Ethereum Must Die (as a currency)



Global currency expectations


Sure fanboys say Eth is going to the moon. Get onboard people. But what does this actually mean? That Eth is an investment vehicle? That the new global penny is going to be a nano-gwei because the price of Eth is going to infinity-squared?


Ugh no. No, most emphatically no. So what exactly are Eth and the EVM really going to evolve to?


Well if you go back to the original whitepaper it is clear that the Ethereum and the EVM are designed to be a form of credit market to backstop trading and other activities in life and business. A decentralized means of tracking transactions, provenance, distinguishing features (identity, others) where trust is lacking. Nowhere is it stated to be a currency for transactions such as buying milk at the corner mom & pop. Even if that was a planned (hoped for!) part of the future, there are too many factors that make this unlikely. While transaction throughput continues to be an issue, as a standalone global currency, I rate its potential at practically nil. As a medium for currency exchange, perhaps it has a long-term future.


Cryptocurrencies challenge to sovereign monetary policy


Monetary policy most simply stated is the set of actions undertaken by a country’s central bank to control money supply and achieve sustainable economic growth. Make money more or less available to achieve more or less economic growth (with the odd emergency lending program thrown in the mix).


A global stateless currency that is used for transactions within a country’s borders (or without) is an illicit market economy of which monetary policy has little or no effect. This is wonderful if the naïve goal of cryptocurrencies is to stick it to the government that doesn’t know how to stop printing money. Ok, ask yourself how likely is it that all of the largest economies in the world are going to surrender their currency status as global reserve fund (or in the case of China – desired global reserve) currency? The chances of this are zero. As in zilch, ling. They can’t afford to let this happen. Seriously, they cannot afford to let this happen.


What can they do to prevent the rise of a global currency, well, they do have armies, air forces, and navies. More seriously (I hope) they can pass laws. They can create regulatory requirements such that any advantage of a cryptocurrency is negated or even more onerous than fiat. Is regulation coming? Well unfortunately crypto fans, it’s already here. Countries have already seen what Eth makes possible. Now expect them to co-opt the technology and regulate the hell out of stateless currencies.


Does the world need Ethereum?


The rise of central bank digital currencies (CBDCs) threatens to usurp some or all of the values that Ethereum presents. Theoretically, any type of network could be overlaid on a digital token. If that token is a global reserve currency or a basket of currencies (Libra --- > diem!), then it provides a stable enough environment to transact internationally. Heck, you could start your own network overlaid on the coming US CBDC. Korea is looking at an Ethereum-based technology for its CBDC. The Bank of Canada has suggested that it will be doing the same on its next round of testing CBDC on Ethereum-“BASED” technology. In other words, the tech is fine, but we are not going to have the global masses control the money supply.


Can Ethereum be used to wrap country currencies? Yes. Does it provide value doing so? Well yes, until electronic country currencies exist. After that, it becomes solely a reference for currency exchange rates. Is that enough of a value add to the global financial economy? I am uncertain but we can try to calculate the network costs.


As of August 2, 2021, approximately 5.4% of the total Ethereum in service has been staked with a value totalling nearly 16.6 billion USD.


The annual cost to the network, assuming a 5% rate of return for the stakers, is approximately 840 million USD/annum. For scale, this is about 30X less than the annual revenues of the VISA network (approximately 30 billion USD). About 12-15 times less than their annual operating profit. So we see the potential for cryptocurrencies to disintermediate the global payment networks. But the profits of VISA and Union Pay, do not threaten the monetary sovereignty of states. And by the way, VISA and Union Pay and their competitors see the potential too.


The question that must be asked is, does a network with 16 billion USD at risk, sufficiently provide enough value to support the layering of an added 840 million USD of costs annually? VISA alone has a market cap in excess of 500 billion USD and apparently, that is enough at risk to allow them to manage a global payment network with a certain amount of trust (and profit!). But the VISA market does not support the global inter-banking market where transaction volumes are lower but values are substantially higher. Therefore the stakes are substantially higher. Transaction throughput volume is less an issue in the latter, but transaction timing and certainty are important.


Does that mean the value of the Ethereum staking network must get to 500 billion USD to ensure global confidence? Before we Ethereum holders rub our hands with glee, a 5% rate of return of 500 billion USD is 25 billion USD per annum. Hmmmmm 30 billion USD VISA revenues….…. Does that mean we earn less on our investment once Ethereum appreciates to this potential value? Do we care if we bought in at 500 or 2500 $/Eth? But if the investment is no longer paying a rate of return more than some small risk-free or almost risk-free amount, then who is likely to hold onto such an asset?


Institutions.


Possible paths forward for Ethereum


There are multiple potential paths forward for Ethereum.


Path 1:


Victory for the decentralized network and demise of the sovereign-backed/controlled currencies (not betting on this one….). Political economies will struggle mightily to surrender monetary tools such as their sovereign currency, their taxation policy and their regulatory policy. An independent global currency completely undercuts all of these tools. Which, in a sense, is maybe what was partially intended by Satoshi (naively or optimistically) back in the day. Never going to happen. Expect the power of the state in passing laws to forever prevent this from happening - even if it might be an admirable dream. There is never going to be enough wishing this to come true that will make it come true.


Path 2:


The collapse of Ethereum as a medium of exchange. I think this is unlikely. Ethereum will hold some value as long as its promise of utility is fulfilled. But it won’t underpin the global economy. Even DeFi products will struggle to survive if they pose a threat to underlying capital and currency markets. Unregulated products that undermine the global currency and other asset markets will not happen. Think of the sideswipe the world economy with the packaged financial products primarily in the US subprime markets. People will always take risks and cryptocurrencies provide an excellent medium to develop exotic derivative products.


Path 3:


Eth becomes a form of collateralized, decentralized service backing exchanges amongst parties lacking trust. This would be a system for tracking provenance, maybe identity, not much else.


Path 4:


Eth becomes a middleware service for global inter-banking using Eth as a form of collateral (my bet). Indeed JP Morgan is already testing this with their own Ethereum-Based (NOTE ETHEREUM-BASED, NOT ETHEREUM!!) network for the inter-banking repo market.


Path5:


Imagine……..

Everything in between and beyond the subset above. This one is a cop-out but I have to include it.


My view of the likely path forward


I believe that Ethereum will maintain its first-mover advantage for a period of time and that it may become the de facto blockchain upon which asset tracking systems are built. DeFi systems may be overlaid but they will succumb to regulation. Coincident with regulation will be central bank digital currencies. What advantage will Eth maintain over them?

Will Ethereum be a global currency used in day-to-day transactions? No, because CBDCs will fulfill this role. The coming creation of CBDCs will prove the most existential threat to all current cryptocurrencies. This is because once all currencies are digital, the need for the current systems/cryptocurrencies will be significantly reduced, potentially to irrelevancy.


Ethereum may remain relevant as a measure of creditworthiness amongst the system operators of the EVM. In such a system, Eth may hold or expand its current unit value but always measured against the value of state-backed currencies. The question is, will the users of this system value it enough to continue using it, or will they choose a new solution? Will a major credit event or other event undermine the security of the current system?


The Ethereum system itself is an immensely powerful technology, but I don’t see global inter-banking operations adopting a blockchain technology underpinned by 30,000 home stakers, even if they do have excellent LED simulating neon dragons lighting up their CPU towers. Consolidation of Ethereum holdings from smaller Ethereum holders could happen. But in this case, why buy the milk when you can design/build your own cow? With an open-source technology (not fully-formed mind you), the question one must ask is consolidation even necessary or will the network eventually become tightly controlled by global banking interests – essentially a private blockchain amongst favoured parties with a certain amount of trust? Perhaps in the short term holders of Ethereum will realize even more staggering gains over those already witnessed in its short life. Put another way, large inter-global banking entities have two choices. (1) Adopt the current network by acquiring Ethereum from small investors wishing to cash out – i.e. consolidation of Ethereum holdings to large already creditworthy entities, or (2) create their own Ethereum-based network for less cost than acquiring/consolidating current holdings from existing Ethereum holders. And if it is the latter, when does a current Ethereum holder like you cash out – how much runway is left?


With EIP 1559 it seems that the Ethereum Foundation has realized that the path to global currency is improbable if not impossible and therefore its path forward begins to resemble that of BITCOIN – a deflationary asset that provides a store of value - exactly what is necessary for an interbank market-based form of credit. This, in the short to medium term, will extend the value runway for Ethereum.


Almost coincident with EIP 1559, the US Congress, however, started down the inevitable road to folding crypto-currencies into the regulated world. The threat of stateless currencies to the current financial system is too great to ignore. With the advancement of CBDCs, Ethereum is about to find itself surrounded by state-backed competitors. The technology and network will now need to fight to prove its value proposition.




Thanks for subscribing