2020s: The Rise of Ethereum

TL DR; What the Internet did to data, Ethereum will do to finance. As a result, Ether will be the best risk-adjusted investment this decade.

Ethereum is the first permission-less global economy. For those new to the ecosystem, Ethereum is the economy. Ether (ETH) is the currency. It is essentially a borderless “digital country” where code is governance and everyone in the world is a “citizen”. Anyone, anywhere in the world can write code to provide automated, logic-based services such as digital bank accounts, financial exchanges, lending platforms, etc… and deploy it on Ethereum.

The code on Ethereum is audit-able and will always act as coded; anyone in the world with an internet connection can access services without asking for permission from a third party. The creation of Ethereum has massive implications for global finance. Current fiat currencies, such as the USD and Euro, have systematic problems due to their permission-based nature. Ethereum is primed to be the best economy in the world, by improving trust and efficiency in global trade and settlement.

Digital Currencies, Blockchain and the Future of Money | Data Driven Investor

Many investors look at crypto markets and still remember the ICO boom, where scams were prevalent, and lofty valuations existed for projects with no fundamentals outside of pure speculation. A few years later and it has become clear that during the next cycle, Ether is likely to grow due to fundamentals rather than speculation. We will conclude by exploring the mechanics behind the price of Ether and why an expected surge is likely this coming decade.

The Global “Permission-based” Economy

The economy is a series of transactions built on trust. The global economy is the summation of all transactions within and across countries. Within each country (e.g. USA), the set of transactions are added up to form Gross Domestic Product (GDP). Without trust between two parties, there will be very few transactions, grinding the economic machine to a halt.

Governments issue fiat currencies to facilitate trade and have complex legal systems to enforce rules and arbitrate disagreements between two or more parties. A major responsibility of the government is to manage the welfare of its citizens by keeping unemployment low, setting minimum wages, and ensuring the currency remains stable so citizens can use their incomes to purchase goods and services (foreign or domestic) they need to live.

To meet these goals, the government utilizes a complex system of technical infrastructure and human capital to support its fiat currency. The systems deployed by governments today typically enable online transactions, credit card payments, and physical cash, with threats of jail and violence for those who commit financial fraud or try to counterfeit physical money.

The government not only manages the technology behind these currencies, they also manage its issuance; they can and do print as much money as they want. However, they need to be careful not to print so much money they cause inflation or lose trust in the global financial markets; causing a rapid rise in the price of goods and services. Countries who do a good job at keeping inflation low, while maintaining low unemployment with quality jobs, flourish.

Governments manage their financial infrastructure through a permission based system. The government gives permission to banks, which then give access to technology companies (Visa, PayPal, Venmo, Plaid), which then give permission to other businesses or users to access their applications or APIs, and so on. At each level, permissions are used to control the economy, prevent money laundering and enforce know your customer rules. The government sees and enforces everything from the top layer.

Lack of Financial Innovation

A permission-based system is critical for nation-state governments and ensures that there is trust in the economy. However, it does have some negative implications as the government has the ability to censor any application not obeying its rules.

In the case of payment networks like Visa, many fiat currencies are supported at an exchange rate determined by the larger financial markets. This makes it easier for citizens of any country to travel and enables a healthy, global economy. However, in order to provide these services, Visa needs permission from every government / country in its network.

Therefore, in order to build financial products, companies have expensive legal bills in order to ensure they meet regulatory requirements and are allowed to operate. A company must pay these costs per country that they operate in and make sure they stay up to date on the latest laws and requirements. These high costs protect citizens from fraud but come at a cost to innovation and enable rent seekers in finance. Rent seekers reduce economic efficiency by increasing their share of existing wealth without creating new wealth.

It is nearly impossible to create new and innovative startups to compete against incumbents like Visa without a large war chest of funding. The amount of money needed to request approval from and interact with multiple permission based governments is too high for anyone without access to large amounts of capital.

“Trusted” Platforms

Because it is hard to compete against them due to high barriers to entry, large financial firms are allowed to charge monopolistic premiums and have been making a fortune. Despite these advantages / profits, companies like Wells Fargo are engaging in illegal activities and just recently received a $3BN fine. Wells Fargo created millions of new accounts for existing customers without their knowledge, resulting in unexpected fees to these customers.

The trust consumers place in these “trusted” institutions is not always warranted. These companies have no problem with the status quo, but users who are being charged high fees and developers who can build better products should not be so complacent.

Wells Fargo fined $3BN — should we trust centralized institutions led by human actors?

Unfortunately, only a small percent of the population is able to innovate in the financial sector due to the permission based nature and high barriers to entry. You might have a team of talented developers, but if you don’t have a track record, or don’t live in a country with a strong network of venture capitalists, or didn’t go to a prestigious university, it’s unlikely that you will innovate in finance as the odds are stacked against those without significant capital.

Unlike the retail and newspaper industries, finance has not seen the same level of disruption from the creation of the Internet. What was needed was a platform for anyone to build upon that people can trust. One that does not require a massive amount of funding to navigate rent seekers and overly complex legal systems. One that presents a permission-less viable alternative built by a large community of developers and researchers: Enter Ethereum.

Ethereum: a Platform for Innovation

The Ethereum economy is an online country / economy that is not controlled by any third party, where users can trust that any code placed in its system will always execute as coded. Ethereum is a tool used by developers to provide people from anywhere in the world access to novel and innovative self-sovereign products, including but not limited to, bank accounts, exchanges, exchange traded funds, derivatives markets, lottery systems, gambling sites, virtual reality land, gaming items and digital collectibles.

Ethereum has two main advantages against nation-state economies and their product offerings. First, Ethereum is permission-less and second, it has much more efficient technology compared to legacy banking systems. Instead of having humans involved in the settlement process; everything is automated. That being said, most governments and banks are currently transitioning to using blockchain technology similar to Ethereum, such as JP Morgan’s Quorum which is a permission based, slightly altered version of Ethereum. Therefore, as the technology nation-states use converges to be more efficient, it is the permission-less aspect that makes the Ethereum economy truly innovative.

Ethereum is an open financial system. This is an extremely powerful driver of innovation. No one can stop or censor anyone in the world with an Internet connection from developing services on Ethereum or accessing these services. An army of smart developers are working on building better financial services. Much like the Internet changed the way data flowed, Ethereum will change the way money works.

Early Traction

Right now, using Ethereum you can have a stable currency that tracks the dollar in value, spend or trade this currency, earn ~8% interest on it (this is unheard of in today’s economy), use the interest to participate in novel offerings, such as no-loss lotteries or donations to charities where your principle balance remains untouched. You will soon be able to gain investment exposure to literally anything from stocks to sports to political outcomes, all with very low fees. And the list of possibilities goes on and on.

We are now in 2020 and Ethereum is in its infancy. Developers are exploring network effects and user interfaces to interact with Ethereum products are continually innovating.

A major problem around adoption of Ethereum is the self-sovereign nature of the ecosystem and the management of private keys. Private keys are long passwords that access user funds and require technical expertise to properly store and use. However, new wallets are being created using advanced cryptographic techniques like multi-party computation (MPC) that make usability and ease of account recovery much simpler for the every day user.

Alongside improvements to the current Ethereum 1.x technologies, Ethereum 2.0 is launching soon and will completely revolutionize the space, allowing for enough throughput for Ethereum to become the de-facto global settlement layer for the world economy; as governments and banks migrate to Quorum and other blockchain technologies, Ethereum will be at the epicenter.

Network Effects

There are massive network effects in Ethereum; any innovation made by a single developer on Ethereum is accessible to all other developers. If a developer creates a protocol, such as an interest generating bank account, all other developers can use it in their application and no one can stop them. They do not have to ask them for permission. So every time a new innovation happens in Ethereum, it exponentially grows the ecosystem.

Photo from ETH Denver: https://twitter.com/TrustlessState/status/1228802403819872256/photo/3

No other platform besides Ethereum has these network effects and developer interest. Lots of venture capital firms poured money into Ethereum “attempted murderers”, which are similar platforms that are almost universally unnecessary. It will be some time before these projects go away as they have lots of funding, however, they are simply empty chains. All of them. Ethereum is the only platform with real traction to date.

Bullish on Ethereum

We have explored the reasons why developers are building on Ethereum and how the platform is primed for a massive wave of innovation, but how will this be reflected in the price?

There are 5 main drivers for the price of Ethereum to grow this coming decade. Each factor will drive price up by reducing supply or increasing demand.

1. Staking

Staking is the process of securing the Ethereum network by locking tokens and using them as collateral to provide good security for users. If a Staker acts in good faith, they are rewarded; otherwise, they are penalized through a mechanism known as slashing.

It is estimated that up to 30MM of the current ~110MM tokens will be locked and taken out of circulating supply due to Staking. Staking is currently expected to launch July 30, 2020, but could be delayed if security testing indicates additional changes are necessary.

Other chains, who also offer staking, have much more of their supply locked; for example, Tezos is at 77.65% of total supply staked as of today, but that higher amount is because there is little use for the Tezos token outside of speculation. As we will soon see, Ethereum is a robust ecosystem with a multitude of applications vying for Ether to be locked as collateral, reducing the available supply for staking.

2. End of Mining

The permanent removal of miners from the system in favor of staking will reduce new supply and will happen in the next year or two after staking is initially implemented. For a brief period both mining and staking will co-exist. Mining, popularized by Bitcoin, secures the blockchain network but generates new Ether as reward for miners. Currently, new mining rewards are estimated at 3.6% of Ether’s total supply annually.

Mining issuance is much higher than staking proposed structure and getting rid of it will dramatically reduce new supply. It is expected that by the time mining is stopped there will also be a mechanism to burn transaction fees to offset staking rewards and make total issuance of Ethereum negative, increasing scarcity.

3. Collateral for Applications

Many of the innovative applications on Ethereum require Ether locked as collateral to function properly. For example, MakerDAO is a project that creates a stable coin DAI that currently tracks the dollar. There are complex mechanisms for how that works, but Ether is the collateral backing the DAI; DAI is essentially stabilized, synthetic Ether. An alternate form of Ether that can be used as a reliable payment for goods and services. DAI has remained stable even when the value of Ether used as collateral collapsed from $1428 to $83; an impressively robust system.

Simply by growing their business and having more users purchase and lock Ether to create more stable coins, MakerDAO is reducing the supply of available Ether. There are many applications that rely on ETH / DAI and are competing for this scarce resource. As more projects launch, expect the demand for ETH to increase dramatically, while more and more of the supply is locked in these services.

defipulse.com -> value of ETH locked in applications over time

4. Gas Fees

Ether is used to pay for gas on the network. In 2019, Ethereum had an average of $95k in daily gas fees. As Ethereum 2.0 launches and throughput increases and more developers build on Ethereum, expect total gas paid to increase significantly, forcing users and / or companies to purchase Ether in order to access services.

5. Speculation

And last but not least, we have pure speculation, which is pervasive in all financial markets, especially high growth tech industries. As we have seen before in 2017, a bull market in crypto can lead to staggering price growth. What will happen next time when users have real products and protocols to use. Instead of investing in false promises, they can experience the power of an open financial system.

For further reading on Ethereum economics: Here are a few nice pieces that go into more details on that topic: ETH the Reserve Asset, Ether: a New Model for Money, and The Trillion Dollar Case for ETH.

Conclusion

10 years from now, millions of developers will have worked rigorously over the course of the 2020s to create a new, open financial system on Ethereum, displacing existing financial markets and exchanges and creating new products we can’t envision yet, just as Facebook, Amazon and Google were hard to fathom at the dawn of the Internet. And Ethereum will have use cases outside of finance as well, such as creating better voting systems, decentralized social networks, decentralized cloud computing, and the list goes on and on. Stay tuned. Exciting times ahead.

Not financial or tax advice. This article is strictly educational and is not investment advice or a solicitation to buy or sell any assets or to make any financial decisions. This article is not tax advice. Talk to your accountant. Do your own research.

About the Author

David Schwartz is a software engineer and graduate of U.C. Berkeley currently living in Los Angeles. David helps organize Ethereum meetup events in Los Angeles and co-runs the @EthereumLA twitter handle.

David works for Nash Exchange as a senior full stack developer. Nash is a cross-chain decentralized exchange that currently supports Ethereum, Neo, and will soon be adding support for Bitcoin. Nash is a regulatory compliant, high speed decentralized exchange, where users retain custody over funds at all times.

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