Why does ETH not maintain a currency premium in the long run?

Foreword: The author of this article is a staunch supporter of Bitcoin, so it's no surprise that his views. The author believes that ETH can not maintain its currency premium in the long run. He has adopted the Ethereum currency direction from various aspects such as Ethereum's monetary policy, the possibility of node concentration, the second system syndrome, and the vulnerability of relying on DeFi applications to achieve value accumulation. Criticized. It is foreseeable that this article will be supported by Bitcoin supporters and opposed by Ethereum supporters.
From the perspective of Blue Fox Notes, it is too early for the author to conclude. What do you think? The author of this article, Checkmate, was translated by "LH" from the Blue Fox Notes community.

The Ethereum project has been criticized for a long time, especially from bitcoin enthusiasts. The criticism involves many aspects, including design, implementation, and failure to deliver products raised by crowdfunding. Ethereum is currently trying a huge engineering challenge, trying to restructure the entire blockchain to integrate existing chains, while allowing both chains to run in real time.

It's not so easy. It highlights the irrefutable issues in the original design and the continued uncertainty of investors in the future.

At the same time, Ethereum has found a new direction, focusing on distributed financial applications. This is supported by the so-called "moat" of developer activities. The underlying spirit of this movement is "open and unstoppable finance" and establish ETH as a reserve currency asset for the entire ecosystem.

This article explains a different stance: Despite this development, ETH tokens are unlikely to develop a credible currency premium. This is especially important when ETH is competing with a digital currency (such as Bitcoin) that has a fixed supply, is issued in a certain way, and has deep liquidity. The core arguments will be centered on the following topics:

  • Uncertainty of monetary policy and centralized governance
  • Second System Syndrome and ongoing project direction change
  • Rely on application layer for value accumulation
  • Underestimated the "tortoise and the hare" reality of Bitcoin development
(Blue Fox Note: The Second System Syndrome, also known as the Second System Effect, was presented by Fred Brooks, author of Mythical Man-Month. It means that a small and simple successful system is being completed Later, people will tend to look forward to a better next plan, and the actual results are often the opposite, and may create large and complex systems with complex functions, that is, over-designed systems, and ultimately fail)
Monetary policy and governance

The core design of Bitcoin's monetary policy is that it is hard-coded into software from the beginning, it has a pre-defined supply curve and a supply of 21 million tokens. Bitcoin's monetary policy has only been changed once in the history. It removes Satoshi's abnormal undefined behavior in C ++ through the BIP-42 soft fork, and supports the development of alternative clients.

Today, this monetary policy is protected by a solid social contract. Unless the basic value of the project is destroyed and the chain is hard-forked, it is unlikely to change Bitcoin's monetary policy. Most Bitcoin supporters agree that if the supply curve is tampered with, it will no longer be Bitcoin.

This provides investors with relative certainty and has attracted an impressive value capture in Bitcoin's 11-year history. Bitcoin's design gives people confidence in future inflation and supply expectations.

For Ethereum, its crowdfunding in 2014 was carried out under the recognition that it will turn to PoS at some stage in the future. To encourage developers to move towards this goal, the "Ice Age" was included in the agreement, which intentionally increased the block time by ending PoW difficulty. This plays a role in restraining miners from supporting the PoW chain, making it easier to switch to PoS.

Due to hard fork changes to consensus rules, the Ice Age was recently postponed for the third time in Ethereum history. In all cases, PoS implementations are not ready for deployment, and the first two hard fork delays are tied to reducing the ETH issuance rate.


Unstable monetary policy

Those who are bullish on Ethereum often point out that the continued decrease in block rewards is a sign of increased currency hardness and scarcity. However, a clear distinction must be made between asset issuance (hardness) and asset robustness or resistance to tampering.

Although the issuance rate has decreased so far, the choice of inflation is a product of developer intervention, rather than a deterministic, reliable hard-coded change.

The point here is that a small group of people has the right to determine the inflation rate that should be considered a global monetary asset. As long as you play this game long enough, in the end, people at the helm will abuse this power.

Future inflation and token supply are unknown. Even at ETH 2.0, who has the right to decide what is the success at the minimum feasible circulation? Someone will have the right to adjust the pledge rate until the subjective and dynamic goals are reached. If it were left to the algorithm and found vulnerable, someone would enter the agreement and change inflation. Since the attack vector never stops evolving, this process will never stop. Therefore, Ethereum can only be regarded as having an unstable monetary policy, and its social contract grants monetary authority to a small collective.

Centralization of nodes and validators

During the extended war against Segwit activation, Bitcoin once experienced the most controversial period. The UASF (Blue Fox Note: User Activated Soft Fork) campaign invalidates miners' capture of the Bitcoin chain through social contracts. User nodes are upgraded so that miners who do not comply with the requirements cannot get valid rewards.

To achieve this, Bitcoin node software is always designed to be lightweight to ensure simple hardware requirements and easy access by the public. Ethereum has historically required more specialized high-performance hardware to run nodes. This is usually the result of a larger transaction range and an increased demand for block space from Turing's completeness.

Although node hardware will continue to be optimized, synchronization time and hardware requirements will only increase. If Ethereum truly enters the global population, this may lead to the centralization of nodes, and large-scale participants can replace SSD drives and achieve frequent upgrades. Node operators will likely focus on a collection of Ethereum core developers (such as EF and Consensys), traders, crypto banks, and equity pledge service providers.

Because ordinary users lack technical capabilities, ETH2.0's pledge reduction measures actually promote centralized behavior. Ordinary users will preferentially choose exchanges and equity pledge service providers for convenience.

As the above-mentioned centralization takes effect, users' intentions to initiate and launch UASF-type defense capabilities against malicious actors will be greatly reduced.

This highlights the gradual concentration of governance relations among core developers, who hold a large amount of ETH to verify PoS and influence the direction of monetary policy experiments.

Currency experiment

Monetary policy is under discussion. The latest experiment is EIP1559, which introduced the ETH destruction mechanism, which has completely changed the blockchain mechanism and incentive system.

In the end, this destruction mechanism will have the greatest benefits for current ETH holders, but will be detrimental to future holders and users. Assuming the network is growing, the destruction rate of ETH will increase the cost of gas (expense inflation) in US dollars. Pledgers are largely unaffected, as they benefit from non-dilutive block rewards, as well as taxes generated through destruction.

The author is worried that this kind of monetary policy experiment is carefully designed by the person with the most revenue, and is designed to respond to the "research forecast" that developers find that the current gas fee mechanism cannot accumulate value. This looks very similar to central bank experiments and the Cantilon effect in today's world. (Blue Fox Note: The Cantilon effect means that the currency increase will not have the same impact on all commodity prices at the same time. The way in which the incremental currency affects the economy depends on the way and the injection of new currency injections. It does not necessarily benefit everyone. Those who get the currency first may benefit. The addition of currency causes some people to gain while others lose.)

One can only conclude that Ethereum's monetary policy is relatively flexible and it is influenced by people, not by code. This uncertainty reflects an unstable monetary policy (susceptible to human intervention) and instills a justifiable concept for centralized governance. There is no doubt that this hinders the development of the Ethereum currency premium, and it seems that it will only worsen over time.

Second System Syndrome

The original design of the Ethereum project was to extend the feature set of Bitcoin by introducing Turing's full scripting capabilities. It was designed to create a global computing network, or "world computer." In fact, this is an effective design goal, and Ethereum is very suitable for this goal, if so, it provides a CAPTCHA verification code for the new transaction Internet.

The trade-off of this design decision is to increase the complexity of the protocol, create larger vulnerabilities and hacking surfaces, and unavoidable blockchain expansion. Ethereum's design direction also responded to market demand and made several changes. Its narrative has shifted from world computers to unstoppable dApps, to token issuance, and now it is an open financial application.

It is worth noting that the original Ethereum design explicitly excluded the use case of ETH tokens as currency. It has since been revised on the Ethereum.org website and its project documentation.

Although this represents the innovative side and the lessons learned, the design trajectory of the Ethereum project shows a continuous attraction towards Bitcoin design as a monetary asset. During this period, Bitcoin continued to build currency characteristics, such as liquidity, network effects, and financial products that ultimately promote good reputation and product market fit.

Ethereum is a perfect example of Second System Syndrome in many ways. In this case, simple technologies like Bitcoin were deemed to be unable to meet their design goals, so iterating into more complex and "promising" projects ultimately resulted in an endless cycle of research, discovering new issues, and delaying delivery plan.

As the reconstruction of ETH2.0 becomes the latest solution to this problem, it once again paints an uncertain future for holders of ETH. This new blockchain will eventually reset the already developed Lindy effect of the existing chain. At the same time, it can reasonably be expected that more research and more problems will be discovered. (Blue Fox Note: The Lindy effect refers to things that do not die naturally (relative to organisms that die naturally). The longer they exist, the longer they will survive. For example, classic books, cryptocurrencies, etc. The author here refers to that because ETH2.0 is a new blockchain, it caused the Lindy effect of ETH to be reset and new problems arise)

In addition, the ETH2.0 beacon chain is very similar in design to Bitcoin, only processing consensus and global state, and pushing applications and expansion to shards (in the case of Bitcoin, sidechains or Layer 2).

Rely on application layer to accumulate value

Although the open financial ecosystem has made great achievements in technology and engineering, there is still a risk of relying on third-party agreements to obtain the accumulation of ETH value.

Recently, a lot of high-profile "non-stop", "unmanaged" and "decentralized" applications have appeared … Actually … can be stopped, hosted, and centralized:

* MakerDAO has a zero-latency drain mechanism, and user funds are also managed.

* Compound Finance was found to be escrow, with a developer backdoor and churn mechanism.

* After finding an error in the 0x V2 upgrade, the developer turned off 0x.

These challenges narratives that are “unstoppable,” and are actually not honest product marketing campaigns, because although the promotion is “decentralized,” there are actually custodians of backdoor products. Although security protection is effective in the early stages of research and development, it sounds a lot like Second System Syndrome. Permanent research supports an “almost ready” development schedule.

Cryptography has no secure backdoor. If it can be accessed by developers, then it can also be accessed by attackers.

Rely on a centralized oracle

The core MakerDAO of the DeFi ecosystem is guided by the MKR governance token. One might say that without Maker and its DAI / SAI tokens, the DeFi ecosystem will rely on centralized stablecoin infrastructure that requires permission, such as USDT and USDC. In addition, most ecosystems rely on a centrally controlled Maker ETH / USD price predictor.

It is not easy to solve this problem without trust. In fact, this paper does not consider trustless oracles to be a problem that can be solved in the medium term, but emphasizes that this topic has been studied for decades. Price flows on any chain (such as Uniswap) are vulnerable to liquidity attacks and require such a large scale that it will be difficult to achieve for at least decades. (Blue Fox Note: This assertion is too subjective)

Therefore, the trustless oracle, the key component of DeFi, will likely maintain a centralized state for decades. In the foreseeable future, attacks on these centralized oracles will be a fundamental risk to investor capital. It is very applicable to use the concept of "House of Cards" to describe DeFi. These centralized oracles are used as the primitives for other composable protocols. The elasticity of the entire stack is just the same as the elasticity of the weakest link, resulting in confusing users' actual risks.

This seems to be a source of systemic risk and inability to mitigate it.

Depends on MakerDAO

The main criticism of MKR is that the tokens are highly concentrated in the hands of well-known venture capitalists and teams. Indeed, a proposal was recently passed to reduce "decentralized" bank rates by 4%, with 94% of the votes coming from a single entity. This shows the indifference of voting groups, insufficient participation incentives, and the strong influence of a small number of large token holders.

Now, given the entire open financial ecosystem and the centralised oracle that relies heavily on Maker, people must ask themselves, what would happen if Maker and its token holders were regulated or hacked? Because the grassroots fork can be rebuilt, Maker can only be closed temporarily. But what does ETH holders pay?

Hacking the MakerDAO oracle will not only lead to the liquidation of the CDP / treasury, but all subordinate protocols will allow the cheap liquidated ETH to be captured by savvy attackers.

If all 3% of ETH is transferred by hackers, will the rollback be on the desktop? What if it is not 3% but 30%? The attacker is now the biggest verifier on the PoS network. (Blue Fox Note: 3% of the amount of ETH currently locked in DeFi here)

This is a real risk, and the results are unclear.


If the value proposition of locking ETH to promote open finance is dispelled, then it is reasonable to expect that all value accumulation under this assumption will also be dispelled. Those who are bullish on Ethereum believe that smart contracts native to the protocol can be forked by third parties. This is true, but this article questions the iteration of the new narrative-> prosperity-> regulation / hacking / false promises-> bust, how many times will investors tolerate before indifferently destroying future value accumulation.

Turtle wins the game

As a summary, the Ethereum project is affected by the following factors:

  • There are signs of relatively centralized governance and unstable monetary policy that this will only worsen over time.
  • EIP1559's latest experiment seems to contradict the needs of all users, except for the current holders of ETH. This creates an unfair system, and because of rising fees, user transactions are becoming increasingly unpopular on the chain.
  • Due to the complexity of the protocol, Turing completeness, developer backdoor, and centralized oracle, compared to Bitcoin, Ethereum faces a much larger attack surface.
  • The narrative, project direction, and experimental functions continue to change over time, and are gradually being fixed to the narrative of a robust currency similar to Bitcoin.
  • Excessive reliance on third-party applications to increase the value of ETH tokens, these applications can be stopped. The unlimited supply and liquidity of monetary policy require this mechanism.
  • Any centralized pool of ETH (including hosted DeFi applications) is under constant threat, which is not good for PoS validators.
  • In the case of the reconstruction of the entire basic blockchain, the second system syndrome reached its peak. This is a huge feat of rolling one chain into another, and it will take years.

Ultimately, the reasons why Ethereum is difficult to develop and difficult to maintain a long-term convincing currency premium are simple.

Investors are not sure what they are buying. Systemic and irreversible risks are part of the social deed contract, and there is no tangible data suggesting this reality will change.

One cannot count on potential investors who are aware of the scale, history, and depth of the aforementioned uncertainty, and are reluctant to exchange ETH tokens with part of their capital.

As the original vision of the world's computer, it is the best project narrative. If there is no endless change in direction, it is an achievable goal. The problem is that compared to "monetary assets" like Bitcoin, the result of "World Computer" is a smaller potential market. Therefore, its narrative gradually turned to "ETH is currency".

Bitcoin is achieving its goal of a digital, robust, immutable currency, while Ethereum has explored countless dead ends. There is a general misunderstanding of the potential of systems such as the Lightning Network, sidechains, and various higher layer solutions that can enhance Bitcoin's ability to serve as a global reserve asset.

This article predicts that if Bitcoin achieves the status of a global currency, most users will rarely interact on the chain because of its high cost. Ordinary users will basically interact at higher layers of the technology stack, and final settlement is the main function of the base layer.

Intuitively, it makes sense to build a very secure and immutable foundation layer with transaction settlement as its sole purpose. More complex layers have fewer security and consensus requirements, and these should be isolated to higher layers in the stack.

Indeed, this is the design goal of the ETH2.0 beacon chain, which is only responsible for finality and settlement. No inflated blocks. The 2.0 shard simply replicates Bitcoin's second, third, and higher layer solutions, but it does not have the liquidity, reputation, and security premium that Bitcoin already has, and these will continue to evolve.


Risk Warning: All articles of Blue Fox Notes can not be used as investment advice or recommendations. Investment is risky. Investment should consider personal risk tolerance. It is recommended to conduct in-depth inspection of the project and make good investment decisions.