Final Interpretation | Ethereum is Winning

Author | Gulu

Source | DeGate

I believe the ultimate goal of the cryptocurrency industry in the financial sector is to form a super-large-scale, efficient, and neutral asset platform, serving as the "Internet Financial Center" for all humanity.

I will elaborate on this in two articles: 1) Why only sufficiently decentralized blockchains with enough throughput can build such an Internet Financial Center; 2) Why a blockchain-based Internet Financial Center is particularly needed in our era and what it might look like in the future.

The Internet Financial Center is built on blockchain protocols and serves as the infrastructure for global finance, with direct and indirect users numbering in the billions and an asset scale of at least tens of trillions of dollars.

A vast array of asset types is issued on the Internet Financial Center. Because assets are on the blockchain, they inherently possess "programmable" attributes, enabling efficient handling day and night: transferring (Transfer), trading (Trade), collateralizing, packaging, splitting, and issuing derivatives based on underlying assets, among others.

1. Why is Blockchain Valuable?

Why is blockchain valuable? This is a question that all cryptocurrency investors have asked at some point. The commonly accepted answer in the crypto industry is: because of decentralization. I believe this answer is correct, but when we talk about "decentralization," what exactly are we referring to?

I think "decentralization" is a means, while the goal is "trustlessness."

So, what is trustlessness?

Let's first discuss what trust is. When you give someone trust, you grant them the "power" to harm you while holding a positive expectation that they will not do so. People initially stored gold in vaults, and the vaults issued a deposit receipt, promising that as long as you presented the receipt, they would return your gold. You trusted the vault, which now had the ability to harm you by not returning your gold, but you believed it would be fine; the vault would return it. The subsequent events are well-known; the vault realized it was unlikely that all depositors would come to withdraw their gold simultaneously, so it lent out some of the gold to earn interest, eventually evolving into a "fractional reserve system," turning the vault into a bank, leading to repeated bank run crises. In 1971, the promise of converting dollars to gold was broken, and the "deposit receipt" became void, turning the "dollar" into an unanchored "USD." From then on, fiat currency became a runaway wild horse, and we entered an era of credit currency with arbitrary issuance.

What is trustlessness? Trustlessness means you do not need to give the other party the power to harm you. Therefore, "trustless services" are those where you do not need to grant the service provider the power to harm you, yet you can still receive the service. Blockchain provides trustless services. In the blockchain world, as long as you control your private key, no one can take away or freeze your BTC or ETH; as long as you pay the miner's fee on the blockchain, you can send coins to any address. Yes, no one can harm you. These trustless services are achieved through decentralized means and represent the core value provided by blockchain. Trustless services are particularly suitable for application in the financial sector, including: issuing assets (BTC, ETH) according to pre-agreed rules; various handling of assets, such as transfers, trades, collateralization, etc.

Today's traditional financial centers, such as New York, London, and Singapore, are all built on a robust legal environment because, in the traditional model, only a good legal system can provide sufficient trust: if others can arbitrarily take or freeze your money in the bank, they will be punished by law, so you trust that they will not do so. This falls under the category of "Don't be evil," but does not mean they "can't be evil." Former financial centers can turn into "financial wastelands" because they have the capacity to do evil, just as Hong Kong is currently experiencing a transformation.

Trust is inherently fragile.

It can go a long time without issues, but once something goes wrong, the party that granted trust may suffer significant losses, just like those large depositors who were "haircut" during the 2013 Cyprus banking crisis; like those who held gold exchange receipts (USD) in 1971; like the people who are now leaving Hong Kong and cannot retrieve their pensions, which were originally stipulated by Hong Kong law to be retrievable.

In contrast, trustlessness is inherently anti-fragile and extremely stable because there was never any power given to harm the other party.

Blockchain achieves "can't be evil" through decentralization, which is a further step, surpassing their "ignorance of better ways," establishing the Internet Financial Center in a light-hearted manner.

2. Blockchain is 10 Times Better!

Peter Thiel mentioned in his book "From Zero to One" that if a new product is more than ten times better than an old product, it will sweep the market at a storm-like pace, and users will migrate in large numbers. In creating the Internet Financial Center, I believe blockchain is more than ten times better than traditional methods:

1) In providing trust, "trustlessness" is more than ten times better than "trust";

2) Creating an address on the blockchain is more than ten times easier than flying to Switzerland to open a bank account;

3) The global financial platform built on the blockchain will have enormous "network effects" and extremely high efficiency in handling, both of which are more than ten times better than traditional financial infrastructure.

Do you have the feeling that after using blockchain, you can never go back to using banks? Regarding why such an Internet Financial Center is built on blockchain, and why it is the call of our era, I will elaborate in the next part of this series. This article will continue to discuss why this blockchain is based on Ethereum.

The blockchain for building the Internet Financial Center must be: (A) sufficiently decentralized; (B) capable of providing sufficient throughput services. Both points must be satisfied simultaneously; neither can be lacking. In my humble opinion, Ethereum is the only player in this field.

Why must it be sufficiently decentralized? Reflecting on our previous discussion, the attribute of decentralization provides trustless services, and trustless services are the foundation of the Internet Financial Center. Why is trust, or "trustlessness," so important?

Imagine if the Bitcoin blockchain were not decentralized but instead ran on a centralized server, then:

• Satoshi Nakamoto would have to open an account for each user on the Bitcoin network, and during the account opening, Satoshi would need to verify each user's uploaded documents, such as identification and proof of residence.

• Satoshi would ask you, where did your BTC come from? Please provide proof of funds!

• Satoshi would need to apply for operating licenses from various governments.

• Satoshi would have to report various suspicious transactions to governments.

• Satoshi would need to provide tax-related information to governments.

• Satoshi would have to comply with government directives to freeze BTC and sometimes transfer frozen BTC to designated accounts.

• When Satoshi might receive a directive from the U.S. government—please freeze the BTC of the Central Bank of Russia. How should Satoshi respond? After all, Satoshi also applied for an operating license in Russia.

• Satoshi might receive another directive: let's do a "quantitative easing" of BTC, please help print 700 billion BTC, thank you.

Satoshi realizes that clearly, a single server cannot run the Bitcoin network. So why can a decentralized network do it? Because decentralization acts as an "army," providing the blockchain network with a form of "sovereign independence" akin to that of a nation, thereby offering neutral, independent, and predictable security services for the Internet Financial Center.

Indeed, the blockchain network resembles a nation and provides government-like services in certain aspects, especially excelling in protecting property rights, being more than ten times better.

First, let's discuss why people need governments. What should governments do for people? The Enlightenment pioneer John Locke articulated in "Two Treatises of Government": "Everyone has natural rights, including the right to life, the right to survival, the right to freedom, and the right to property. These natural rights are not granted by the government but are inherent to humans. People relinquish some of their rights to society and establish a government to safeguard these natural rights; if a government deprives people of these inherent rights, it is evil."

Are there many evil governments in the world? Yes, many! And they have been increasing over the past few decades, especially in terms of protecting property rights. This is the historical backdrop for the birth of Bitcoin, which has the phrase inscribed in its genesis block: "The Times 03/Jan/2009 Chancellor on brink of second bailout for banks," which translates to: "The Chancellor is on the brink of a second bailout for banks," the headline of The Times on January 3, 2009.

The independent space constructed by blockchain can protect property rights better than governments because decentralization provides trustless guarantees. The many decentralized nodes of the blockchain form an "army," creating a long-term, independent space that will give birth to a massive, user-friendly "Internet Financial Center" for all humanity. This independent space, as the name suggests, is independent of governments, but it does not seek to destroy governments or the order they establish; rather, it competes, providing services and products that are more than ten times better in certain aspects, establishing a better order.

Governments do not like competition because no one likes others competing with them. Switzerland was able to maintain neutrality during World War II due to its geographical advantages and its strong military; "independence" has never been begged for but is based on one's own strength, standing tall among the nations of the world. The same goes for blockchain. The blockchain where the Internet Financial Center resides must have a sufficient degree of decentralization to realize its sovereignty, protecting an economy worth tens of trillions of dollars, with a military strong enough that the cost of potential external attackers (the most powerful being governments) launching an attack is too high, making them willing to coexist. After all, the Internet Financial Center only provides competitive services and does not threaten the existence of governments or disrupt the order established by governments, just like today's offshore financial centers.

The second and third-ranked blockchains may hide in the shadow of the first, spending less on military expenditures for decentralization, but the economic value of the second and third will be significantly lower than that of the first, because the Internet Financial Center itself has network effects, as all applications and users are willing to collaborate on the same platform, which is the most efficient for everyone.

When I was starting a business in Shanghai, I could meet four groups of people in a day; if I were not in Shanghai, I could not achieve that. If all 1.4 billion people in China could live in the same city without physical constraints, it would be optimal for everyone in terms of efficiency and collaboration. However, the physical world lacks sufficient "scalability," which is why I believe the high throughput of blockchain (i.e., scalability) is crucial for building the Internet Financial Center, alongside decentralization. The gap between the first and second-ranked blockchains may be as significant as that between Google and the second-ranked search engine.

As a nation-like entity, the network consensus of blockchain is akin to a constitution. Unlike a government, however, all actions on the blockchain must be subject to real-time "constitutional" review by all consensus nodes; "unconstitutional" actions will be eliminated from the start. From this perspective, the efficiency of the judiciary is also more than ten times better. As a more efficient model for constructing order, blockchain holds the promise of building the next generation of human institutions—decentralized systems that do not rely on governments, benefiting all humanity.

3. How Much Decentralization is Enough?

If external hostile forces want to attack the blockchain network, the attackers must target numerous "decentralized consensus nodes." For example, if a certain large country's government wants to freeze BTC on a specific address, it must ensure that more than 50% of the Bitcoin network's consensus nodes reject any "unreasonably abrupt" blocks if those blocks "dare" to include any BTC transactions from that address. Similarly, if a large cross-border remittance company wishes to prevent transactions on Ethereum to curb potential competition, it must get more than 1/3 of the Ethereum consensus nodes to refuse service, preventing the Ethereum network from achieving "finality."

There are several methods to launch these attacks, such as: 1) sending legal letters to the operators of consensus nodes (yes, laws can sometimes be arbitrarily formulated); 2) disconnecting nodes from the internet; 3) injecting viruses into the devices running the nodes; 4) launching missiles at nodes; 5) shutting down the entire internet; and so on.

How do decentralized consensus nodes as a whole defend themselves? 1) By ensuring a large number of nodes, even if a few are taken down, it does not affect the overall operation of the blockchain network; 2) Nodes are inherently based on a "pseudonymous system," making it difficult to identify the real individuals behind them and send them legal letters; 3) Nodes are located in various jurisdictions around the world, each with different laws; 4) Joining and exiting consensus nodes is dynamic, allowing nodes to engage in guerrilla tactics.

Thus, if there are enough decentralized nodes and the organizational mechanism is good enough, it is not easy to defeat this "army." If the attackers' motives are not strong enough and the difficulty of the attack is high enough, there is no reason to launch an attack. The motivation for an attack is related to the scale of the blockchain economy itself and the adverse impact that the blockchain poses to powerful potential attackers. Regarding the former, the larger the scale of the Internet Financial Center, the stronger the "army" needed for protection; regarding the latter, blockchain practitioners should not actively provoke powerful potential attackers. For example, I believe that anonymization services on the blockchain are unacceptable to governments because they could cause significant disruption to the existing national order, thus likely provoking a collective backlash from governments.

So, how much decentralization is enough? Everyone's judgment is different, and this threshold is dynamically changing, depending on the severity of the external environment.

We know that the current external environment is not friendly; China has long banned all cryptocurrencies, and many people in the U.S. government are also not fond of the crypto industry. For instance, the U.S. Securities and Exchange Commission, after a 10-year delay, reluctantly approved the application for a BTC spot ETF this year.

I believe that dozens of consensus nodes are definitely not enough to build an Internet Financial Center; hundreds may not be sufficient either; thousands start to feel more reassuring. The degree of decentralization is not only related to the number of consensus nodes but also to the nature of the nodes themselves. For example, if the hardware requirements for nodes must be data center-level, then even if there are thousands of nodes, this "army" remains fragile because the privacy of the nodes is almost nonexistent, and the "soldiers" cannot engage in guerrilla warfare. The Ethereum community believes that allowing ordinary people's computers to run consensus nodes is crucial and serves as an important foundation for Ethereum's decentralization.

Regarding how much decentralization is sufficient, another consideration is to prevent the corruption and malfeasance of decentralization. If billions of people entrust their inherent property rights to 21 nodes, giving these 21 nodes dominion, how can we ensure they will not become corrupt? How can we ensure "we do not become human mines for the people"? Will these 21 nodes collaborate with certain countries to implement controls on "capital outflow," targeting our hard-earned money? Even if people can leave, will the money be allowed to go?

Greed, the greed for interests and power, is the "factory setting" evolution has given humans, from Louis XIV of the Bourbon dynasty as the "Sun King" proclaiming "I am the state," to the personal dictatorship of revolutionary leader Robespierre who overthrew the Bourbon dynasty, to Napoleon who achieved personal power by maintaining the results of the French Revolution, all proclaiming human greed. The philosopher-king in Plato's "Republic" does not exist in the "real world"; in the "real world," there are Robespierre and Napoleon. Therefore, we must sacrifice a certain degree of efficiency and adopt a democratic route of checks and balances, which in the blockchain world means decentralization, allowing such "decentralized systems" to benefit all humanity.

4. Throughput is Equally Important!

The blockchain for building the Internet Financial Center must not only be sufficiently decentralized but also capable of providing sufficient throughput services. However, before the advent of Layer 2 technology, the crypto industry once popularized the "impossible triangle" assertion. This assertion holds that it is impossible to achieve scalability, decentralization, and security simultaneously; only two of the three can be obtained. Clearly, security cannot be compromised, so scalability (i.e., high throughput) and decentralization must be chosen between.

As a result, many blockchains have made deep compromises on decentralization to achieve high performance. For example, an entire blockchain network relies solely on 21 high-performance hardware consensus nodes. As previously discussed, I believe such compromises have already disqualified them from the race to build the Internet Financial Center.

Many years ago, I believed that the assertion of the "impossible triangle" was incorrect because it mistakenly assumed that every node must verify each transaction in the block individually. In fact, Layer 2 technology has broken this assumption. There are several types of Layer 2 technology, and the concepts are mixed; some unscrupulous platforms even deliberately switch concepts to confuse the audience, claiming that other independent blockchains are also Ethereum's Layer 2. I believe the criteria for Layer 2 are simple: whether the Layer 2 system can ultimately achieve the "trustlessness" level equivalent to Layer 1 (Layer 1 being the underlying blockchain). Layer 2 is an extension of Layer 1, together forming the overall blockchain ecosystem. If it loses the most important "trustlessness" attribute after being extended, then such a Layer 2 system is not part of the overall blockchain ecosystem and cannot be called Layer 2. Otherwise, logically, centralized exchanges could also claim to be Layer 2 because after you deposit (renamed as bridging) to a centralized exchange, you can also conduct transfers and trades.

Setting aside those "pseudo Layer 2" systems that claim to be Layer 2, I believe the most important branch of true Layer 2 technology is Rollup technology. The working principle of Rollup technology is to package a large number of transactions into a single Rollup transaction and upload it to the Layer 1 blockchain. Currently, there are two types of Rollup technology: Optimistic Rollup and ZK Rollup, both of which have broken the so-called "impossible triangle" in their own ways. Optimistic Rollup outsources the verification work that would originally need to be completed by Ethereum nodes. Anyone can challenge the state after Optimistic Rollup transactions on Ethereum within a specific timeframe (typically 7 days), and an incentive mechanism can be designed within the challenge mechanism to reward those who successfully challenge, encouraging active public oversight and challenges to any errors. In ZK Rollup, through zero-knowledge proofs in cryptography, it mathematically guarantees that the state after ZK Rollup is correct, and the zero-knowledge proof technology allows Ethereum nodes to verify a large batch of packaged transactions quickly with minimal computational resources. I believe ZK Rollup technology is magical; in addition to its extremely high compression efficiency, it cleanly extends the trustlessness attribute of Layer 1 without introducing additional hard-to-evaluate security assumptions.

5. "L1 + L2" is the Future

In the long run, I believe Ethereum's future will be a combination of "Layer 1 blockchain + Layer 2 systems equivalent to Layer 1 trustlessness" (hereinafter referred to as "L1 + L2"), especially when ZK Rollup solves the technology for general smart contract platforms. This combination provides both the current level of decentralization of Ethereum and high throughput services, making it the best choice to support an Internet Financial Center worth tens of trillions of dollars.

The future is bright, but the road is tortuous, with many difficulties in reaching the "L1 + L2" endpoint, the most significant of which are two major challenges: 1) technical challenges; 2) the abandonment of the "trustlessness" concept.

L2Beat (L2Beat.com) is a very useful website backed by a young team that strongly believes in the spirit of decentralization and the concept of "trustlessness." This website comprehensively and thoroughly displays the status of various Layer 2 projects (including "true Layer 2" and "pseudo Layer 2"). If you recognize and wish to invest in a future like "L1 + L2," I recommend checking L2Beat regularly; it is very helpful.

We will use the information displayed on L2Beat to outline these two major challenges. The following screenshot shows all 38 Layer 2 projects currently running on L2Beat, sorted from high to low based on the "STAGE" evaluation standard.

First, let me introduce L2Beat's "STAGE" evaluation system. L2Beat assesses the completion of "trustlessness" based on five risk factors, which they refer to as "maturity." These five risk factors are (1) State Validation, (2) Sequencer Failure, (3) Proposer Failure, (4) Exit Window, (5) Data Availability. In the following example, only if all five risk factors are rated green can a project achieve a STAGE 2 rating. Currently, among all ZK Rollup projects, only one has achieved STAGE 2, which is DeGate, as shown in the image.

In L2Beat's "STAGE" evaluation system, to obtain a STAGE 2 rating, the following requirements must be met: providing users with at least a 30-day exit window, allowing users to react within the window to enjoy Ethereum Layer 1-level "trustlessness" security guarantees. I believe this evaluation standard is reasonable and aligns with the current stage of overall Layer 2 ecosystem development. My admiration for the L2Beat team lies not only in their pursuit of the "trustlessness" concept but also in their non-dogmatic and flexible approach. For instance, they did not set the STAGE 2 evaluation standard to require an infinite exit window for users, as that would be unrealistic and could adversely affect the development of the overall Layer 2 ecosystem, which is currently in a rapid growth phase.

For example, Ethereum will implement EIP4844 in 2024, introducing a cheaper data type called Blob Data. After implementing EIP4844, I expect the cost of using Rollups (i.e., Gas costs) to decrease by at least 80%. However, each Rollup system will need to have upgradeability to take advantage of the cheaper data services brought by EIP4844, so the user exit period cannot be set to be infinite; otherwise, they would not be able to use Blob Data through system upgrades and would have to redeploy, leading to the abandonment of the old Rollup system and the need for users to migrate all their assets to the new Rollup system. The cost of doing this is too high and overly demanding, and I believe it would be detrimental to the overall development of the Layer 2 ecosystem. Therefore, L2Beat's current evaluation system is reasonable, maintaining the concept while being practical and non-dogmatic.

Now, let's discuss the first challenge among the two major challenges: why is it so difficult to technically achieve "Layer 1 trustlessness equivalent" Layer 2? The core reason is that Layer 2 systems are very complex; the more complex a system is, the harder it is to ensure secure operation, and the longer it takes to build the necessary security. Moreover, both Optimistic Rollup and ZK Rollup are entirely new technologies, especially the zero-knowledge proofs used in ZK Rollup, which are very advanced in the field of cryptography. In fact, the application of ZK Rollup is rapidly promoting the development of zero-knowledge proofs in academia. Among the Layer 2 systems displayed on L2Beat, the earliest to implement ZK Rollup, Loopring, has been in development for at least five years; DeGate, which achieved STAGE 2, took three years, going through five rounds of "security audits" and one ongoing "bug bounty program."

Despite the technical difficulties, as I mentioned earlier, I believe the future is bright because a mature "L1 + L2" blockchain system will create a tens of trillions of dollars Internet Financial Center serving all humanity. Currently, there are five projects on L2Beat that have achieved STAGE 1 or higher: DeGate, Fuel, Arbitrum, dYdX, and zkSync, and I commend them.

The second major challenge is the abandonment of the "trustlessness" concept, meaning that it cannot achieve Layer 1-level "trustlessness" in design, which I refer to as "pseudo Layer 2." I suspect the primary motivation here is to reduce Gas costs and provide cheaper services. While cost is indeed important, it should not come at the expense of abandoning the core value of "trustlessness." Such a compromise, in my opinion, crosses the line, as the cost is that these Layer 2 systems cannot become part of the "L1 + L2" trustless system. Only "true Layer 2" can bear the burden of a tens of trillions of dollars Internet Financial Center alongside Layer 1. On the other hand, "true Layer 2" can also reduce costs through other means. The biggest cost for "true Layer 2" is the data cost of being on-chain to Layer 1, which will significantly decrease after Ethereum implements EIP4844 this year, and I expect it to drop by at least 80%.

Recently, there has been a wave of discussions in the blockchain industry about modular DA (data availability) layers, with some proposing to migrate DA services out of Ethereum to use other cheaper data services. If DA services are migrated out of Ethereum while Rollup systems can still maintain Layer 1-level "trustlessness" in design, I wholeheartedly support it. In fact, there are indeed such proposals (see Faust, an article by Geek Web3), and excellent teams are actively exploring and practicing this. However, recent discussions seem to abandon Layer 1-level "trustlessness," allowing Layer 2 to downgrade to "pseudo Layer 2" for lower costs.

I believe that all Layer 2 projects focused on financial applications aim for large-scale growth and ultimately aspire to become important members of the "L1 + L2" system. Therefore, whether to abandon Layer 1-level "trustlessness" in design from the outset must be carefully considered, as a "gold necklace" that rusts around one's neck is not a gold necklace. I believe that abandoning "trustlessness" will severely hinder the scalability of "pseudo Layer 2." Currently, among the 38 Layer 2 projects running on L2Beat, the funding scale of "true Layer 2" is more than ten times that of "pseudo Layer 2," indicating that the market cares about this, and no one wants to end up as "human mines."

6. Conclusion

In summary, this article discusses:

• Why is blockchain valuable? Because of decentralization.

• Decentralization is an "army," aimed at achieving "trustlessness."

• Only a sufficiently powerful "army" can provide protection for the Internet Financial Center.

• It elaborates on how much decentralization is enough.

• The blockchain for building the Internet Financial Center must simultaneously meet (A) sufficient decentralization; (B) provide sufficient throughput services. Currently, only Ethereum is a player in this field.

• It discusses how Layer 2 breaks the "impossible triangle" of blockchain.

• It provides criteria for distinguishing "true Layer 2" from "pseudo Layer 2." Money is smart, and the market chooses "true Layer 2."

In the next article, I will discuss why a blockchain-based Internet Financial Center is particularly needed in our era, has significant market potential, and what it might look like in the future.

Thank you for reading.