The Currency of Bitcoin and Ethereum

Editor's Note: This article comes fromEthereum enthusiasts (ID: ethfans)Editor's Note: This article comes from

Ethereum enthusiasts (ID: ethfans)

Ethereum enthusiasts (ID: ethfans)

• , author: Josef Tětek, translation & proofreading: Min Min & A Jian, reprinted with authorization by Odaily.

• Over the past two years, the cryptocurrency industry has been undergoing a major cleansing, weeding out low-quality coins. Most altcoins have languished, plummeting more than 90% from their all-time highs. The market value of BTC has regained more than 60% of the total market value, maintaining the industry's first place. According to some, this is a clear sign that BTC is poised to become a non-fiat world currency. On the other hand, the rapidly developing Ethereum DeFi cannot be underestimated.

I want to analyze two ways to achieve currency through this article:

The way Bitcoin adopts is to consolidate the base currency first, and then only consider the secondary currency on the second layer/side chain (montary aggregate, which is the general term for statistical indicators of the amount of money under different calibers. Here we take its extended meaning and translate it as "Secondary currency" is a financial instrument that is similar to money generated during the use of the base currency——Translator's Note).

Monetary aggregate

The fundamental difference between Bitcoin and Ethereum is their understanding of what constitutes money. In the current monetary system dominated by fiat currency, currency is actually a very vague thing. We usually discuss currencies at different levels and calibers, and each level has different levels of liquidity and counterparty risk.

We can visualize the concept of money through an inverted pyramid structure:

image description

-Translator's Note: Base currency includes banknotes, coins, and commercial bank deposits; M1 is base currency plus demand deposits; M2 is M1 plus money market share, short-term deposits; M3 is M2 plus institutional funds, long-term deposits. Note that there is often consensus only on the calibers from M0 to M2 for the different measurement calibers of the quantity of money. -

As can be seen from the above figure, the Bitcoin community mainly focuses on the characteristics of the base currency, while the Ethereum community pays more attention to making a fuss about higher-level currency applications.

The base money is at the bottom of the inverted pyramid - the cash in our wallets and the reserves held by commercial banks at the central bank. Base money is narrow money because it is the ultimate settlement instrument: whether you are a citizen holding cash or a commercial bank depositing reserves at the central bank, there is no counterparty risk.

Plus, whether you're a citizen with deposits in a bank or a commercial bank with an overnight deposit at the central bank, you have very little counterparty risk - your depository institution could become insolvent or go bankrupt. This is one of the reasons why commercial banks in the US started depositing excess reserves with the central bank after the financial crisis, because the trust between commercial banks was gone (another reason was that the Fed started paying interest rates on reserves).

The fractional reserve requirement system is the root cause of the formation of the inverted pyramid institution-banks can issue various forms of loans, which are worth several times the reserves they hold, and the specific size of M2 is often based on the credit rating of the lending institution. The higher the level of the pyramid, the higher the level of trust required, and the lower the liquidity of the asset (ie, the harder it is to exchange).

• (Interestingly, Ethereum’s monetary aggregates are positively pyramidal because of its over-collateralization regime. However, this will change once a non-over-collateralized money market model is formed.)

• In fact, the vast majority of transactions we are exposed to are M1 and higher-level currencies. Individuals and businesses around the world are increasingly using electronic transfers/credit/debit cards and less cash.

Let’s wrap up this section and then discuss the implications of this for Bitcoin and Ethereum. We came to the following two conclusions:

The definition of money is not one-dimensional: it depends on the level of trust and liquidity at different levels.

• While base money is the most trustless and liquid, M1 - M3 are the source of monetary utility.

• Bitcoin's Road to Currency Attributes

• As I hinted at in the last section, Bitcoin's first and always first effort is to create a reliable base currency. Let's take a brief look at the theoretical basis proposed by everyone:

• The widely circulated hard money theory, and Plan B's "stock to flow ratio (Stock to flow) model" (in fact, it is just a popular version of the hard money theory); the day of halving the output is a festival in the Bitcoin world (Other festivals include: Pizza Festival, White Paper Festival, Genesis Block Festival)

• Emphasize the importance of decentralized governance and Bitcoin's history of success in this regard (e.g. UASF (user-activated soft fork) and the No2X movement (against doubling the size of Bitcoin's blocks))

• The ever-discussed and analyzed future of Bitcoin's security budget (see Nic Carter, Dan Held, Hasu, and more below)

• Scalability of payments: from startups building on top of Bitcoin technology that are working on scalability and fungibility of payments (e.g. Samourai, Wasabi, Strike, Lightning Labs, Square Lightning SDK)

Social scalability: Bitcoin’s efforts in value storage and payment methods may be seen as a lack of enthusiasm, but it is these efforts that make Bitcoin a natural Schelling point for global fiat currencies (a common choice that naturally forms), Because only soft forks are used when the protocol changes, there is no need to worry about the ongoing governance disputes (if there is a need to participate in the debate collectively, there is also a headache, which language should be used for governance discussions)

Conservative approach to protocol upgrades: Only soft forks are used to activate upgrades, and the content of the upgrades is rigorously peer-reviewed. Even "less brain-intensive" upgrades like the Schnorr signature scheme took years to implement

All in all, the Bitcoin community has accepted a very conservative and transparent approach to leading protocol development, trying to avoid undermining the broad consensus and Bitcoin's Schelling point status. "Reliable base currency" is the first priority, and the functions presented in the layer above the base currency are implemented by the second-tier network or even the third-tier network on the blockchain (Lightning, Liquid, Debnk, etc.). The store of value function driven by a clear and reliable monetary policy seems to be the main reason why Bitcoin has gained global acceptance over the years.

Of course, such a conservative approach has been criticized by some. Some people don’t think this kind of conservatism is meaningful, and then initiated a fork (mainly BCH and BSV), or proposed a new project (Ethereum), which also produced a lot of expressions Bag.

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- Emoticon Pack Author: Fiskantes -

Parker Lewis of Unchained capital sums up Bitcoin's monetary evolution particularly well in his article "Bitcoin Will Replace All Other Currencies":

• However, no currency can be simply "scarce for scarcity's sake". Conversely, currencies with a capped quantity can most efficiently mediate transactions. Monetary goods with the strongest relative scarcity can preserve their value in transactions across time to the greatest extent. The relative value and relative price of all other goods is the information that people need only after the collaborative function of money; in every transaction, every individual is motivated to maximize the value that can be preserved into the future. The limited scarcity of Bitcoin will ensure that the value of the current exchange can be preserved into the future to the greatest extent, and as more and more individuals recognize Bitcoin as the most relatively scarce monetary commodity, its price will stabilize will come naturally.

• The road of Ethereum to realize currency attributes

• If we regard the DeFi movement as the application scenario where Ethereum is most suitable for the market, we will find that the path of Ethereum to achieve currency attributes runs counter to Bitcoin. Let's briefly explain why:

• Ethereum focuses on the utility side of money — using its native token (Ether) as the “economic bandwidth” of a decentralized ecosystem, rather than a store of value or a means of payment.

• Ethereum's monetary policy is flexible and focused on maximizing on-chain security (rather than a planned inflationary policy); therefore, there will be no hard cap on ETH issuance, or a defined inflation curve ——In contrast, Ethereum implements a monetary policy of "minimum necessary circulation".

As David Hoffman explained, there are three ways to achieve the scarcity of Ethereum: DeFi, PoS pledge, and fee destruction; it can be seen that the path of Ethereum to achieve currency attributes is a continuous iterative process (mentioned above 2 out of 3 mechanisms are not yet implemented).

David Hoffman also pointed out that the concept of currency has always been inseparable from debt (see Graeber's book "Debt: The First 5,000 Years"), and the DeFi protocol uses this to give Ethereum currency attributes—making Ethereum a Standard deferred payment facility.

"Move quickly and innovate" is the consistent style of Ethereum. The community is always trying out multiple use cases at the same time, and iterating again based on what is left at the end. DeFi seems to be one of the tried and tested scenarios, and various DeFi services are steadily attracting Ethereum as their "economic bandwidth":

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-Source: DeFi Pulse-

DeFi services have been praised for their permission-free nature (at least some services have this characteristic) and composability (referring to the possibility of interaction and synergy).

In my opinion, the reason why DeFi can disrupt the blockchain industry is because of its transparency and auditability. As Ryan Sean Adams recently pointed out in a discussion on the Ivan on Tech podcast, we can't audit the collateral and inner workings of Coinbase or Kraken - but we can do the same for MakerDAO and Compound. Therefore, the fact that bZx was able to use audits to find vulnerabilities so quickly is something to be celebrated, and people should not blindly condemn it as insecure. In contrast, Mt. Gox has been insolvent for more than two years, but no one knows. Once bZx was hacked, everyone knew about it within a few hours.

The reason why DeFi can give Ethereum currency attributes is because it just overcomes the shortcomings of the modern financial system-closed, narrow and exclusive. Even centralized “cryptocurrency banks” are severely restricted: Kraken’s futures trading is banned in 36 countries, including the US — Kraken itself is an American company! Additionally, placing assets such as bitcoin and ether in custodians is highly risky and could be the Achilles' heel of this monetary revolution - custodians can easily confiscate assets, just like in the 1930s The executive order issued by the President of the United States compels citizens to turn over their gold to the Federal Reserve Bank.

First, there is always a trade-off between functionality and decentralization. Simple protocols, like Uniswap, can be "full contracts", but can advanced modules like money markets be full contracts too? With governance, with admin keys, there's always a compliance risk and a governance attack risk.

Summarize

Second, composability (the interplay of protocols) brings both new opportunities and new problems. Nobody foresaw the flash loan attack. And with the refurbishment of the DeFi field, many more complex attacks will also come. Transparency and access-free attributes have also produced many coveted money jars. While insurance such as Nexus and Opyn may help, if the attacks become regular, the premiums will be higher and higher. Therefore, DeFi application projects must ensure that they can use bounties to attract people who expose vulnerabilities, instead of making their applications a money pot.

• Third, DeFi is still a very small field, and it may just be something inside the complex Ethereum circle. There are many reasons to think this way: Maker, Compound, and other services, where the vast majority of value locked comes from a few large players; when the price of ETH rises, the amount of ETH locked in DeFi protocols decreases (this occurred in the summer of 2019 and 2019). February 2020). The metric "ETH locked in DeFi" has not grown exponentially, like the entrepreneurial trend, which increased by 3,000% in 2018, but only 52% in 2019, and now (2020) even has a decline. As of the date of writing, DeFi has absorbed 2.6% of the total ETH supply, which looks good, but is still a niche field.

• Summarize

Both Bitcoin and Ethereum are promising to become the first world digital currency without government intervention, but both will have to overcome their respective potential weaknesses in the next 5 years:

Bitcoin must survive with its hard-coded monetary policy: the two halvings that will occur in the next 5 years will tell us whether this monetary policy will work or not. Providing "transaction density" through sidechains and economic activity on the L2 network is critical. Auctioning future block space demand via futures contracts would also help the overall market (if there is a predictable demand for futures settlement).

Ethereum has to prove that it can achieve monetaryity on top of a fickle base currency layer. If the migration to Ethereum 2.0 is going well, the work of removing the need to focus on governance and automating monetary policy should follow suit. But there should be no strong leaders in a decentralized currency protocol, no matter how strong the charismatic personality of the person in place. personality).

Both Bitcoin and Ethereum also need to create an internal circular economic circle and eliminate the dependence on legal currency access channels. This is especially true for Bitcoin - in order for Bitcoin to become the base currency of the future, Bitcoiners should consider starting to use Bitcoin/Satoshi as the unit of account.

Judging from the past few weeks, it is very difficult to predict the future, and the future possibilities are far more than we think.

(over)

Judging from recent global market and social dynamics, mankind is entering a new era. Hopefully, in this new world, there will still be demand for fiat world currencies.