Category: Crypto

The bull case for Ethereum

As I’m getting frequent questions from my ‘non-crypto’ friends re: why I like crypto and ETH in particular, here is my take as it stands today (March 2022).

TLDR version

  • The coming POS upgrade will enable large institutions to invest as the Proof of Work / ESG complication is removed.
  • The supply of ETH will drop in June from 12,000 ETH per year to 1,200 ETH per year which will all go to the holders of ETH.
  • Staking rewards will rise from the current 5% pa to 10-15% pa
  • ETH is growing like a rocket, with usage up 10x just in 2021
  • Companies like Consensys will hold ETH on their balance sheet
  • In the aftermath of Canadian truckers and Russian sanctions, the importance of de-centralization will increase, working against ETH challengers like SOL, FTM, Terra etc.

Background

Ethereum is the first ‘programmable blockchain’ with the whitepaper written by Vitalik Buterin in 2014, and the blockchain was launched in 2015. The genesis block was mined, so Ethereum today is a Proof of Work (PoW) blockchain. 

Ethereum use cases

Ethereum enables a vast array of ‘decentralized applications’ or ‘dapps’ to be launched on top of it. The dapps are essentially smart contracts (programs) that run on Ethereum, and fees denominated in Ether (the native Ethereum currency) are paid (currently to PoW miners) to record the transactions on the Ethereum blockchain.

Dapps cover a wide array of use cases:

Decentralized Finance / DeFi – where the dapps today provide almost all of the services you can find in traditional finance (trad fi) – such as lending, staking, trading, options, etc. Yields on crypto assets in DeFi can often be very lucrative, with ‘stablecoins’ (e.g USDC – that is US Dollars on a Ethereum) you can earn yields of 8% to 19% p.a. with no fluctuating crypto prices. What is the interest you are getting in your current bank account?

The most popular DeFi dapps include Uniswap, Sushiswap, MakerDao etc. Just to be crystal clear here these are all autonomous programs that “live” on the Ethereum chain, and carry out all those functions with no human intervention. This is why banks are worried about ‘disintermediation’ from DeFi- meaning that banks would be put out of business.

NFTs – or NonFungible Tokens enable creators or communities to prove digital ownership of an asset, membership or status. The use cases range from:

  • Music – e.g. music artists being able to offer their fans different levels of interaction – where die-hard fans could buy access to a VIP lounge after a concert, or access to a discord channel with early releases of the artists more experimental music. This enables a ‘tiered pricing model’ which is much more favorable for the artists and fans.
  • Sports – sites like NBA Top shots allow fans to collect, share & trade ‘moments’ of their favorite stars (like digital trading cards).
  • Community via POAPs – Proof of Attendance Protocols enable you to show on your profile attendance to physical events, making it easier to connect with likeminded people.
  • On-chain ownership: eventually the ownership of your house or your car will be an NFT that you hold in your digital wallet. You will be able to borrow from your house (home equity loan), rent out your car for a weekend (like Turo) or even create an NFT out of the blog post or video you created.

Gaming – the fundamental shift of being able to own the artifacts, loot in the games give players a stake, a reward that was not possible before. Then being able to trade those artifacts for ‘money’ has given rise to the ‘play to earn’ phenomenon – shown eg by Axie Infinity. Granted there is pushback in the gaming community against cheap monetization, so as always the formats will be iterated on.

DAO’s – decentralized autonomous organizations are new ways for communities to organize themselves, and distribute decision making to the community. Quoting from the Bankless DAO article:

“What sets DAOs apart from all previous organizational forms is their flat, decentralized structures and absence of central planning. DAOs share a treasury and raise equity capital through the issuance of their own token, attracting anonymous investors and workers who believe in its mission.

The transparent nature of the blockchain means that all organization’s activities are managed on-chain and anyone can audit its smart contract codes, giving both investors and workers greater transparency into the inner workings of the organization.”

Bankless, Ryan Sean Adams

IMO DAOs are at the earliest stage as they have the promise of re-organizing how we work, how we form communities, how we deliver public goods (see GitCoin), how we do politics (see Andrew Yang on Lobby3).

Move from Proof of Work to Proof of Stake

Ethereum will move to from the current Proof of Work consensus mechanism to “Proof of Stake” within the next 3 months in a process called the ‘Merge”. This will bring the following benefits:

  • Energy consumption to secure the chain will drop around 99.8%. Instead the chain is secured by having ‘node validators’ stake their ETH (in a smart contract). 
  • The cost of attacking the network will increase, and enable further de-centralization down the road.
  • In POS – for every new transaction validators can be called randomly to validate whether a particular transaction is ‘valid’ or ‘fraudulent’. If a malicious actor were to send in fraudulent transactions and your node were to validate the transactions as ‘valid’ – the Eth staked on that node would be ‘burned’ (rendered useless). Instead the nodes which validate transactions correctly are rewarded in ETH – currently on the order of around 5% per annum.

Ethereum Scaling 

TLDR on scaling: Combined the POS / Layer 2 and Sharding solutions could take Ethereum from the current 15 tps (transactions per second) to 100k tps.

Scaling Ethereum will happen mainly via so called ‘zero knowledge’ roll-ups, or Layer 2 solutions. There are multiple Layer 2 solutions that are built today – but not yet in wide-spread use which enable faster, cheaper transactions.

Different variations exist such as:

  • Side chains like Polygon or Gnosis chain
  • ZK-roll-ups – such as ZkSync or Starkware enable batching of transactions so that the cost /speed of execution can be reduced by 100x or so. The key is that the code is ‘EVM / Ethereum Virtual Machine’ compatible so it can be deployed very quickly / instantly by a ‘dapp’. If the Dapp has been developed for Ethereum, it would in many cases work ‘out of the box’ with the Zk roll-up as well.
  • Optimistic Roll-ups such as Arbitrum, Optimism, Metis – bundle transactions as well, and reduce transaction fees by about 50x-100x as well. They have been in use for about one year, but are still experimental. The optimistic roll-ups “optimistically” assume that all transactions are valid during processing, but only validate each transaction later on. This means that it takes up to 7 days to move your funds off an Optimistic Roll-up.

On-chain scaling of the Ethereum main-net will happen via a process called Sharding, which splits the main-net into 64 different ‘shards’ to spread the load. This will happen sometime after the “Merge” – I’m not going to venture a date here… :-).

Ethereum valuation

With staking earning ETH holders ‘dividends’ – Ethereum can be evaluated using business valuation methods. Taking into consideration Ethereum’s growth rate in the past few years and the growing network revenue that will accrue to ETH holders – analysts have estimated ETH to be valued:

And yes there are risks to these investment theses – competitors such as Solana, Polkadot, Terra, there are geopolitical issues, technical unknowns, malicious actors etc so DYOR. (***This is not investment advice***)

The recap

IMO Ethereum is setup for multiple events that I do not think ‘the market’ has fully priced in, such as:

  • The coming POS upgrade will enable large institutions to invest as the Proof of Work / ESG complication is removed.
  • The supply of ETH will drop in June from 12,000 ETH per year to 1,200 ETH per year which will all go to the holders of ETH.
  • Staking rewards will rise from the current 5% pa to 10-15% pa
  • ETH is growing like a rocket, with usage up 10x just in 2021
  • Companies like Consensys will hold ETH on their balance sheet
  • In the aftermath of Canadian truckers and Russian sanctions, the importance of de-centralization will increase, working against ETH challengers like SOL, FTM, Terra etc.

Thanks for reading,

Oskar

Future of money in 2022 and beyond

Reading the very good series and predictions about the future of money on Coindesk inspired me to put some of my own reflections down.

These points are drawn from sources like Balaji Srinivasan (here and here), Raoul Pal (here), Robert Breedlove (here), Alex Gladstein (here ) and many others.

If you peruse those talks and videos you will notice that a lot of them are about history, as in order to understand the present you have to understand your history. In order to predict the future, you have to understand the present. Underlying themes driving these predictions include A) Demographics, eg Fourth Turning B) Things can stay the same much longer than what any of us expect (see Japan) and C) Software is eating the world (ref Marc Andreessen).

There will be a monetary battle, a test of wills, between the following forces – Authoritarian capital (Eg China), Western Fiat (Fed, ECB) and Crypto capital. The Authoritarian capital requires the citizens to Submit as it is the Legal authority. Fiat capital / central banks claim to know what is best for the citizens, and the message is ‘sympathize’ so the CBs will spend greatly in order to keep the current house of cards going. Crypto capital is wild, volatile and offers get rich schemes interwoven with real world utility.

Fiat money central banks will, due to the economics of the fiat system, need to continue their QE infinity, but they will mask the fact that the system is broken in a language of social spending, of taking care of the inequalities in society. My prediction is that we will have some type of UBI (Universal Basic Income) or monthly Tax Credit scheme in most western countries within 5 years.

Unfortunately this will lead to further asset price inflation (as it has for the past 20 years) and secondarily to commodity and wage price inflation, so the main effect will be that asset prices (stocks, houses) continue to compound at 10-15% per year in fiat money terms, but measured against M2 money supply staying flat. Houses will cost double from now in 5 years and equities will have doubled as well, and we will still wonder who the hell buys any at those nose-bleed levels. The answer is TINA – There Is No Alternative.

The UBI / Social spending will be carried out via CBDC – Central Bank Digital Currencies that can be spent via your phone / device, as this will be cheaper for merchants than credit cards. Government can track the spending in real-time, can tax your income and purchases (via VAT) in real-time and merchants can provide discounts in real time based on your location, purchase history, memberships etc. Consumers will as usual have chosen convenience over privacy.

There will be some wage pressure due to the “Great Resignation” as especially Baby Boomers are feeling better about their finances while uncertain about their health, meaning there will be fewer job applicants for many open positions. My prediction is that wage inflation will outpace government CPIs (CPIs say 3-4% annually, wages 4-5%) while both will lag asset price inflation. But since asset price inflation ‘doesn’t really count’, government economists will still be wondering why the rich get richer and the poor get poorer. How much actually in ‘real terms’ will be spent to equalize the income/wealth divides will still depend on election results and politics.

Today (Dec 12th, 2021) the combined market size of Crypto is around 2.3 Trillion, Global Equities are around 120 Trillion, Global Government, Household and Corporate Debt around 300 Trillion, and Global Real Estate around 330 Trillion, so we can call the ‘real world’ financial markets a nice round 750 Trillion.

The ‘Defi Matrix’ will be the Crypto markets ‘eating the financial’ world in the 2020s.

In the words of Balaji Srinivasan :

The DeFi matrix may be to the 2020s what the social graph was to the 2010s. Once every asset can be represented in a digital wallet – bitcoin and ethereum, yes, but also CBDCs , stocks, loans, bonds, etc. – all these billions of assets will trade against each other every second of every day around the world.

This is not inevitable because I love crypto, and blockchains will create some utopian society ruled by empathy, code and crypto bros / babes. This is because I think most main-stream thinkers, politicians, businesspeople etc severely underestimate the power of:

A) how blockchains can enable Trust, an objective Truth to flourish in business and personal transactions. This is because Blockchains are a revolution in Accounting – Triple Entry Accounting (Debit, Credit, Public). Imagine for example every invoice sent, on a chain where the payer / payee can instantaneously verify its status, pay the invoice, confirm receipt and dispute it if needed.

B) Linux systems today run about 50% of the worlds webservers, and Linux is about 99% built on free labor, open source. Now imagine a similar system except that the people building the system can be rewarded in the token of the system, they gain as the token appreciates in value and the gain in the token allows creation of more utility, which brings more users, more value – creating a virtuous cycle. * How some-one like Charlie Munger who’s a student of human incentives can not see the benefits in this is beyond me..

C) The utility and financial rewards available in the Crypto / Defi markets will slowly drain away capital and resources from the TradFi world, and while the market size, number of participants in Crypto increases, the volatility and insane rewards fade away slowly.

So in the end some of the value in the 750 Trillion real world value will accrue to the Crypto layer, but obviously not all of it (as the real utility will still be in the actual houses, companies, factories etc). Raoul Pal has thrown around a number of 200 Trillion for Crypto markets, I’d be more ‘cautious’ with guesstimate of a nice 10x (25T-30T) in about 5 years time.

These predictions are basically based on a continuation of ‘more of the same’ as today, and could be upended of course if there were severe financial / monetary system crashes, wars etc. I hope not.. That’s all I got for now, any comments / feedback is always welcome.

Thanks for reading,

Oskar

Review of “the Bitcoin Standard”

The book “the Bitcoin Standard” by Saifedean Ammous was really influential in convincing me there is value in Bitcoin. Money is a complex, emotionally laden topic, with a rich history, and this book definitively deserves a read. Here is a summary of the 10 key points from my perspective.

#1 Money is a concept


Any value in a currency is an agreement between humans that there actually IS value there. I.e. no chimpanzee will agree there is value in the USD, Yuan, gold, seashells etc. Money – starting out as a medium of exchange – is a concept, such as the nation state or a company and does not ‘exist’ in the physical world.

#2 – Money Transfers Value over Time and Space

For ‘money’ the value primarily exists due to its salability – to transfer Value over Time and Space. In a free market humans have over time selected gold over millennia to be used as money, mainly due to criteria – such as being scarce, it’s divisible, it’s recognizable, other humans agree there is value there and you can’t easily find/create more of it – i.e. it has a high ‘stock to flow’ ratio. (stock to flow ratio means how much exists ‘in stock’ – eg above ground gold – compared to how much new flow – eg gold can be dug up – annually). The high stock to flow ratio is key as it means that the money can’t be inflated by market actors.

#3 – Money is a Network

Currency / money is a network between humans, and desirable qualities of money resemble those of gold. However should a better money emerge (say Bitcoin), in a free market humans would choose the money which best fulfills the criteria of money (ie that Best transfer Value over Time and Space). We have learned the hard way in some countries like Venezuela, Argentina what happens if Money doesn’t transfer Value over time.

#4 Bitcoin is open source Money


The number of Bitcoin is set algorithmically –there will be 21M bitcoins by 2140, the stock to flow ratio of Bitcoin will in 2025 be lower than that of gold, and the flow will be halved every four years.

It is also a remarkable innovation in terms of solving in code the ‘Byzantine Generals Problem’, that is how to co-ordinate distributed forces (think nodes) where some nodes might be traitors or corrupt. This solution establishes a consensus in the network about which transactions are legitimate, so it resolves the double-spending problem.

That is “Bitcoin can be best understood as distributed software that allows for transfer of value using a currency protected from unexpected inflation without relying on third parties”.

#5 Bitcoin network value

You can track the number of humans who agree there is Value in Bitcoin by tracking different metrics – eg market cap, number of wallets, hash rate, price etc. As more people consider it a store of value, that is the price grows higher, it also incentivizes more miners to secure the network – which in turn makes the network safer.

The value in Bitcoin is there due to network effects, and there are real switching costs involved- eg a fork won’t do any good. It’s the difference between an open source library that is copied, waiting to be executed, and a Live network that is running with transactions, users, data etc.

#6 Money printer go “Brrr”


Recent actions by central banks to print money – eg 5 Trillion in the US in response to the Covid pandemic – alter the perception humans have of their national currencies, and as central banks are inflating the supply, they are increasing the flow compared to the stock, and eroding the value in the currency.

While most of the world trusts markets for the pricing, allocation of capital goods – nonetheless there is a central planning board in every country of the world for the most important market – the market of capital.

#7 – Keynesian economics

JM Keynes was an influential economist in the 1930s who has influenced governments around the world that in a recession, governments should ‘stimulate’ the economy to make up for the slack from the private sector. Keynesian economics are the mainstream economics that are taught in Economics schools, opposed to classical/Austrian economics, with one of the main tenets of Keynesianism being that inflation is good, and should be ‘managed’ to about 2% per year. What is then not often mentioned is that the money in your wallet declines by 2% per year.

Ammous points out the example of the ‘depression that never happened’ – in 1921, where the government did not take ANY action, wages initially dropped 10%, but within 9 months the economy was strongly growing again leading to the ‘roaring 1920s’.

This is in opposition to the Depression in 1933 where the government froze wages, stimulated with public works programs and by confiscating US gold reserves, and eventually devalued the dollar 70% from $20/oz of gold to $35/oz.

#8 – A deflationary currency leads to lower time-preferences

An individual with a low time preference chooses to defer gratification, and work on items where the pay-off is further out in the future. We know from psychology this is good for individuals, and economics tells as investment in the future is beneficial. Therefore a money that is deflationary, that retains or increases in value, should be preferred by society and individuals alike.

However the opposite is taught today as beneficial – more consumer spending to satisfy cravings, wants, and less saving is good. Less capital therefore available for investment and growth, and pressure on companies to perform in the short term.

#9 – Bitcoin as a concept is many things

A concept has the ability to be multiple things at the same time – that is Bitcoin was initially planned to be a digital currency to be used for day to day purchases, however at the moment due to the price volatility and transaction speeds it is not feasible for that at the moment. There are eg second layer solutions (eg Lightning network or Strike ) that are working to resolve the issues. Taxation issues would have to be resolved as well.

#10 – Bitcoin as an option / hedge

Currently Bitcoin can more appropriately be thought of as

  • an option (hedge) towards central banks eroding the value in national currencies
  • an option on a true global money
  • a volatile investment with a lot of possible upside
  • but also a chance of going to zero.

If you’ve made it this far – I will again recommend you check out this book – “the Bitcoin Standard” by Saifedean Ammous. It can change how you think about money, as it did for me.

Thanks for reading,

Oskar