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Why ETH Will Sustain a Monetary Premium:
- Read Vitalik’s rebuttal
- Read Foobazzler's rebuttal (👈you are here)
- Read bull case for ETH’s monetary premium by David Hoffman
Foobazzler's rebuttal of "Why ETH Won't Sustain a Monetary Premium"
Post by: Foobazzler, crypto investor & engineer
For the sake of consistency, I’ve broken my arguments into the same sections Checkmate uses in his article.
Monetary Policy and Governance
“It is unlikely Bitcoin’s monetary policy will ever change without destroying the project’s fundamental values and splintering the chain. Should this supply curve ever be tampered with, most Bitcoiners agree, the result would no longer be Bitcoin.”
This 21 million supply hard cap “social contract” that Checkmate describes is a meme that is simply not sustainable. Miners derive most of their revenue from block rewards, not transaction fees. When block rewards effectively go to zero, their revenue will be derived entirely from transaction fees. One of two things will happen here: either individuals will pay exorbitant fees to transact, or hashrate will decline, resulting in decreased security. Either scenario is undesirable, and this possibility may result in yet another contentious hard fork that will leak network value and potentially ruin Bitcoin’s status as the most logical Schelling point in the crypto space.
Unsound Monetary Policy
“Whilst the issuance rate has been reduced to date, the selection of the inflation rate is the product of developer intervention rather than deterministic and reliable hard coded changes.”
This argument is designed to make Ethereum’s monetary policy appear arbitrary, uncertain, and in the hands of a cadre of core developers. Ethereum has a social contract of its own enforced by its entire community and ecosystem: minimum viable issuance. While superficially it’s not as appealing as a 21 million supply hard cap, it’s a monetary policy that’s both sustainable and informed by real data rather than speculative theorizing. When Ethereum transitions to PoS (a process that is progressing as planned), Ethereum’s inflation rate is predicted to be between 0-1%, lower than Bitcoin’s issuance rate--even after the halving--and generating a higher stock-to-flow ratio than gold.
Centralisation of Nodes and Validators
“Should Ethereum reach a truly global audience, this threatens centralisation of nodes to large scale actors who can replace SSD drives and afford to upgrade frequently. It is possible that node operators will centralise around Ethereum core devs (e.g. EF and Consensys), exchange merchants, crypto banks and a collection of stake service providers.”
- You can run an Ethereum full node on a Raspberry Pi.
- SSD drives are commodity items nowadays, not specialized hardware.
- The number of Ethereum nodes is comparable to the number of Bitcoin nodes.
- Light nodes require even fewer system resources
- Stateless clients will be available soon and allow synchronization over time instead of having to download the entire history first before validating.
- Eth2 nodes will run on mobile devices.
- Decentralized infrastructure such as The Graph enables blockchain queries without relying on centralized infrastructure such as Infura.
“Slashing in Ethereum 2.0 actually promotes this behaviour as the average user lacks technical proficiency and thus will opt for the convenience of exchanges and stake providers.”
The slashing mechanisms in Ethereum 2.0 are designed to prevent centralization because validators are penalized much more harshly if they experience a fault in availability simultaneously. This disincentive discourages infrastructure consolidation and encourages validators that rely on their own independent infrastructure.
“Ultimately, this burning mechanism is of greatest benefit to current ETH holders and is to the detriment of holders and users in the future.”
There are several rationales behind the burning mechanism presented in EIP-1559 and they do not exclusively benefit holders to the detriment of everyone else. To summarize, the proposal:
- Substantially reduces transaction cost volatility
- Reduces transaction latency
- Reduces inefficiencies in transaction processing
- Reduces Ethereum’s attack surface by making selfish mining more difficult
- Prevents fee manipulation by miners
- Ensures that only Eth can be used to pay for the base fee
As you can see, there are a variety of nuanced technical reasons why the fee burning mechanism makes sense, and these reasons are not strictly motivated by a desire to increase the price. In any case, if the price does increase because fee burning makes Eth more scarce, all stakeholders benefit. A high market cap means that Ethereum has the economic bandwidth needed to secure high value assets.
“One can only conclude that the monetary policy of Ethereum is relatively fluid and influenced by people rather than code.”
All monetary policies are influenced by people, even Bitcoin’s. As Checkmate himself stated, the 21 million dollar supply cap is part of the social contract. If the Bitcoin community collectively decides to uncap the supply, code is no obstacle.
Second System Syndrome
“It is notable that the original Ethereum design explicitly excluded money as an intended use case for the ETH token. “
“Ethereum in, many ways, is the perfect example of Second System Syndrome. This is where a simple technology like Bitcoin is deemed incapable of meeting its design goals, iterated upon by a more complex and ‘promising’ project, that is ultimately caught in an endless cycle of research, newly discovered problems and delayed delivery schedules.”
The original goal of Ethereum was to create a programmable blockchain not limited by the lack of expressiveness constraining Bitcoin, a goal that it has dutifully fulfilled since the very beginning. But even if it were the case that Ethereum has pivoted, pivots happen in every industry with almost every product because finding product-market fit is not a straightforward process. Even Bitcoin was originally designed to be p2p digital cash and pivoted to digital gold because due to its inability to scale, high transaction fees, lack of privacy, and price volatility--all issues coincidentally solved by Ethereum through L2 solutions. It’s also worth noting that the reason Ethereum has so many narratives is precisely because it enables many use cases that Bitcoin cannot support without introducing serious trust assumptions.
The cambrian explosion of innovation on Ethereum is not happening on the base layer where security is of utmost importance, it’s happening permissionlessly on L2 by independent developers with different interests seeking to create brand new novel applications by combining and iterating on established financial primitives. It’s not one group of centralized core devs endlessly researching and going in circles as Checkmate likes to characterize the situation, it’s distributed ecosystem of diverse devs experimenting with what works and what doesn’t--a bazaar of software and financial products that the world has never seen before.
Reliance on Application Layer for Value Accrual
“In recent times, a number of high profile ‘unstoppable’ and 'non-custodial' 'decentralised' applications were found to be...well stoppable, custodial and centralised.”
All projects start out centralized and then decentralized over time--even Bitcoin underwent this path. The reason why many DeFi protocols are not yet fully decentralized is because they need to be scrutinized and tested in the real world thoroughly before they are permanently cemented in their current state. The developers of these DeFi protocols are well aware that their projects are pointless if they are ultimately centralized, and these same teams also don’t want a target on their back that might attract governments or malicious entities. With that said, current DeFi centralization is a real risk that all users should be made aware of.
Reliance on Centralised Oracles
“Furthermore, a vast majority of the ecosystem is reliant on the centrally controlled Maker ETH/USD price oracle...This is a problem not easily fixed in a trust-less manner.”
The oracle problem will never be fully solved, but there are solutions in works to mitigate the risks that oracles pose. As an example, Chainlink offers a decentralized oracle solution that combines economic incentives (through staking) such that oracles are incentivized to have a high uptime, acceptable performance, and report data accurately. Add to that with the fact that oracles have a reputational score and can be programmed to pull in data from various data aggregators which themselves pull data from various exchanges, and the end result is a system whose weakest link is not its oracle implementation.
Reliance on MakerDAO
“A major critique of MKR is the high concentration of tokens in the hands of known, KYC’d venture capitalists, and the team themselves...This constant threat and uncertainty of severe financial loss again makes ETH an unattractive investment.”
Fortunately for the Ethereum ecosystem, DAI is not the only trust-minimized stablecoin nor will it be the last one. Other decentralized stablecoins such as sUSD that use different mechanics to sustain their peg and don’t depend on a potentially centralized governance token such as MKR.
Yes, Defi is still very risky, and yes, some of these experiments will lamentably unwind and collapse. This is precisely why these projects need to decentralize gradually and methodically, because if they don’t then there aren’t levers to pull when everything goes awry. Pointing out that these projects are too centralized while at the same time complaining that they are too fragile is an unfair argument.
Even projects like Bitcoin and Decred whose communities prioritize “sound/hard money” are not vulnerable to financial gaming. Just because those projects are incapable of building sophisticated financial infrastructure onchain doesn’t mean that they won’t ever be gamed on the traditional financial system (and subsequently fall victim to price bubbles/collapses).
The Tortoise Wins the Race
- Ethereum has a sustainable monetary policy informed by data and not by memes or fringe theories such as Austrian economics.
- EIP1559 cement’s Eth’s place as an invaluable native asset that can never be replaced by a simple ERC20 token
- An order of magnitude more developers and researchers scrutinizing Ethereum means that it is arguably more secure than Bitcoin
- Ethereum is capable of pivoting to thousands of different use cases and isn’t dependent on one in particular that the market may end up rejecting anyway
- Lots of applications will all need Eth for economic bandwidth, no one use case will completely dominate the supply, making Ethereum less vulnerable to individual points of failure.
- PoS represents a new economic system that isn’t susceptible to the centralizing forces of economies of scale. A validator with a modest amount of staked supply can operate from anywhere in the world, not just where ASICs are manufactured and where green/cheap energy infrastructure is most ubiquitous (e.g. China).
- A new chain informed by years of best practices means a more modern, robust system with less baggage. Backwards compatibility and a universally agreed-upon social contract means all of the network effects will carry over to the new chain.
The project that will win this race is not necessarily the first protocol--it’s the first good enough protocol. And Bitcoin is not good enough to support all of the use cases that people want to use crypto for. Ultimately the best store of value is not one dependent merely on speculation, market psychology and market cycles, but backed by real-world utility as well.
Not financial or tax advice. This newsletter is strictly educational and is not investment advice or a solicitation to buy or sell any assets or to make any financial decisions. This newsletter is not tax advice. Talk to your accountant. Do your own research.
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