Why ETH Must Have a Currency Premium

Editor's Note: This article is from:Ethereum enthusiasts (ID: ethfans)Editor's Note: This article is from:

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introduction

introduction

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Money Premium = Liquidity

Although Bitcoin and Ethereum obtain liquidity in different ways, they are both rooted in the value of the asset itself. As the price of an asset rises, its liquidity also rises.

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Bitcoin has value first, then liquidity, and then currency. Of course, it all stems from its limited supply. The constant scarcity of Bitcoin gives people a strong incentive to hoard coins because people are betting that it will be the next generation of money. That's all the secrets of Bitcoin and nothing else. If that's not enough to make Bitcoin a currency, Bitcoin has no other cards to play.

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• Ethereum first creates a mechanism that requires ETH to drive the operation, and then allows ETH to obtain liquidity. In Ethereum 2.0, there will be three artifacts to program the scarcity of ETH:
• Locked in the DeFi ecosystem - increases the usefulness of ETH, thus increasing the demand for ETH

Burning ETH——Increase the scarcity of ETH and reduce the rate of issuance of ETH

These are the three equations driving the scarcity of ETH, which is yin to Bitcoins 21M yang (is yin to Bitcoins 21M yang). Importantly, each equation complements the other two. Bitcoin has only one pillar (capped at 21 million), Ethereum’s three pillars, although smaller, complement each other and strengthen each other.

Scarcity as a Precursor to Liquidity

Cryptographically constructed assets like Bitcoin and Ethereum are homogeneous, divisible, and globally mobile; in order to be used as money, they also need a bookkeeping system from beginning to end. For a cryptocurrency to become a currency, the only abyss that needs to be crossed is to become the most valuable/liquid cryptocurrency. For cryptographically constructed assets, there is one and only one life-and-death battle, which is to obtain a higher price, because at the same time it is competing for liquidity, that is, striving to become a currency.

The total market cap is equal to the amount of money (Total Market Cap = Money).

In my opinion, these statements are like saying "Why ETH is not worthy of currency status (why shouldn't ETH be used as currency)", or "It must be unfair if ETH can become currency", rather than "Why ETH will not acquire currency status". In the final analysis, "how to view Ethereum" is just a subjective preference, and there is no right or wrong; only "what will happen to ETH" is a question that we can use data and trends to study.

This article is to use real data and trend analysis to tell you why ETH will eventually become a currency.

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Reasons why ETH ~will~ be a currency

ETH is on the way to establishing itself as a currency.

As a platform, Ethereum has been looking for a suitable market; in 2018, we saw the emergence of financial applications driven by locking ETH. The "Amount of ETH Locked in DeFi" metric quickly became popular as the Ethereum community began to realize the promise of ETH: as a reserve asset for a zero-entry financial system.

The main point of this article is: All applications on Ethereum will eventually help ETH, and help ETH on the road to organic (or accidental?) programming of ETH as a currency. From the perspective of the history of the blockchain, it is not a contradiction to say that engineering has been made into something else by accident: from 2015 to 2018, Ethereum has put out many dApps, depending on which ones can survive. As it turns out, the ones that survive are the applications that make ETH a currency.

1. Programmed requirements

Requirements for the Application Layer: This section is a response to Checkmate's "Depending on the Application Layer for Value Accumulation" section.

The application layer of Ethereum will change the financial system of this world. Financial components like MakerDAO, Uniswap, and Compound are expected to serve global users; and the result of growing usage is the rising amount of ETH locked.

“ETH Locked in DeFi” is a metric that measures the amount of ETH out of circulation caused by Ethereum applications. Every Ethereum application provides an incentive to lock ETH (I explained it in the article "Ether is Equity"). So basically, the application layer of Ethereum is the sink of Ethereum circulation, causing ETH to leave the circulation field and increasing the scarcity of ETH (I also explained this concept in the article "Ethereum: Money-Game Landscape").

There is an identity for money-commodity transactions that is MV=PQ (see the Wikipedia hyperlink attached here for a full explanation). From the perspective of this article, MV=PQ explains the relationship between the velocity of money flow (that is, the speed at which money changes hands) and the total value of the total amount of money (that is, the "market value" mentioned above). Once the velocity of money flows decreases, the market value increases accordingly.

The magic of the Ethereum application layer is this: there is always room for more applications! There is no upper limit to the number of applications that generate ETH locking incentives, and there is no upper limit to the fees paid to those who voluntarily lock ETH to participate in the pledge. Therefore, in theory, there is an infinite demand for ETH (bitcoin fans often say this about Bitcoin, but in practice ETH has the way to make this a reality).

look at the picture

The amount of ETH locked in DeFi apps keeps growing ⬆️

The ratio of DeFi locked-in volume to ETH issuance is fluctuating🔀

Ethereum is still PoW mining; migrating to PoS can reduce the increase rate of ETH from 4% per year to about 0.4%. With PoS, the additional issuance of ETH will be much lower than the locked amount of ETH in DeFi.

0.4% is the upper limit of the issuance rate of PoS Ethereum. Does not include ETH burned from EIP-1559. We don’t yet know how to predict this burn rate, but it can be assumed that if all 64 shards of ETH 2.0 are used, the net increase of ETH can be negative. I'm looking forward to seeing the yellow line in the graph above drop below 0.

• 2. Programmed scarcity
• Two major innovations on Ethereum marked "programmed scarcity".

1. It is generally assumed that PoS can attract 10% to 30% of the total supply of ETH
2. Eric Wall explained in his recent article "PoS is less wasteful" (Editor's note: see the hyperlink at the end of the article for the Chinese translation) that the staker group of the PoS system will mainly consist of those who are bullish on ETH in the long run because they can accept a lot of ETH. Low return on staking. what does that mean:

• Ethereum can guarantee security with the lowest issuance rate

The transaction fees paid to buy block space will flow to those who are bullish on ETH in the long run. PoS rewards the bullish side and self-reinforcing asset appreciation. This is another great example of Ethereum being able to realize itself as a currency, unlike some projects that can only rely on memes

Further complement the flow sink effect of ETH

1. EIP-1559 introduces the ETH burning mechanism, which will burn ETH in the same proportion according to the transaction congestion of Ethereum while improving the experience of using Ethereum.

2. Checkmate sees some big problems with EIP-1559:

3. EIP-1559 represents tinkering with monetary policy. In his view (and the view of many Bitcoin fans), tinkering with monetary policy is absolutely wrong, and "cannot be modified" will produce the best monetary policy.

1. EIP-1559 will make the transaction fee more expensive.

2. My response:

Again, this is just a moral statement, saying "Ethereum does not deserve a monetary premium", not a factual proposition that says "it cannot receive a monetary premium".

• I totally disagree with this. The Cantillon effect exists and can be used to criticize the fairness of ETH as an asset, but this criticism is only related to PoS as a security mechanism and has nothing to do with EIP-1559. In fact, EIP-1559's changes to the PoS economic model directly mitigate the Cantillon effect in PoS. If you're really worried about this effect, EIP-1559 is ally.

• I've already explained this in "Ether is Equity" and "EIP-1559: The Final Piece of the Ethereum Monetary Policy Puzzle", but I'll repeat it here:

• The fee income in the cryptoeconomic system fluctuates greatly, and this cannot be changed. In 2015, the transaction fee of Bitcoin was less than US$0.01, and it rose to more than US$100 in October 2017. The miners in October 2017 made a lot of money, while the miners in 2015 were struggling to survive with low fees, and they were simply subsidizing services.

EIP-1559 guarantees a stable income for PoS validators in ETH 2, protecting validators from a fundamentally unstable fee market. Moreover, EIP-1559 will take part of the profits from the stakers and redistribute them equally to all ETH holders.

When Ethereum’s income (fees) is less than its expenditure (security budget, i.e. block rewards), it suffers losses. Regardless of income, ETH will be issued to validators to compensate them for their contribution to security. This means that even when the income is low, the validators will still be compensated. If EIP-1559 does raise fees, it is also because it raises the price of ETH. Checkmate's point of view here is that the handling fee is related to the price of ETH. If the price of ETH rises, the handling fee will also rise. Recall my point: the monetaryity of an asset is a function of its price. If the price of ETH goes up, its liquidity will go up, and so will its currency. Checkmate seems to have casually admitted that EIP-1559 will help Ethereum gain currency.

3. Programmed mobility

Bitcoin is the world's first native encrypted asset on the Internet. Bitcoin liquidity is gathered on large exchanges such as Coinbase, Wyre, Gemini, Kraken, and services such as LocalBitcoins. These exchanges also provide external liquidity for Ether.

External liquidity: The liquidity between an asset and the outside world. Basically all assets have only external liquidity.

Internal Liquidity: Liquidity between an asset and its native ecosystem. To date, only Ethereum has an internal ecosystem.

From an external liquidity perspective, there is no fundamental difference between Ethereum and Bitcoin. Both rely on the same infrastructure: on-ramps and exchanges. While Bitcoin currently has the most external liquidity, it does not have its own internal liquidity like Ethereum.

1. Being able to provide sufficient liquidity for transactions between ETH/DAI is the first step in building a self-sufficient economy. In such an economy, participants do not need to seek external liquidity. Personally, there are many times when I want to buy ether, but it often takes 5-7 days for the funds to clear, and I don't want to wait that long. I can use the DAI generated by the pledged debt warehouse to buy Ether, and then sell the Ether and exchange it for DAI after a few days, all thanks to the internal liquidity of Ethereum.
2. With internal mobility:
3. my needs are met

I paid a fee to Ethereum

I paid Uniswap

1. The article "Uniswap is Infrastructure" explains the feedback loop formed in the above process:
2. Uniswap scales based on the economy in which it is located. The size of any market is related to the volume of transactions in that market.
3. The more volume traded on a market, the more trading fees that market gets (0.3% per trade)
4. The more transaction fees the market receives, the greater the incentive for liquidity providers
5. The more liquidity providers, the stronger the liquidity on Uniwap
6. The more liquidity there is on Uniswap, the more participants will use the platform for large transactions

As more participants make larger transactions, the total amount of transaction fees earned by the exchange rises.

go round and round

1. Don't forget the theme of this article: Ether will be money, and money is liquid. In any case, currencies are the most liquid assets in the world, and Uniswap is one of the infrastructures that enhance the liquidity of Ethereum.
2. Again, liquidity is directly proportional to total market capitalization. Assuming an asset has a market cap of $100, then the asset is inherently illiquid. Assuming that the total market value of an asset is $100 billion, then this asset is extremely liquid. Price is directly proportional to liquidity. Keep the following points in mind:
3. All Uniswap markets are denominated in Ether. When the price of Ether rises, liquidity increases across all markets on Uniswap.

Ether liquidity increases when the price of Ether increases.

Ethereum will create liquidity for itself and endow itself with currency attributes.

The diagram above shows how Ether has evolved into money.

4. Programmed fairness

Critics of ethereum argue that ethereum's issuance and distribution system is unfair. Although some people have analyzed in depth and pointed out that the ICO of Ethereum has reached a very ideal level in terms of distribution/fairness, critics say that ICO is essentially an unfair way of distributing new currencies, and pre-mining/ICO itself has nothing to do with The nature of money is contrary. In my opinion, this critique simply ignores the real data we use to measure the fairness of ethereum ICO?

I personally like to analyze the is-ought problem through indicators and data. I have found that the Gini coefficient of Ethereum is comparable to that of Bitcoin, and I am already very satisfied with it.

However, DAI is the fairest of all cryptocurrencies.

Since the rise of the modern financial system, this model of using certain assets as collateral and issuing credit under its endorsement has become the most basic currency generation mechanism. The rationale behind it is difficult to briefly explain here, you can go to David Graeber's "Debt: The First 5000 Years".

In his book, David explains how "debt" and "creditor" institutions can be mutually beneficial hunter-gatherers. The beneficiary owes the beneficiary a debt. Among small hunter-gatherer tribes, those who benefit more than they benefit are seen as burdens, or "brokers," whom others will not help because they know they will not be able to repay.

Those who hold Ethereum can issue a "debt repayment commitment" through MakerDAO, namely DAI. Because MakerDAO requires a pledge rate of no less than 150%, there is no need to worry about someone "breaking their promise".

Money is essentially a debt-creditor relationship. MakerDAO has created a perfect currency system: a currency with debt security. Think Ethereum lacks fairness? OK, let's use DAI then. The price of DAI is still stable.

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Let's start to refute the opponent's argument

In the end, I went straight to Checkmate's point of view.

My conclusion is that the Ethereum project faces two problems. On the one hand, the governance model is relatively centralized, and on the other hand, the monetary policy is not perfect, and there are signs of gradual deterioration.

Just a fallacy that confuses what is and what should be. First of all, is the degree of centralization of the Ethereum governance model really that strong? In terms of certain rules, yes. All consensus on modifications/updates is reached through a centralized process. Ethereum monetary policy is modified in a centralized manner, but also based on a social contract. If you agree with Hasu's point that all cryptoeconomic systems are executed according to a social contract, then Ethereum's social contract is to abide by the minimum necessary issuance principle (minimum necessary issuance). Any changes to the rules governing the issuance of ether must conform to this social contract. If not, I am afraid that the currency management of Ethereum will be in a big mess, but so far there has been no case of non-compliance with the minimum necessary circulation principle.

The latest experiments in EIP 1559 seem to run counter to the needs of users other than ethereum holders. This damages the fairness of the system, causing users on the chain to drive away more and more customers because of the transaction fee premium.

I have explained it above. “…seems to be at odds with the needs of users other than ethereum holders.” How is this different from Bitcoin’s early holders? Early bitcoin holders also benefited greatly from the scarcity of bitcoin. Of course, due to the nature of the Bitcoin protocol, people may feel that the distribution mechanism of Bitcoin is fairer, but if judged by data and indicators, the distribution mechanism of Ethereum can also be considered fair. Therefore, I think this argument is less well-founded than the "programmed monetaryity" section I expounded above.

Due to issues such as protocol complexity, Turing completeness, developer backdoors, and centralized oracle machines, the attack surface of Ethereum is an order of magnitude larger than that of Bitcoin.

If you accept the two articles "Two Sides of Ethereum" and "Ethereum is Equity", then you will also agree that Ethereum has been working hard to solve the above problems. If the concerns stated in this comment are valid, then there will be a natural transition for applications on Ethereum from their current state to one that is more suitable for them to survive in this environment.

The project vision, direction, and experimental features are constantly changing, and now finding ways to stay close to Bitcoin's "sound money" narrative.

There is no evidence that a sound monetary policy brings about monetaryity. This is a made-up claim that Bitcoin fans have been preaching since 2015 until now. But in my opinion, that statement has run its course. It is facts and figures that matter, not narratives and memes. The former is the nemesis of the latter.

Ethereum relies too much on third-party (potentially shut down) applications to accumulate value for Ether. But because there is no upper limit to the supply and the monetary policy is vacillating, they have to rely on them.

Those who ignore Web 3.0 do so at their own peril. DeFi is not an appendage of Ethereum. Conceptually, DeFi is bigger than Ethereum. However, there are no other platforms available for DeFi development yet. Until a real competitor emerges and takes a share from Ethereum, Ethereum will always monopolize DeFi and will fill the gap in DeFi demand. When I saw Checkmate's sentence "(Ethereum) relies too much on third-party applications", my understanding is that "Ethereum can realize the currency properties it needs through programming, and no protocol can do this. "

All Ethereum centralized pools (including custodial DeFi applications) have the potential to become malicious PoS validators, or they may be hacked to become malicious validators.

Finance entails risks. I'm happy to take that risk if the protocol of my choice provides the application. Ethereum is like a hydra. We have also seen the end of EtherDelta: centralization will become the Achilles heel. However, EtherDelta was replaced by Uniswap, which was designed to completely avoid centralization risks. This is a legitimate concern. The facts show that all Ethereum applications are likely to be replaced or absorbed by a new application that is better and more resistant to attacks.

The end result of secondary system syndrome: the desire to completely rebuild the underlying blockchain. But integrating one chain into another is a bottomless pit that will take years to complete. Definition: Secondary system syndrome refers to the replacement of successful small and beautiful systems by over-engineered grandiose systems due to high expectations and overconfidence.

The idea is that Ethereum is trying to “become a better Bitcoin with an over-engineered, costly, and maintenance-intensive system.”

In my opinion: Ethereum is a financial system that will be updated and upgraded, based on research on cryptoeconomics and user needs. The currency of ether is a product that can be iterated and improved!

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in conclusion

The above 4 points demonstrate how Ether is programmed to be money.

1. Monetary is Liquidity

The reason behind it is not important, what is important is that it is so. If there is one thing that is the most liquid thing in the world, it is currency.

2. Liquidity is proportional to value

Assets with higher market capitalization are more liquid

3. No other protocol can give itself liquidity and value through programming

Uniswap = programmed liquidity. All DeFi applications = programmed value. Which do you prefer, programmed fluidity or memetic fluidity?

4. The criticism of "why Ethereum will not become a currency" in the mouth of some bitcoin fans is a fallacy that confuses what should be and what is.

There are two ways to generate currency: passive adoption and programmed features.

Bitcoin fans generally believe that the popularity of Bitcoin will happen naturally, and that the acceptance of Bitcoin is destined from the beginning.