal mining profits expand sufficiently, there will be no room for mining. The network will not generate enough ETH through block rewards to meet its usage in Ethereum.

At this point, the economics of the network fails. ETH is priced high, and HODLers are holding a trump card, but if DeFi applications requiring gas fees pursue it at all costs, they will soon head towards poverty. Considering how we know the community will respond to existential threats (see the DAO hack incident), would you want them to stand by and watch the network commit suicide due to a flawed inflation plan? If a hard fork has been implemented once, it can be done again.

The deflationary issuance and gas fee burning plan will be sacrificed so that DApps can be used for the capacity needed to power the decentralized computing network.

Therefore, those betting that the current EIP-1559 inflation timeline will never change need to revisit the history of the protocol. One of the major driving forces of this bull market is that the exponentially growing DeFi must transact on-chain, leading to more fees being spent and then burned, reducing supply and boosting prices.

If the price of ETH really reaches $150,000 and the network is eliminating parasitic CeFi mechanisms, merely suggesting that the protocol must change its inflation timeline to continue cracking CeFi skulls will push the price to the bottom of the Mariana Trench.

Failing to understand the impact of the deflationary burning mechanism timeline on the foundational technology supporting price could have fatal consequences. Ethereum will never be the most reliable form of cryptocurrency until it fulfills its true mission of powering the global decentralized computing network.

However, this does not mean that Ethereum's market capitalization cannot surpass Bitcoin. It merely means that achieving this goal is much more difficult because Ethereum cannot have its cake and eat it too.

4. Technology is More Valuable than Currency

Global reserve currencies are the most valuable because they have the largest network of participants willing to accept them in exchange for goods and labor. Currently, that is the US dollar. The approximate value of currency is M0, which is the amount of base money in circulation. Currently, the M0 of the dollar is $5.8 trillion.

The total market capitalization of FAANG (Facebook, Apple, Amazon, Netflix, and Google) is $6.36 trillion. The dollar is merely pure currency operating on the network of the US financial system. It is not more valuable than companies providing actual goods and services priced in dollars.

Dollar holders do not cry on social media like children because the market value of companies selling products priced in dollars is higher than the dollar itself. So why are Bitcoin maximalists threatened by the inevitability that the value of other cryptocurrencies with industrial use cases will exceed Bitcoin? This sentiment does not seem to be mutual; many of the most successful altcoins have raised initial funding with Bitcoin.

If Bitcoin's market capitalization were significantly lower than its current level, it would still be equally useful as the most reliable crypto collateral. Bitcoin holders must believe that there is Bitcoin collateral in any cryptocurrency-enabled economy. They should strive to support this mission, as doing so further solidifies Bitcoin's role as the foundation of the external crypto pyramid.

5. Gresham's Law

Fiat currencies and gold require living humans to exchange for other forms of currency, goods, and/or services. These traditional forms of currency rely on human networks. As long as humans exist, this network can operate.

While Bitcoin is the most solid currency ever created, it also requires a group of selfish miners to expend real-world energy to maintain this network. Miners only receive Bitcoin as a reward. If the energy exchange rate for Bitcoin wobbles for various reasons, miners will not mine, and the network will disappear.

The higher the transaction speed of Bitcoin, the more on-chain fees are generated. Besides block rewards, these fees allow miners to purchase energy to maintain the network. We all know that the block reward amount halves every four years until it completely stops in 2140. Fortunately, the number of on-chain transactions has increased significantly.

Bad money is spent, such as dollars and other paper currencies; good money is hoarded, such as Bitcoin. This is Gresham's Law. While hoarding gold does not diminish Bitcoin's value, in extreme cases, hoarding Bitcoin without using it in any way will destroy the economics of the network that gives Bitcoin its value, because after the block rewards end, miners will only receive transaction fees, and without transactions, no fees will be collected, and miners will have no incentive to maintain the network.

6. Bitcoin Network Transaction Volume May Decline

Most people want a simple way to gain exposure to Bitcoin against fiat currency. That is, they believe the price of Bitcoin will rise but have no interest in becoming financial institutions themselves. They want to call 1-800 when they forget their password and find someone to complain to when things do not go as planned. Service providers are happy to sell paper Bitcoin derivatives that provide asset exposure while charging to handle all the annoying blockchain issues.

From the success of Grayscale's GBTC, Coinshare's XBT provider, and other paper derivatives, ordinary investors only want price risk. All my close friends who actively trade also use these products because they are easy to use. They fully recognize that if you do not hold your own cryptocurrency, the truly revolutionary aspect of blockchain will be completely lost. But that does not matter because what they crave is inflation hedging, not a new financial ecosystem.

In the long run, a large batch of Bitcoin stored in custodial accounts may drag down miners' profitability, especially if these accounts are not used for commercial activities or as collateral in the new digital financial economy. Another drag factor is those who fully believe in the “be your own bank” philosophy but prefer to spend fiat currency on necessities rather than their precious Bitcoin. If both ends of the belief system are steadfast, the growth of on-chain transaction volume will slow and/or decline completely.

Due to the ongoing semiconductor chip shortage needed to manufacture new mining machines, the enormous profit margins for miners will continue to exist in the context of relatively high Bitcoin and energy prices. Even if you have the money to buy machines, it is not enough to significantly increase the network hash rate.

As a reminder, the truly important exchange rate is Bitcoin against energy. Fiat currencies come and go, but miners must somehow use the Bitcoin they earn to purchase electricity to maintain operations, and the remaining Bitcoin after purchases is their profit. $1 can buy 1 kWh or 1000 kWh; however, 1 kWh is always 1 kWh.

Currently, large mining farms do not need a significant increase in transaction volume to cover ongoing capital expenditures. Even on second-generation mining equipment, they are printing so much money that it does not matter whether Bitcoin is used for actual commerce.

When primary commodities, intermediate goods, and final products are priced in Bitcoin, credit priced in Bitcoin can extend to all steps of the value chain. A true Bitcoin economy allows for unsecured loans to be provided in Bitcoin. When/if this future arrives, on-chain transaction volume will soar.

7. The Lesson from Dogecoin

The most powerful force in the universe is the power of human collective imagination. Every non-natural physical object we interact with begins with the imagination of one or more individuals. Everything starts with belief and then transitions into physical reality.

The value system supporting our collective illusion is tightly guarded. We only need to record the millions of lives lost over thousands of years of human civilization due to differing views on political systems and religions. It is not surprising that people take their beliefs about monetary systems very seriously. They should, because your monetary belief system may distinguish between leisure and futile labor.

Humans inherently know that money is purely fictional. Therefore, when you challenge their belief systems with other narratives, they may become hostile. The best way to elicit a response is through humor.

The most talented comedians highlight the logical fallacies of our most cherished beliefs as a society through humorous arcs. If you cannot take a joke, you might need to think about why you feel so insecure about your beliefs. Perhaps it is because deep down, you know they are complete nonsense.

Dogecoin has both enraged traditional financial officials and infuriated crypto cowboys. It is an incredible internet currency that has no pretense of technological innovation. It is simply a cute dog displayed on a computer screen.

Its founder, Jackson Palmer, left Doge years ago in anger, emphasizing that he found it absurd that this obvious crypto joke still held value.

One of the best salespeople in human history, Elon Musk, aptly uses Dogecoin to illustrate the absurdity of our current monetary system. Tesla, the company Musk leads, has a market capitalization greater than that of most car companies combined, while producing only 1/60th of the number of cars.

This is unabashed pure speculation. Musk creates more shareholder value through his Twitter megaphone than by providing safe, fast, and environmentally sustainable electric vehicles.

Love him or hate him, he is the spokesperson for the digital rise! The joke of Dogecoin has created many millionaires living in basements. This will surely anger traditional financial gatekeepers who have been touting value and growth investments on television while barely achieving single-digit returns in an era where global central banks have expanded their balance sheets at a compound annual growth rate of 15% since the 2008 Global Financial Crisis (GFC). It is a joke.

This joke also occurs among those utopian crypto believers who preach decentralized technology. Their dogmas are also threatened by Dogecoin. How can this technically flawed cryptocurrency enter the top ten by market capitalization? What does this say about the value systems of their peer projects? They lament that Dogecoin “makes us look bad” and “makes the crypto industry look unprofessional.” If professionalism means wearing suits and ties or black pencil skirts while earning inadequate returns, then give me Dogecoin.

The crypto industry has nothing to fear from Dogecoin. On the contrary, it should be used as a backdrop to show that the emperor has no clothes. Money is a psychological abstraction. The sooner a generation realizes that everything is fictional, the faster they can transition from government-issued physical cash to purely digital decentralized currency.

They are both the same kind of counterfeit. In the face of rising costs for energy, food, and housing, which narrative can preserve your purchasing power? Which narrative is inclusive rather than exclusive? Which narrative can you participate in developing?

8. I Will Face My Fears

It is simple; I worry that global central banks will slow the growth of their balance sheets. Without this, there is no reason for the value of any cryptocurrency to be multiples of today’s value. When the price of money is no longer distorted, traditional cash flow analysis will once again become meaningful.

The various fears I discuss in this article are specific to certain cryptocurrencies. Like stocks, real estate, and commodities, as the issuance of assets increases, the entire asset class will continue to grow. Understand your fears and choose the right ecosystem to protect your wealth from the ravages of inflation.