Ethereum Fantasia: A New Model for Ether's Currency

Editor's Note: This article comes fromBlue Fox Notes (ID: lanhubiji)Editor's Note: This article comes from

Blue Fox Notes (ID: lanhubiji)

, Author: David Hoffman, Compiler: LHR, reprinted with authorization by Odaily.

Preface: Many people say that the public chain is cool. But in fact, in the entire blockchain field, except for centralized stablecoins, in terms of potential, there are very few projects that have the opportunity to surpass Bitcoin, and the public chain is one of the very few candidates. The reason is the possibility of public chains in open finance, including lending, exchanges, futures, synthetic assets and many other scenarios. This field has just begun. If the public chain can make a breakthrough in DeFi in the next two to three years, then it will be overwhelming. If the public chain cannot make progress in open finance and continues to be in a small-scale state, it will be more difficult for the public chain to rise at this time, unless new growth points are found. The next two to three years will be the key to whether the public chain and the blockchain can break through. This article "David Hoffman", translated by "LHR" of the "Blue Fox Notes" community.

This article explores the role of Ether as an asset in Ethereum. This article uses data from the Ethereum economy over the past two years and proposes a new definition for understanding Ether, which is an asset: permissionless bandwidth within Ethereum.

This article is divided into two parts:

Ethereum is the basis for building an alternative Internet financial system. This financial system has the ability to be completely open and trustless. This new financial system needs a native currency to function. In this new context, financial applications require a form of trustless collateral to function, and the only truly trustless asset on Ethereum is Ether.

• As a result of this need, Ether has become an economic trifecta; a "triple point" asset that fulfills all the requirements of the new economy at once. Thus, Ether becomes the best currency model that can be proposed in this world. (Blue Fox Notes: Triple point, triple point in English, means that in thermodynamics, three states of a substance, a value of temperature and pressure when solid, liquid and gas exist at the same time. This value is the three-phase point.)

• ETH2.0 has enabled ETH pledge

EIP-1559 has been implemented, it will consume ETH in transactions

Part 1: Defining Ethereum

Before defining Ether, we need to define Ethereum. Ether will be defined by how Ethereum is used. Defining Ethereum is also not easy. Trying to define Ethereum now is a bit like defining the Internet in the 1980s: no one knows exactly what will happen in the future. The coolest thing about open source technology is that uses and applications of the technology continue to evolve and emerge as communities build and discover its use cases.

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• Application Defined Internet

• If you Google how to define the Internet, you will get answers like this:

• global computer network

• Provide various information and communication facilities

Composed of interconnected networks

Just personally, I don't find this definition helpful. Technically it's correct, but it's a definition made for the sake of technology. If you ask, "What about the Internet?" or "How does the Internet affect people?", we need to look at what we spend 99% of the time on the Internet. At this point we thought of:

The Internet is a stack of different technologies, and the top layer is the application. Although the "Internet" cannot exist without any part of these stacks, it is the application layer of the Internet that defines how the Internet meaningfully impacts our lives. All layers below the application layer are means to an end: delivering products and services to people.

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Missing Layer: Value

The innovation behind the Internet was to make data cheap, accessible, and infinitely replicable. This innovation opens up a world of abundant and cheap information, and humans are better off for it. However, cheap, available, and replicable are the opposite of money and value. By definition, money and value are scarce, expensive, and difficult to obtain.

When Bitcoin solves the Internet's double-spending problem, it achieves scarcity on the Internet. For the first time in human history, when you send something on the Internet, you can no longer keep it for yourself. But, with Bitcoin, it's only true when you're sending it; the Bitcoin protocol only provides scarcity to Bitcoin, and nothing else.

This is where Ethereum comes in: a platform that provides digital scarcity for any digital asset. Ethereum does not only provide digital scarcity to its native currency.

The official website of Ethereum currently defines Ethereum as follows:

• Ethereum is the global, open-source platform for decentralized applications.

• On Ethereum, you can write code that controls digital value, runs exactly as programmed, and is accessible from anywhere in the world.

On Ethereum, you can write code that controls digital value, runs exactly as programmed, and is accessible from anywhere in the world.

Applications on the Internet define what the Internet is. Similarly, applications on Ethereum define what Ethereum is.

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Ethereum's application layer

The innovation of Ethereum is that it establishes a new application layer on the Internet. The Internet of Web2.0 is an Internet of centralized databases and centralized data. Facebook, Google, Amazon, and their products represent large applications of Web 2.0.

Ethereum offers an alternative. A new layer, the value layer, which allows for new applications. Although the Web 2.0 Internet is saturated and controlled by giants, Web 3.0 can provide a broad potential value application space.

Financial applications built on Ethereum have begun to dominate the application field. Under the leadership of MakerDAO, DAI has built permissionless stability, and Ethereum's permissionless financial network has exploded. Open finance on Ethereum has begun, which locks Ethereum as a global value settlement platform. What started as open finance in 2018 as a curiosity has evolved into what may be the main purpose of Ethereum: a permissionless network of financial applications and services.

The open financial field of Ethereum was conceived in its Internet of Value. Each application can be combined with other applications, resulting in an endless sequence of transactions between each application. However, Ethereum is not a flat field. Financial systems and economies are inherently layered, and Ethereum is no exception.

Money is always at the bottom of every financial system. Gold is a great permissionless store of value currency, but it's heavy, tangible, and easy to capture. 90% of the world's gold supply is stored by central banks, and the financial products and services under these central banks have all been downgraded to legal tender. Due to the capture nature of gold, each financial layer below the Fed must obtain permission from the layer above, because these layers hold the currency above.

This very promisingly illustrates a permissionless, programmable store-of-value currency at the bottom of a new alternative financial stack. Gold is permissionless, and so is Bitcoin. However, if the systems that exploit the value of these assets are not themselves permissionless, then, over time, they can capture that asset and generate permissioned systems, which creates rent-seeking.

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• stitch it together

• If you believe the description of Ethereum so far, here is my definition:

• The global settlement layer of digital assets native to the Internet.

The field of permissionless financial applications, together supporting a permissionless economy.

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Ether is a difficult asset to define. The maximum flexibility provided by a Turing-complete blockchain (Ethereum) means that Ether can literally do anything. This makes it difficult to define it within the context of other asset classes.

In order to define Ether as an asset, we need to understand what an asset class is.

Define asset classes

Robert Greer proposed in his 1997 paper "What Are Asset Classes?" Chris Ponisk popularized it in the crypto space. The paper proposes three asset superclasses:

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• capital assets

• productive assets

Generating value/money/cash flow

Examples include stocks, bonds, leasehold properties, taxi licences. In some way, the asset generates cash flow for its owner.

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• Convertible/Expendable Assets

• You can consume/destroy it - single use

its consumption produces economic benefits

Examples include gold, oil, commodities (wheat, coffee), and energy. Assets of this type are often used in industry to produce some economically favorable outcome. Consider the gold plating in an electronic device, the gasoline in a car, or the coffee beans in a coffee machine.

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• unable to consume

• scarcity

Value persists across time/space

scarcity

Such as gold, currency, real estate, art, bitcoin.

When we talk about "currency premium", we are really talking about SoV assets. You may have noticed that some assets fall into more than one category. Real estate is a great SoV, and you can also rent them out for cash flow.

Likewise, gold is an important part of industrial products due to its ability to carry electrical signals and resist decay. At the same time, it is also the most valuable SoV asset of mankind so far.

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Ether: All three asset types

Ether fits perfectly into the three asset types. Depending on the context, Ether can operate as any of the three aforementioned asset classes, or even as all three types of assets simultaneously.

• Ether is a capital asset.

• In capital asset form, Ether is:

• Recourse to Ethereum fees (Blue Fox Notes: Staking can capture the value of fees)

The right to work for Ethereum (Blue Fox Notes: Staking can obtain mining rights)

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The Ethereum network is a decentralized institution. The Ethereum network provides products and services for its value network, and it tries to expand its network, grow its users, and capture more value.

On top of it, the better products and services are created (MakerDAO, Compound, dYdX, Augur), the more users will use Ethereum. The users of Ethereum are both the applications built on it and the users who use them.

Recourse for Ethereum Fees

To keep the network running, Ethereum must pay miners. These miners come in the form of validators who ensure that all users operate in accordance with Ethereum’s terms of service, such as following the rules of the EVM and not double-spending. These fees pay miners for their work and also act as a wall to protect Ethereum. The height of the protective wall is highly related to the total cost incurred by the network. The height of the wall is the cost of attacking Ethereum.

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The right to work on Ethereum

Owning Ether is the right to work for Ethereum, and you can charge fees. Ether is the mechanism that ensures incentive alignment between the Ethereum network and its miners. All miners must own ETH to earn the right to work for Ethereum.

If you want to be an employee of the Ethereum network and get paid for your services, you must own ETH to ensure your interests are aligned with the network.

These are all components that make Ether a capital asset. When staked, ETH is a productive asset for its owner. Staking Ether generates more assets for the owner and does work for Ethereum.

The current specification of ETH2.0 has a dynamic release plan. When the amount of ETH pledged is small, ETH stakers will get more income. This will incentivize more ETH holders to come in and pledge, work for Ethereum, and provide security.

Ethereum tends to reward everyone less when more ETH is staked, because more overall security is provided, so further security is no longer necessary.

However, this is not the only source of income for ETH stakers. The above returns are only rewards for newly issued ETH. ETH stakers also receive a portion of transaction fees paid to the network.

Below is Ethereum’s ranking of paying customers (September 18). Fees collected are added on top of network issuance and are paid to Ethereum miners.

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Ether is a consumable/convertible asset

Consumable/convertible assets come in many forms. The most obvious asset of this type is not one specific asset itself, but multiple assets that produce this thing. That stuff is energy.

Energy is a consumable asset that we all convert into various things we need. Energy turns raw earth ore into the steel of tall buildings and the frames of cars. Energy allows people to take elevators to offices, and allows people to interact and do business through computers/mobile phones. Energy is what moves goods and creates commerce around the world. Energy is also the energy in the oven that turns raw food into edible meals.

Energy makes the world go round. Without energy, we cannot convert useless things into useful ones. Demand for an energy matrix gives oil global value, why are electric cars a hot topic, and why are batteries so expensive?

Energy is the economic substrate that powers the world economy.

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Ether is the economic substrate of the Internet

• The original definition of Ether is "Ethereum's gas", which is a good illustration of this point. Ether consumption is the cost of turning the economic wheels within Ethereum. Ether is consumed whenever any activity is completed.

• transfer assets

• Trading

• generate loans

• Trading

Start DAOs

Ether will be consumed.

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Ether is a store of value asset

If you’ve ever paid attention to the “ETH locked in DeFi” metric, you’ll have noticed that Ether is a store-of-value asset. "Locked" means it's being used as collateral for something. If it doesn't promise to serve as value backing some protocol/contract/asset on Ethereum, it isn't "locked".

If Ether was not permissionless, or if these open finance applications on Ethereum were based on permissioned collateral, such as centralized stablecoins, tokenized gold, then they would not be completely permissionless systems. We must trust the centralized institutions that issue on-chain assets, that their off-chain assets are legitimate assets, and that they will respect all redeemability.

Thankfully, Ether is permissionless. Therefore, if we use Ether as collateral inside DeFi/Open Finance, we don't have to worry about the above problems.

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Ethereum's first dApp: MakerDAO

Not first in time, but first in running order

MakerDAO is critical to the development of open finance on Ethereum. Stability is important to finance, and without a stable reference point to Ether, many financial applications on Ethereum cannot function. Compound, dYdX, and Set all require stablecoins in order for their applications to function properly.

DAI is the only native stablecoin based on Ethereum, which is realized through the native support of Ether, a trustless asset on Ethereum.

DAI achieves its value through Ether's value storage function, and realizes its permissionlessness through its over-collateralization.

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Permissionless Stability Enables Permissionless Finance

If all DeFi runs on USDC, then we will only have to trust Circle to manage our funds. DAI is the only stablecoin that cannot be removed, revoked, and destroyed from a user's wallet by a central authority.

This is why open finance applications can be guaranteed when they use DAI to build their applications: if DAI runs on their applications, then, no central authority can destroy their applications or assets.

A new currency for a new economy

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Compound

All of this is based on the fact that Ether is a permissionless, programmable store of value asset.

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Compound Finance is a lending application on Ethereum. It is a financial primitive and an important building block on the Ethereum financial stack.

Compound brings together borrowers and lenders and matches supply and demand with variable interest rates. This will generate a DAI borrow rate and a DAI lend rate, or the cost of borrowing DAI and the interest earned on lending DAI.

Because of this collateral, Compound is trustless.

Staking makes Compound a permissionless platform. Borrowers must over-collateralize their loans so that lenders always have money to withdraw from the bank, i.e. no trust required.

The figure below has two lines. The red line represents the total value of all collateral locked in Compound, denominated in ETH. The purple line is the total amount of ETH locked as collateral. The difference between ETH locked and total value locked is that a bunch of REP is also used as collateral.

• The vast majority of collateral in Compound is Ether. Borrowers lock up ETH as collateral for their loans. In this case, Ether is being used as collateral for permissionless loans on SoV assets that the market believes will hold their value for a certain period of time. This permissionless collateral powers Compound’s borrowers, as the Compound application ensures overcollateralized, self-liquidating borrowers’ collateral. Lenders don’t have to trust borrowers: Compound apps remove trust from the equation.

• Using Ether as a store of value

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dYdX

Use Ether's programmability to ensure trustless lending/borrowing

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dYdX is a platform for margin trading, lending, and borrowing. dYdX runs smart contracts on Ethereum and allows users to transact without intermediaries.

dYdX provides users with the ability to borrow or trade on margin by requiring store-of-value collateral. In theory, collateral can be various assets, and dYdX can use USDC as collateral. However, as can be seen from the chart below, the majority of collateral on dYdX is still Ether.

You will see that 94% of the demand on dYdX is Ether or DAI. Remember, DAI is just a token that represents collateralized Ether.

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Uniswap

Ether as a store of value makes dYdX permissionless and trustless.

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In the Uniswap V1 version, all token pair transactions are carried out with Ether, which is the store of value. Ether’s role as SoV makes it an excellent collateral for all token pair transactions.

In the V2 version of Uniswap, probably by the end of 2019, Uniswap will support trading pairs of any token to any other token, and I believe the second most commonly used collateral is DAI, a stable form of Ether.

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Ether is the store of value for open finance

Ten years after the birth of the blockchain, only one use case for the blockchain has been discovered: permissionless value management across the Internet.

Open finance is the new fertile ground for new financial institutions. In the world of open finance, institutions are autonomous, human-free contracts on Ethereum. And, what we’ve seen so far from DeFi is that they use Ether as the underlying store-of-value asset for their applications.

It's all ETH!

Open Finance applications remain completely permissionless with Ether and DAI. If Open Finance leverages off-chain trusted assets, then, together with trusted assets, they become hybrid Open Finance applications.

It doesn't matter! But it's not as cool as fully trustless and permissionless applications that leverage trustless ETH and DAI.

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• Ether: triple point asset

• Depending on the context, Ether acts as any of the three main asset superclasses.

• Mortgage ETH = capital assets

Consumed ETH = expendable/convertible capital

Locking ETH in DeFi = Store of Value ETH

Ether is the first asset (within my knowledge) to surpass these three asset classes. This is good for Ether, a currency that is by definition flexible. Currency is what you need it to be, and when you need it to be that, Ether fits into all three major frameworks that determine what an asset of value should be.

The story is much more than that. The "triple point" refers to the concept of thermodynamics. In thermodynamics, the triple point of a substance is the temperature and pressure at which the three phases of that substance coexist in thermodynamic equilibrium.

Normally the different forms of matter do not coexist; either solid, liquid or gas. However, if the balance is just right, you can enter a triple point where all three forms can coexist at the same time.

Dan Elitzer has written about the liquidity of collateral inside Open Finance applications on Ethereum:

1. Ether is used as SoV inside MakerDAO to generate DAI

2. Ether and DAI are used as collateral on Uniswao…

3...to generate Uniswap pool share tokens (Pool Share Token)

4. This new ERC20 token has the value of 1 Ether and 1 DAI, which is the native value storage asset on Ethereum

5. Use this new SoV token as collateral for borrowing at Compound

Dan's main point: Ether locked within Uniswap generates new tokens representing its value, which are then re-locked within Compound. The same Ether locked in Uniswap is used as collateral on Compound.

Let's put this into the asset definition defined above.

1. Value storage ETH is deposited into Maker to generate DAI

2. Value storage DAI+ETH is deposited into Uniswap to generate Uniswap pool share tokens

3. Uniswap pool share tokens are both store of value assets and capital assets. Uniswap pool share tokens are collateralized by the asset backing them, but they also receive fees from the trading volume they back. The Uniswap exchange charges a 0.3% fee. This means, the Uniswap pool share token value increases as it collects fees from Uniswap.

Uniswap pool share tokens are thus both a store of value token and a production asset.

4. This new token, which is both a store of value asset and a productive capital, has been deposited into Compound as collateral for loans. Now, then, it acts as a store-of-value asset backing its loans.

Therefore, Uniswap’s pool share token is backed by a store of value asset like ETH+DAI, which now supports Compound’s loan [SoV+CA]*SoV].

In theory, this could also be used in Compound as a lending tool, not just a borrowing tool.

If you replace step 4 with a new one, you get:

4. Allow your Uniswap pool share tokens to be lent in Compound and collect interest denominated in Uniswap pool share tokens from borrowers.

So now, we have a [store of value + capital asset] that can be lent out and charged for, making it [[store of value + capital asset]*capital asset].

Ether acts as a triple point asset because it has the ability to be all three types of assets at the same time.

Why is this important?

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Why is this important?

• Ether is the first asset in history to function as all three asset types simultaneously. Why is this important? What does it mean?

• This model keeps the U.S. economy safe

• Store of Value - USD

Capital Assets - U.S. Treasury Bills

Consumable Assets - Taxes

Currencies are great store-of-value assets. Fiat currencies are designed to hold wealth across time. Although, they can do better. Currencies are tools of trust for communication and value transactions across time and space. One of the most successful currencies of all time, the U.S. dollar is also a store of value asset for the world economy.

Taxes are how the U.S. government pays off its debts and finances new ventures. The IRS represents the entity that collects fees, which are based on economic activity, to support the U.S. economy. (Blue Fox Note: IRS refers to the US Internal Revenue Service, a subsidiary of the US Department of the Treasury.)

The taxes collected go (in part) to holders of U.S. Treasury bills, which is the revenue mechanism used to pay interest to holders of Treasury bills. In theory, the U.S. government also pays off Treasury bond holders through inflation, reducing the dollar’s ​​power as a store of value asset.

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• Ether and Ethereum follow the same model

• The same economic structure is present in Ethereum as well. And this time, Ether is the center, it is the center of the Ethereum economic system.

• Store of value - ETH locked in DeFi

Capital Assets - Collateral of ETH

Consumable assets - Gas

Ether is staked in Ethereum to fund its economic security and earn risk-free interest.

Ether is used to pay the gas fee, that is, the cost of using the Ethereum network, which is a tax paid to the security of the Ethereum network.

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• put together

• At its core, Ethereum is the infrastructure needed to generate an entire new economy. This time, financial services within the economy

• run entirely by code*

trustless/permissionless

Now that we have a new economy, we need a new currency to run it on. If we want to maintain a trustless and permissionless Ethereum economy, we need a trustless and permissionless currency.

The only trustless and permissionless asset on Ethereum is Ether.

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Ether is unlicensed bandwidth.

The demand and usage of Ether within Ethereum is a function of its demand as a permissionless currency within financial applications. There is a finite amount of Ether in Ethereum, which means that when Ether is locked in an application, the application is consuming a portion of the total amount of Ether. The collective competition for Ether by applications results in the use of a fraction of all Ethereum's Ether. This is what we call "ETH locked in DeFi".

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Bandwidth refers to "ETH locked in DeFi" or, "How much ETH does this application need to satisfy its users?"

Currently, bandwidth usage is fairly low. There is still a lot of room for applications to grow and capture ETH.

If the demand for Compound loans increases, Compound will also require more ETH to be mortgaged to support its loans. Again, this applies to dYdX as well. If Uniswap increases in transaction size and liquidity, it will need more ETH or DAI to increase these liquidity pools.

All of the above require a fraction of the total ETH supply, representing the bandwidth usage of Ether as a permissionless currency.

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increased bandwidth

• In the current state of Ethereum, Ether has abundant bandwidth. At the time of writing, Ether’s market cap is roughly $20 billion, while the value of ETH locked in Open Finance is $600 million. (Blue Fox Note: The current market value is 19.6 billion U.S. dollars, and it fluctuates quickly. It is estimated that it will be different every time you look at it). Currently, we have enough bandwidth to meet the needs of our users. (Blue Fox Notes: Less than 5% is used, and there is still a lot of space)

• Still, the Ethereum economy has a lot of room for demand. If we expect Ethereum to be:

• Internet's global financial platform

Internet of value

A global settlement layer for all digital assets

And if we want to be completely permissionless and trustless, then we need Ether to scale to a larger amount.

Trusted finance and permissioned assets are welcome on Ethereum. They have the same roles and functions on Ethereum. But the real innovation is completely permissionless financial applications, which operate with completely permissionless funds. Anything else is a compromise.

A total of 1.7 trillion USD is in circulation. If we wanted Ethereum to meet this level of demand, the price of Ether would be 85 times what it is now. (Blue Fox Note: This scale basically represents the scale of the dollar economy, which is not so easy, at least in terms of time, it is not something that can be achieved in a few years.)

If we want a permissionless world where people can transfer value through a trustless platform, the value of Ether needs to scale to meet this demand. Now, Ether and Ethereum can meet the needs of a small group of believers, and the value of Ether is enough to meet this demand.

But if we want Ethereum to host the next million, billion users, Ether will have to increase its price to support the economic activity required by permissionless and trustless financial applications.

How does Ether scale?

We need the price of Ether to grow so that we can have more capital for more financial platforms. How did this happen?

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three-way tug-of-war

This is the model of how Ethereum appreciates as I understand it. This is the fundamental value proposition of Ether.

1. Open finance attracts ETH. Open Finance applications provide products and services, which lock Ether. Mortgage support does not require trust, and Ether supports DeFi without trust. DeFi applications will create valuable services for Ether holders, which can convince them to lock their Ether in applications to obtain products and services. MakerDAO, Compound, dYdX, Uniswap... have more useful applications, more reasons to lock ETH.

2. ETH pledge rate. Another alternative to locking up ETH in DeFi is to stake your ETH. The ETH staking rate provides a "risk-free rate" for Ether holders. If you believe that you can get a better return than locking in DeFi by staking ETH, then the ETH staking rate is your incentive to staking. Locking and Ethereum staking in DeFi will often compete for ETH. It is worth noting that the more ETH is locked in DeFi, the higher the ETH pledge rate will be. If a large product is produced on DeFi, then ETH will flow to DeFi, leaving higher returns for those who are still staking.

3. USD price. Both of these forces are pulling the price of the dollar. If DeFi and ETH staking are all competing for ETH, there will be less ETH left. The only mechanism by which the USD price creates an equal and opposite pull on these two forces is an increase in price. The USD value of ETH is the result of the cumulative force driven by the ETH pledge rate and DeFi products.