Six Major Reasons to Bet Big on Ethereum
The Ethereum merge is likely to make Ethereum the first economically viable blockchain in the long term.Author: Alphadegen.eth
Original Title: 《Betting It All On Ethereum》
Compiled by: Guo Qianwen, Chain Catcher
Key Points:
- Currently, no mainstream blockchain protocol is economically viable in the long term, meaning that revenue exceeds the operational costs of the blockchain.
- The true power of cryptocurrency technology lies in decentralization. If you want to make a network decentralized, you can't just flip the "blockchain switch." It requires a strong social force—legitimacy—to make it work.
- In the blockchain ecosystem, legitimacy grows and is maintained within the community, which upholds legitimacy and allocates responsibility.
- If ordinary community members cannot run nodes, the blockchain cannot achieve decentralization.
- The Ethereum merge is a historic upgrade that is likely to make Ethereum the first economically viable blockchain in the long term.
ETH is the native currency of Ethereum, serving multiple functions—it is valuable (can be used to pay for transactions), drives the world's largest decentralized computer; acts as a "bond" (used in the POS consensus mechanism), generating profits; and serves as a store of value (as currency in DeFi)—these functions complement each other.
The assets contained in the cryptocurrency ecosystem have been the best-performing assets in the world over the past decade, with the best risk/return ratio (e.g., BTC and DOGE). For many of us, this was the main reason we became interested in cryptocurrency. However, from an investor's perspective, I believe ETH currently offers the best risk/return ratio.
My five main reasons for being bullish on ETH:
Solving the scalability problem
Network effects
"The most important scarce resource is legitimacy"
Making friends with the Morlock
The world computer goes green
Solving the scalability trilemma
The trilemma refers to the fact that if you use "simple" technology, you can only achieve two of the three main characteristics that a blockchain is trying to realize (scalability, decentralization, security). Currently, there are three "simple solutions" that can achieve two of these characteristics:
Without proper decentralization, the "pure mathematical nature" of blockchain technology cannot function, but Satoshi showed us how to do this. Before Satoshi, we already knew how to communicate securely and scalably, which was not difficult (advocates of high TPS chains need to understand this); what we didn't know was how to do it in a decentralized manner. This is similar to how Michael Faraday showed us how to harness electricity with the world's first generator, leading to a domino effect—thanks to this, we produced other innovations that fundamentally changed the way humans live.
Have we solved the scalability problem?
Currently, no blockchain has solved the scalability problem, which is akin to hoping to download a movie in a minute in the 1990s; the technology and its adoption were simply not ready.
People invest time or money in internet projects to gain benefits. However, it is shocking that no mainstream blockchain protocol is economically viable, meaning that fee revenue should exceed the operational costs of the blockchain.
Bitcoin fully realizes its primary function: value storage; but it needs to "print" BTC to pay for security costs. It "prints" about $31 million worth of BTC daily, generating only about $300,000 in BTC transaction fees (as of July 2022). After several halvings, or when all 21 million BTC are mined (estimated to be in 2140), will Bitcoin be economically viable? No one knows. I think most people would agree that as more halvings occur, its economic viability will inevitably decrease (if everything else remains constant).
After Ethereum upgrades to proof of stake, it is likely to become the first economically viable blockchain in the long term, as network maintenance costs are expected to be lower than the fees generated from block creation. In fact, after EIP 1559 (BASEFEE burning), Ethereum has already produced some deflationary blocks.
Ethereum is the blockchain closest to solving the scalability trilemma, having the best scalability strategy by establishing a unified settlement and data availability layer. The Ethereum community is (with appropriate R&D, public goods, and grants) capable of achieving this; it is the only ecosystem that can do so.
Network Effects
On the Ethereum network, roles such as core teams, investors, validators, developers, and users interact using the same currency, creating a beautiful positive feedback loop that builds a stronger community.
Why did the "explosion of crypto use cases" happen on Ethereum? DAOs, NFTs, and DeFi did not magically appear between 2016-2018; these use cases have been incubating since the Ethereum white paper, created by the most innovative people in the industry who have tirelessly built, updated the network, and developed dApps over the years. dApps attract users (and funds), which in turn attract more developers, leading to the creation of more dApps, attracting more users, and so on—creating a positive feedback loop known as "bilateral platform network effects."
"The true distinguishing feature of a bilateral network is that it has two different categories of users: supply-side and demand-side users. They come to the network for different reasons and create complementary value for each other." - James Currier, The Network Effects Handbook.
Is it still a good time to invest in Ethereum?
Hayes wrote in an article that despite ETH's market cap being much larger than its competitors, it is still cheap from a fundamental valuation perspective. Hayes compared ETH with its main competitors in terms of valuation, number of developers, number of addresses, and TVL value. Considering that ETH is cheaper in fundamental valuation compared to its alternatives, from an investment perspective, ETH offers the most attractive risk/return ratio.
"The most important scarce resource is legitimacy"
Blockchain technology is different from many other technologies; if you want to make a network decentralized, you can't just flip the "blockchain switch." It requires a strong social force—legitimacy—to function properly.
Legitimacy is defined in Vitalik's post as:
"Legitimacy is a higher-order acceptance pattern. If in a certain social environment, people widely accept and play their roles to achieve a certain outcome, and everyone does this because they expect others to do the same, then the outcome in that social environment is legitimate."
To understand this idea of legitimacy, ask yourself:
- Why can Ethereum pay more in security fees than any other smart contract blockchain?
- Why can the blockchain recover from a 51% attack?
- Why are some hard forks more valuable than technically identical forked blockchains (e.g., Ethereum vs Ethereum Classic, Hive vs Steem)?
- Why are some NFTs more valuable than others, even though they use exactly the same images to represent them?
The answer to all these questions is legitimacy.
Why is the community so important?
In the blockchain ecosystem, legitimacy develops and is maintained within the community. The community not only carries legitimacy, but the power and responsibility to maintain the blockchain are also allocated to its members, making the network more decentralized.
The stronger the community, the more legitimate it becomes. Given that Ethereum has a mature and strong network effect to support users, developers, investors, and validators, I believe Ethereum has the strongest community among smart contract blockchains.
Making Friends with the Morlock
Early in my cryptocurrency career, I realized that to understand how blockchain technology could help us solve significant problems, one must understand its value. I spent a lot of time understanding the failure of collaboration, known as the Morlock problem.
The Morlock has many definitions; my definition is—it explains "why we can't have nice things." I believe the essence of the Morlock is best illustrated in this failed fish-farming collaboration.
As a thought experiment, let's consider fish farming in a lake. Imagine a lake with a thousand identical fish farms owned by a thousand competing companies. Each fish farm profits $1,000/month. For a while, everything is fine. But each fish farm produces waste, polluting the lake. Suppose each fish farm produces pollution to a certain extent, reducing the lake's productivity by $1/month.
The waste produced by a thousand fish farms is enough to reduce productivity by $1,000/month, meaning no fish farm is profitable. At this point, capitalism is needed: someone invents a complex filtration system that can remove waste. Its operating cost is $300/month. All the fish farms voluntarily install this system, ending the pollution, and now each farm's profit is $700/month—still a considerable number.
But one farmer (let's call him Steve) doesn't want to spend money to operate the filter. Now, the waste from one fish farm pollutes the lake, reducing productivity by $1. Steve's profit is $999, while the others' profits are $699.
Others see that Steve is not spending on filter maintenance, so they disconnect their filters too.
Once four hundred people have disconnected their filters, Steve's monthly income drops to $600—lower than if everyone had kept using the filters, while those poor, ethical filter users only earn $300. Steve tells everyone, "Wait! We all need to voluntarily agree to use the filters! Otherwise, everyone's productivity will decline."
Everyone agrees with his point, and they all sign the "Filter Pact," except for one slightly annoying person, whom we'll call Mike. Now everyone starts using the filters again, except for Mike. Mike's income is $999/month, while the others' income is $699/month. Gradually, people begin to think they should also get a large sum of money like Mike, disconnecting their filters for an extra $300 profit…
A self-interested person has no motivation to use the filter but has some motivation to sign an agreement for everyone to use the filter. However, in many cases, they have a greater motivation to wait for others to sign the agreement while not participating themselves. This can lead to an inability to reach equilibrium, meaning no one will sign such an agreement."
Why is this a big problem?
One way to measure human progress is to see if we can develop better ways to collaborate with each other. Language, religion, government, nations, constitutions, monetary systems, scientific methods, and the internet are all fruits borne from the tree of human collaboration. Each of these inventions is a small battle won against the Morlock (though they all come with their sacrifices). But there are still more battles we have yet to succeed in: corruption, censorship, privacy rights, fair trade, economic justice, and so on.
"Finding, discovering, and building a system that enables unstoppable human collaboration is so desirable for humanity that even the grandest science fiction writers cannot imagine what kind of future we could build with this technology." David Hoffman, Ethereum: The Morlock Killer.
What does Ethereum have to do with all this?
David explains: "Unstoppable code, immutable transactions, and unprintable currency are the ultimate collaboration toolkit humanity has never had… Ethereum is a platform for producing coordination mechanisms… which means the world is about to become more collaborative."
The World Computer Goes Green
The merge is the most anticipated cryptocurrency event of the year and a historic upgrade for Ethereum. According to the latest estimates, the merge is expected to occur between September 14-15, 2022. In short, the merge means the engine for block production will switch from proof of work (POW) to proof of stake (POS).
I want to emphasize why ETH's value is expected to appreciate in the coming months, all related to the concept of Ultrasound Money.
Ultrasound Money can be understood as a culture that believes the combination of EIP 1559 (BASEFEE burning) and this merge may lead to a reduction in ETH supply. After the merge, ETH issuance is expected to decrease by about 60-90% (depending on staking participation), which is equivalent to at least two Bitcoin halvings.
Hal Press, a cryptocurrency analyst at North Capital, wrote an article stating, "From the perspective of price movement, approximately $5 million in new funds is needed daily to maintain its current price, which will shift to requiring only about $30 million in existing holders selling their tokens daily to keep the price stable."
This represents a huge permanent buying pressure for ETH.
After the merge, ETH will meet ESG standards (ESG stands for Environmental, Social, and Governance; here it means ETH will no longer have high-energy-consuming miners), allowing new institutional investors to invest in ETH. We have already seen Swiss bank SEBA making this move.
Many describe staked ETH as internet bonds because through staking, you can stake ETH to generate permanent returns.
Risks
Based on its performance in the previous cycle, I believe ETH is not much riskier than BTC (currently the "less risky" cryptocurrency). Indeed, ETH is currently more volatile, and its performance in bear markets is usually not as good as BTC (although ETH/BTC is currently creating new local highs). However, many of the risks associated with BTC could also impact the entire cryptocurrency market, including ETH.
What are some additional risks associated with ETH?
What if more stablecoins collapse? What if regulators crack down on Ethereum due to its unstoppable nature (like the Tornado Cash case, where the U.S. Treasury imposed sanctions on Tornado Cash), or suddenly decide to label it as a security? What if the merge does not go as planned? What if the complexity of Ethereum causes more problems than progress? What if DeFi is not as resilient as we imagine?
Challenges
Is it environmentally friendly? It doesn't have a limited supply, so is it sound money? Its security costs are high; is it efficient enough? All these challenges can be simply responded to—they are likely to be resolved after the merge.
Is it too expensive for retail users? Is it suitable for mass use? What if retail users don't care much about decentralization? These are all challenging questions, and solving the scalability trilemma is no easy task. But the path is clear; if there is a team/community best suited to tackle these challenges, in my view, it is the developers of Ethereum, as most of the innovation in the blockchain ecosystem comes from them.
Positive Conclusion
ETH offers one of the best risk/return ratios currently available. It can be said to be the best candidate for solving the scalability trilemma; it has the greatest network effects and the highest legitimacy among smart contract chains; its coordination mechanisms can help solve some of the world's biggest problems; and it is likely to become a deflationary asset. All these characteristics provide ETH with a stable advantage, supporting its protocol. Let us not forget that the blockchain ecosystem has the potential to resolve the failures of collaboration among humans, thus creating immense value—much of which still lies ahead, waiting for our exploration.
